Thursday, February 16, 2006

Risky Loans, Down Payments, and Skin in the Game

Great article in the Voice of San Diego today by Rich Toscano of Piggington fame.

The article focuses on some SD statistics, but is almost universally applicable.

No Skin in the Game

Here are some highlights:

Not so long ago, it was very much standard practice to make a down payment of at least 20 percent when purchasing a home.

But those days are behind us. Thanks to "piggyback loans" and other financial innovations, home buyers are effectively able to make whatever down payment they choose. Often -- by which I mean, very often -- buyers choose not to make a down payment at all.

The extensive use of zero-down mortgages may be a convenience for many homebuyers, but it puts the local housing market at substantial risk.

This is not necessarily a bad thing unto itself. There is, after all, nothing sacred about 20 percent down payments. But given that home prices in many areas of San Diego have been fairly flat over the past 12 months, many buyers who made no down payment still owe around 100 percent on their homes. That's a lot of people with no substantial equity to speak of. And to this number, we can add the immeasurable hordes who have utilized cash-out mortgage refinancings or home equity lines of credit (HELOCs) to drain their homes of equity.

All in all, a significant amount of homeowners effectively owe 100 percent on their homes. And that's a problem, because none of these people have "skin in the game."

In the down-payment days, home owners were encouraged to weather whatever financial storms they could in order to hang onto their houses. To do otherwise would result in the loss of their down payments and all the equity they'd accrued over the years.

Now, between zero-down loans, cash-out refinancing, and HELOCs, there are a lot of home owners out there who don't have any such incentive. They have very little invested in their homes. If any of these homeowners run into financial trouble, they will, unlike the 20 percent down-payer of old, have little reason to stick around.


Zero-down mortgages sure have made for a fun housing market over the past few years. But they also make for a dangerous combination with looming mortgage payment shocks and housing-related job loss. There are too many players with no skin in the game, and should times get tough, some of those players could send things from bad to worse.

Caveat Emptor!


Blogger Roadtripboy said...

Wow! I'm the first one to post a comment!

I've read articles like this before, since I also follow SoCalMtgGuy's blog. I think there can be no good ending to this housing bubble deflation/bursting, despite what some experts are saying. Who will bear the burden of all of this debt that debtors walk away from? Wasn't the original requirement of a down payment precisely to encourage the homeowner to assume some responsbility for his home and to his community? What happens to a community when a significant chunk of impulsive buyers decides to walk away because they're in over their heads? And who pays this debt when they discharge it in bankruptcy court? If there is a taxpayer bail out of the real estate industry like there was for the S&Ls back in the 80s I think I will become apoplectic!

I was initially opposed to the changes in the bankruptcy laws by the Bush administration becasue I think it can discourge the establishment of small businesses. But for irresponsible housing buyers, perhaps they deserve to be saddled with the debt until they pay it off? I know that sounds harsh--maybe too harsh. But I don't think these individuals should be able to walk away scot free. And apparently be able to get another mortgage! How many times have we all seen ads that read: Bad Credit? Bankruptcy? No Problem!

What has happened to accountability? We often complain that there is no accountablity in our government but are we the people any better?

There. Now this posting by Grim has at least one response!

2/17/2006 01:14:00 AM  
Blogger grim said...

SoCal' at AnotherF'edBorrower is doing a great job going through that new study on mortgage resets.. I urge everyone to take the time to read through and understand what he is writing about.

As for 'skin in the game', I agree, without a solid down payment what motivation do these buyers really have to 'stick it out'? Not much, and don't forget, a large number of these homes are not primary residences.

The bankruptcy laws really change the situation for many, whether they know it yet or not.


2/17/2006 09:38:00 AM  

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