Lamenting the Loss of 100% Mortgage Financing

While I totally get that 100% financing is seen as a big contributor to the Great Mortgage Meltdown of 2008, I don’t believe this is entirely true, and I’m pretty surprised that they have gone away for good. Allow me to explain.

As a young professional, gainfully employed on a decent salary, I decided in 2003 that I wanted to buy a home. I started saving up for a down payment. However, the housing market was starting to pick up its pace, and I quickly realized that the values were going up faster than I could afford to save a down payment that would make any difference at all to the price of the kind of house I wanted. This being the case, I went out and found a property that I liked, and my step mom (who was brokering mortgages at the time) found me 100% financing with no down payment, a decent interest rate, and no PMI. In this manner, I ended up buying my first (and current) house in June of 2004.

Since then, I’ve never missed a payment, my mortgage was (and still is) affordable within my means, and my credit has always been excellent. Thanks to a solid financial education from my parents, I’ve been debt free (barring an occasional car payment and a mortgage) for as long as I can remember. I’ve also steadily amassed a tidy sum in a money market account over the last decade with the purpose of covering me in case I should lose my job or fall on similar hardship. My wife and I have also routinely tucked away savings for retirement in our 401Ks and IRAs. So, when Jessica and I started looking around recently for a bigger house, I expected that people of our credit standing, financial stability, and obvious fiscal responsibility would still be able to get a 100% mortgage.

As it turns out, this is not the case. 100% loans are gone for good, and the system is back to requiring at least a 5% down payment (unless you go FHA at 3.5% and subject yourself to the loan limits for your locale). Also, PMI is standard once again on loans until the house reaches an 80% debt-to-value ratio, where the “value” portion is equal to the sale price and not the appraised price. And no matter how good your credit is or how much cash you have on hand, those are the rules.

So, let’s explore why these rules are stupid.

It goes without saying that 100% financing (or, indeed, any financing) should only be offered to people who qualify for the loan, and not to people who can’t afford a mortgage in the first place. I’d like to think I fall in to the “qualified” category. Currently, my wife and I have access to enough assets in liquid and retirement savings that if we both lost our jobs, we’d have funds to draw on so that we can keep paying the mortgage and other bills for quite some time. So, with 100% financing and no cash out of pocket, we’re in great shape in even the worst-case scenario.

Now let’s look at the 80% loan scenario. If we take some of the cash we have as our safety net and put it in to the house as a 20% down payment, the safety net is diminished. Even though our mortgage payment is smaller in this scenario due to the lower value of the mortgage loan, we’ve got less access to cash to cover us if one (or both) of us loses our jobs. Thus, the likelihood of us defaulting on the loan becomes higher than it was before. In other words, we become riskier people to lend money to. How this can make any sense to the lending institution boggles my mind.

To boot, if we were to default, we’d lose the cash from our down payment when we lost the house leaving us in an even worse financial position than the default alone. In this way, it just makes no sense to put any cash in to a property: the only cash I’d ever want to invest would be earned equity from the sale of our existing house, but with the market the way it is we’ll probably only earn about 10% profit of our house’s original value if we sold it tomorrow, which is hardly 20% of a more expensive house.

Let’s say we put in 5%. Now we’re paying PMI, which would be somewhere between $200 and $350 extra each month, giving us a larger monthly payment to make. Again, should we lose our jobs, this means that we’ll run out of savings faster paying for something that’s supposed to protect the lender. Once again, we’re in a worse position than we would be with cash in hand and a 100% loan. The same is true for “creative” financing with two mortgages (such as one at a low interest rate for 80% of the house, another at 10% at a higher interest rate, and a 10% cash down payment).

With that all said and done, let’s look at the impact on the housing market. Here you have my wife and I looking to invest in a slightly more expensive house that we can readily afford. But due to the down payment requirement, we’re probably going to avoid it altogether. That means no home sale. Assuming that we’re not the only ones following this thought process, the likelihood for the housing market to stabilize and for qualified people to start investing in it again is slim – other than the investors who summed up fat stacks of cash from the boom and are coming back in to pick over the spoils, of course.

It just doesn’t make any sense. I say bring back the 100% loans – only this time, actually qualify the people looking to secure them instead of just handing them out to anybody who can fog up a mirror.