When Will We Learn
Ring, ring, ring. Good morning. How can I help you? My husband and I are very excited because we've just been prequalified to purchase a new home. Our real estate agent suggested that we contact her banking friend who could get us a really good deal. She said that we could buy the home with no money down on a FHA loan with a really low monthly payment. We can afford the payment and we are cashing in my husband's 401-k for closing costs and moving expenses. We're glad that our real estate agent was able to find such great financing for us. My friend suggested we give you a call just to make sure we are getting the best deal. Can you do better?
She said that they were living with her parents and had one young child. They desperately wanted to get into a place of their own. Money was tight, even living with her parents, so they had no money in savings. He was working a full-time job and she was taking care of a neighbor's child but their income was not as high as they would have liked. They were excited because this "deal" would give them a home of their own. They were assured that this would be a good move financially--"Why throw money out in rent when you can own your own home now".
While listening to her, all I could think was, this is what has gotten thousands of people into trouble and our country into a financial crisis. They were buying a home with 100% financing, a low introductory rate, and they had accumulated no savings, even though they were living at home with her parents. This was a recipe for disaster. But, they were excited because their real estate agent and banker told them they could afford to do this. Their emotions were running high and they were ready to sign on the dotted line.
A year or so ago this type of loan was the norm. A sub-prime lender would write this loan in a heartbeat. The rationale was that since the Depression, property values had always gone up, and in a couple of years the borrowers would be able to refinance into a conventional loan program with a fixed rate. The sub prime loan was merely a stepping stone to help many first-time homebuyers into their new home.
Today, as a result of the mortgage meltdown, lenders are requiring a down payment. And rightfully so, because this shows that a borrower has demonstrated the ability to save, and has an investment in the property. 100% financing loans are basically gone. The only exception are the down payment assistance programs. These programs have skirted the rules and FHA has tried for years to get rid of them. The default rate for FHA loans using this program is much much higher. Even the new recently passed mortgage bill, which provides FHA refinancing, requires lenders to lower the mortgage balance so borrowers will have a 10% equity stake in the property.
My caller's banker has suggested using this type of down payment assistance program. Rather than requiring the buyer to come up with the down payment, the down payment assistance program collects it from the seller plus a $599 fee. At the time of closing, the down payment assistance program "gifts" the money to the buyer. The down payment assistance program touts in their web site " The ------- Program is like money falling from heaven". I asked myself, what kind of financial counseling is this? Fortunately the new mortgage legislation has outlawed this kind of financing effective October 1, 2008.
Moreover, since this couple was short on cash, they were going to raise additional funds by raiding their 401-k. The penalties and fees along with the loss of future appreciation were going to be enormous. I couldn't believe what I was hearing, especially in light of what is happening in today's real estate market.
Next we talked about her interest rate and payment. Working backwards, I calculated that they had been offered a great rate on an ARM. Unfortunately, it could increase down the road. As Gomer Pyle used to say, "Surprise, surprise, surprise", but this is truly no funny surprise. All you have to do is to pick up the newspaper, filled with foreclosures and sad stories, to understand why I stressed to my caller, "You will have to make sure you can afford what your loan payment might adjust to."
At this point in our discussion, my caller really began to question whether she and her husband should move forward with this purchase. After closing they would be upside down on the house, owing far more than the house was worth. There was a momentary pause and then a sigh of relief. Thank you for being so honest. We are going to rent and we will give you a call in a year or so. Buying a home today requires an honest and hard look at the numbers. The old saying "If it seems too good to be true, it probably is" certainly applies here.
When buyers are anxious to make a purchase, real estate agents and lenders are eager to help make it happen. The real bottom line for success, however, is asking whether the transaction is truly in "everyone's best interest". The key is to work the numbers to be sure that you have: an adequate and stable income to service your mortgage loan and other debts, at least 5% to 10% equity in the property, and enough savings to cover the unexpected. Although the real estate market is going through some very difficult times, you can still find many good values and mortgage options which make financial sense.
Good luck with your homebuying experience. Be sure to ask the tough questions and listen to your inner voice before making any decisions.
David Field is a 21 year veteran of the mortgage industry and he specializes in Sound Mortgage Solutions with Carolina Home Mortgage. David welcomes readers comments and opinions on his blog at his website www.loansnc.com or 919-869-8204.
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