The State of the Loan Market and How Much You Can Borrow September 2008 (Part II)

Or, Ways to Minimize Down Payment Requirements

(Continued from Part I which stated the issue)

But with loans so difficult to get right now, that makes it a wonderful time to buy, because the competition for properties is non-existent. In economist terms, demand is low. Many people are too scared to buy, and more people are unable to get the loan that would enable them to buy. But the rule of making a profit is "buy low, sell high." Even if you have no intention of ever selling, wouldn't you really rather buy that property for $300,000 today than $500,000 three years from now? At 6% interest, the difference in the cost of the loan is $12,000 per year. I'm sure you can think of things to do with $12,000 per year, not to mention three years sooner that you pay the loan off and your cost of housing goes down to property taxes plus maintenance - and three years earlier that you have this enormous, appreciating asset that is completely paid for. So what can you do now?

The first, most obvious thing, is an FHA loan. These go up to 97% of the value of the property, and I don't think I've ever seen a situation where the FHA ran out of money. Basically, anyone who hasn't defrauded the government is eligible. This loan, right now, is the broadest solution generally available for cash strapped buyers, essentially equivalent to the adjustable "monkey" wrench of loans. It can be combined with the $10,000 IRA withdrawal feature for buying a first time house or if your retirement plan document enables you to take a loan, it can even be combined with that (consult an accountant for details). Sellers can contribute up to six percent for closing costs, family can gift you up to six percent for down payment and closing costs (consult an accountant for details). The drawback is that you've got to have that three percent down payment from somewhere. The down payment assistance programs that enabled buying FHA without money down are essentially dead, at least for now, and the FHA and lenders do not want them brought back - they've had too large a percentage of defaults from people who don't put any of their own money into a property, and too many unscrupulous agents and loan officers need to go to jail because they've been telling people "You're not risking anything, and you're not putting any money into it, so just walk away if it doesn't work out." It's not for nothing that 100% financing has required a bad reputation in lending circles, but considering that Americans as a group are finding it ever harder to save anything, the requirement to come up with 3% can be a challenge. FHA loans also require an up-front funding fee (which can be rolled into the loan) and an ongoing financing insurance charge that is the equivalent of PMI. This is what pays for the government guarantee that is the reason that lenders will accept these.

The second option, a true magic bullet, is the VA loan. One dollar down moves you in. Closing costs, up to 3% over the cost of the property, can be financed as well. No financing insurance, no mucking about with scraping up the down payment from forty different places, no income limits, and I even know lenders that tell me they'll go up to 1.5 million dollars on a VA loan. The biggest problem with the VA loan is that you have to have earned it from military service, something fewer and are doing these days. I'm just starting to work with a client who'll be my first VA loan in longer than than I like to remember. Still, the VA loan has been much improved in the last couple years, and is a great way to get into a property now.

One sort of "piggyback second" still survives to 100% loan to value, and that is in the form of various municipal first time buyer assistance programs. These are funded by federal grant money but run by individual cities and counties (usually with help from the state). Not all of them take the same form, but the "silent second", where no payments are due, is the most common in my experience, and most of them will lend at 100% of the value of the property. The county of San Diego and most of the suburb cities have this kind of program, as well as several dozen other cities in southern California. Unfortunately, there are several catches: They all either take the form of an equity sharing arrangement, or interest accrues, and they all limit your ability to refinance. On the plus side, some of them are forgivable if you spend enough time in the residence. Back on the minus side - big minuses - there are income limits which vary with the locality, and they run out of money at Warp speed every time they get a new allocation. But if it works for you and you are able to get in on one, they are like the vorpal blade going snicker-snack.

Seller Carryback financing is another option, albeit considerably less attractive to most buyers and sellers. This is where the seller "carries back" a loan for part of the purchase price. Many are the pitfalls for both buyer and seller, and quite often, first trust deed lenders actually refuse to work with these because their underwriting standards include someone having the discipline and income to save the money for a down payment, rather than borrowing still more money.

Finally, there is the lease with option to buy, or "lease option". This is the last gasp alternative for a lot of reasons stemming from the fact that the contract is agreed upon now, but isn't actually consummated for quite some time. This is time and opportunity for things to go wrong, from the buyer deciding they don't want to buy to the seller deciding they don't want to sell, or at least not on those terms. Yes, there's a contract in place giving you legal rights, but the other side can usually contrive to make it more trouble than it's worth if they want to. However dangerous they may be, the lease option still does have the potential to make a sale happen, where without it both the buyer and the seller would be unhappy, unable to trade what they have for what they want.

The loan market will loosen again. Where it might have been too loose a couple of years ago, it's now too tight. Lenders are rejecting applications that are good risks, fully able to repay their loan, or simply telling their loan officer not to bother taking the application. Right now, in paranoid meltdown mode, they don't care, but when then things calm down a bit, they will because they are passing up profit. Unfortunately for those looking to get the best deals, when that happens, lots more people will be able to qualify for a loan and demand will shoot up, followed by price. Right now, things are a lot more affordable in my neck of the woods than an analysis of people's ability to pay suggests that they should be. This is because for the last two to three years, many people who want to buy have been scared of the market, unable to qualify for the loan, or unwilling to actually make their move. When this changes, the prices that people pay will start to rise, most likely pretty rapidly.

Caveat Emptor