Thursday, March 24, 2011

20% Down on a House?

I don't know whether or not home ownership should be part of the "American Dream" but there is quite a bit of talk about getting back to the 20% down model for home buying. I don't think it's as neat as it seems. First let's look at this in a market without securitization...

Buyer's putting at least 20% down have more "skin" in the game. That is: if the house purchase goes south they are out a good chunk of their own money, so they are less likely to make a bad buy or to stop payment if house values collapse. Of course, if banks were to do their job properly then those risks should be mitigated anyway. That is: the lender, having lots of skin in the game themselves, should be unlikely to lend to someone who won't be able to pay or to lend for the purchase of a house with an inflated value. The caveat is that if a house goes into foreclosure then the lender gets a better upside (up to the loan balance), and is, in theory, less likely to lose as much as the borrower. So the house purchase is a lower risk to banks...and gets lower still as the buyer makes a larger down payment. In this market banks like buyers with more money down.

When securitizing loans becomes the norm, however, things flip. Now banks make a loan then turn around and sell it off to others. Banks are middle-men (middle-people?) who effectively make money proportional to the size of the loan (and the interest rate). In this market, more money down means smaller loan values, and more money down requirement means fewer potential buyers. Moreover, it is even possible for banks to make extra profits off the foreclosure. In this market banks have very little interest in making sure that the house value is appropriate or that the buyer can afford the loan...they have next to zero downside risk (compared with above). The buyer in this market (which is what we have now) is better off putting as little as possible down, since any investment they put in is risked and banks are not well incentivized to make sure the house is worth the "assessed" value.

Changing the requirements for securitization nominally protects everyone. People putting down 20% are less likely to buy recklessly. Banks loaning to people putting down less, when they cannot securitize them, are more likely to do their due diligence. So securities become safer, house prices come down, and people get mortgages they can afford. Banks don't like this model, and I'm not sure I do either.

Banks don't like it because they will need to do more work and take on more risk for less money.

I'm not sure because, while I like a more stable housing market, and lower priced homes, and safer investment opportunities, I don't like the barrier for entry. Now things could work out well in that low/zero money down options will still be available through mostly huge banks, and at higher interest rates--the latter of which I have no problem with--and the house prices should eventually adjust to the new reality and all would be well. I worry that banks will, instead, pretty much stop lending to 0/low down buyers.

I'm not too worried about this crippling the market (it might, I just don't care), but I am very worried about it pushing the wealthy and everyone else further apart. The median home price is ~$200k. For an average person to save up $40,000 for a down payment (never minding other closing costs) is, to say the least, hard. It is proportionally harder still in "affordable" markets (i.e. markets where the rental rates are about the same as the mortgage+tax+ins payment on the same dwelling). In essence the easiest way to get that type of down payment is to already have a house you can sell that yields enough extra to cover it--getting into the market becomes hard.

A housing market that really benefits cash buyers is a bad market for most people.

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