BLOG VIEW: Mortgages with no money down have a certain cringe factor – a leftover from the go-go era of real estate financing that ended with the market collapse of 2007 and the loss of millions of homes to foreclosure.
That cringe, however, is hardly fair. By themselves, mortgages with no money down are not much of a danger. One of the most successful loan programs of all time is largely based on 100% financing and yet few people complain about Veterans Affairs (VA) loans.
Now – gingerly – mortgages with no money down are coming back. Slowly, carefully, such loans in their new form may be on the verge of wider use.
According to the San Francisco Federal Credit Union (SFCU), a California lender that now offers 100% financing, “We were seeing too many people interested in home loans who were qualified in every way and either didn’t have enough money saved up, had to tap into their retirement accounts, or needed to borrow from a family member for the 20% down payment required for a conventional mortgage loan.”
Skeptics might point out that there’s plenty of money out there with little down, including the Federal Housing Administration (FHA) (3.5%) and VA (0% down) programs. Also, both Fannie Mae and Freddie Mac now offer conforming loan products with just 3%.
But – and here’s the tricky part – loans with little down typically involve some form of mortgage insurance while the VA program requires qualifying service.
The SFCU’s “POPPYLoan” is different. First, it really is 100%, no money down, financing. Second, no mortgage insurance is required. Third, loans for as much as $2 million are available – far more than borrowers can get from the FHA, VA or conforming loan programs.
The SFCU loan is a byproduct of the steep and unusual prices found in the Silicon Valley area. Borrowers must work in San Francisco or San Mateo counties, and the property itself must be located in one of nine nearby Bay Area counties.
Bay Area rents are skyrocketing, says SFCU. “It’s not that people can’t afford to make a house payment (look at the amount of rent that’s being paid!); it was the lack of funds or access to the size of down payment that is typically required. We wanted to find a solution to this growing problem and help our community.”
Not only are local rents skyrocketing, but so are sale prices. As of Nov. 15, the California Association of Realtors says the median sale price for a San Francisco home was $1,323,860. In San Mateo County, it was $1,195,000.
On a far broader scale, Navy Federal Credit Union – the world’s largest credit union – also has a 100% product called the “HomeBuyers Choice Mortgage.” This loan goes up to $1 million, and no mortgage insurance is required.
One difference between the two products is that the SFCU loan is a 5/5 adjustable, while the NavyFed mortgage is available with a fixed rate. The SFCU adjustable-rate mortgage has 2/6 caps, meaning the interest rate cannot rise more than 2% with each adjustment or more than 6% over the life of the loan.
The Attraction Of No Money Down
The attraction of financing with no money down is instantly obvious: the ability to buy with lower closing costs; less time needed to accumulate savings and get into the housing market; no need to disturb savings or retirement funds; and the ability to use cash for other purposes, such as starting a business or financing an education.
Another advantage is that jumbo loans may actually be cheaper than conforming mortgages. For instance, the Mortgage Bankers Association reported on Jan. 6 that conforming loans were priced at 4.20%, while jumbos could be had for 4.09%.
“While jumbo financing has traditionally been more expensive than conforming loans, that has not been the case in recent years,” says Rick Sharga, executive vice president at Ten-X. “One reason is that jumbos are not being purchased by Fannie Mae and Freddie Mac, so they don’t include the g-fees that conventional loans carry. And, lenders are pricing jumbo loans very attractively because they want those high-net-worth borrowers as customers for other banking services.”
The Dangers Of No-Money-Down Loans
Going back to that cringe factor, there’s no doubt that some mortgage observers worry about a return to weak standards. These are legitimate concerns; however, the marketplace today is very different from a decade ago.
First, the rules have changed. Under the ability-to-repay standard, lenders must verify such things as borrower credit and income. There are big penalties for sloppy underwriting. Such things as no-doc, low-doc and stated-income residential loan applications are gone.
Second, the level of risk attributed to down payments appears overstated. According to Fannie Mae, “Borrower equity and loan-to-value (LTV) ratio are both important factors when determining the borrower’s ability to repay the mortgage in support of sustainable homeownership. Our analysis indicates that there is minimal difference in default risk for loans with LTV ratios greater than 90% up to 95% compared to those with LTV ratios greater than 95% up to 97%.”
Even if you go further and look at loans with nothing down, the increased risk is minimal. In fact, there may not be any additional risk. As the Urban Institute reported in 2014, “Delinquency rates on VA loans have consistently been much lower than on FHA mortgages, even after correcting for borrower characteristics.” VA loans, of course, are available with nothing down.
The secret to reduced loss rates concerns how loans are underwritten. As the Urban Institute explains, “In the VA program, the lender has a stake in how the borrower performs. The VA provides insurance in the form of a first-loss guaranty, but the lender is at risk if losses exceed that amount.”
Also, the VA has “a residual income test, as well as debt-to-income (DTI) guidelines, whereas the FHA and conventional lenders rely exclusively on DTI guidelines to measure affordability.”
The VA has essentially provided a template that lenders in search of fewer losses and less risk can follow. That said, there is always risk. If the economy turns down, if home values again stall or fall, there are loans that will not be repaid regardless of how much borrowers put down. The trick is to keep losses at a minimum, and that means strong underwriting and sensible guidelines – standards that loans with nothing down can meet.
Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Ten-X. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.