Legislators fail to implement down payment requirements
Home equity is needed to keep housing markets stable. First, people with equity have a financial stake in sustaining home ownership. It was the plethora of no-money-down mortgages that prompted so many to strategically default. People simply don’t walk away from their financial obligations if they have an equity stake. They may sell to get their cash, but they won’t strategically default as long as they have something tangible to lose. Further, home equity provides a buffer for lenders. If due to an economic downturn prices should fall and borrowers default on their mortgages, the cushion of equity provides room for prices to move without exposing the banks to potential loss of original loan capital. If we had high down payment requirements during the housing bubble, the banks wouldn’t currently be exposed to a trillion dollars in unsecured mortgage debt.
Given these facts, and few dispute them, it’s dismaying to see regulators waver on their intention to require a 20% down payment in the qualified residential mortgage rules.
Concerns about the availability of mortgage credit appear to be leading regulators to craft new mortgage-lending standards that are less strict than the real-estate industry had initially feared.
Regulators at the Federal Reserve on Tuesday backed off of a proposal that would have required banks to hold more capital for certain mortgages, particularly those that have higher loan-to-value ratios for borrowers that have made smaller down payments.
The rules are “significantly friendlier” to the housing-finance market—and to homeowners looking for a mortgage with a low down payment—than the initial proposal, wrote Ken Fears of the National Association of Realtors on Wednesday.
This is a potential disaster waiting to happen. The lynchpin the the entire home finance system reform package is the requirements for down payments. If this ends up being watered down, the housing market will remain volatile, and future bank bailouts are all but assured.
Over the past year, real-estate and mortgage-banking groups have warned that a cocktail of new mortgage regulations would make credit access much more difficult for first-time buyers and other Americans without large amounts of cash for down payments.
This is a red herring. Higher down payment requirements would reduce their business income, which is why they oppose it. It would also lower house prices, and restore the need to wisely manage money in order to become a homeowner, both of which are good things.
… Those regulators issued a proposal two years ago that would have required minimum 20% down payments for a qualified residential mortgage, but they have yet to issue a final rule, in part due to disagreements over the down payment standard. …On Tuesday, Fed staff justified the move away from the stiffer capital-reserve requirements on mortgages because of the recent changes to mortgage underwriting regulations as well as concerns about the potential effect of unfinished mortgage regulations.
“The Fed is looking at the qualified mortgage rule and saying, ‘Already there’s potential for a dampening effect on the mortgage market,’” said Anthony Sanders, a housing-finance professor at George Mason University in Fairfax, Va. While low down payment loans weren’t the sole cause of the housing bust, “they clearly had a role,” he said, which is why Tuesday’s roll-back of the tougher capital rules “kind of took me by surprise.” …
I can’t say I’m surprised, but I am very disappointed.
But the lighter touch from regulators on some of these rules could reflect growing concerns that the housing market won’t see a durable recovery until more first-time homeowners are able to buy homes. Big home price declines have swept away one major source of down payments for many households, while low interest rates have made it hard for would-be buyers to save for a down payment.
One of the reasons mortgage originations are stuck at mid-90s levels is because potential borrowers don’t have the down payment to complete the transaction. There isn’t much point in applying for a loan if you don’t have the down payment. This is probably one of the main reasons regulators are backing off the 20% down requirement.
Lewis Ranieri, the pioneer of the mortgage securitization market, outlined those concerns in a speech at a Washington think tank last month. Against a backdrop of stagnant incomes for younger workers and higher student-loan debt, he said, “unless we’re willing to let the dream of homeownership whither except for individuals with significant resources, we will need a mortgage-finance system that will recognize the importance of prudent, low down-payment lending.”
Is there such a thing as “prudent, low down-payment lending?” I have my doubts.
Home Equity Lockbox
Down payment requirements would boost aggregate home equity, but unless access to this home equity is also restricted, even those that start with equity will foolishly extract it and negate the advantages to the market and to banks that home equity provides. Extracting home equity — or as I refer to it, HELOC abuse — is very enticing. When prices are going up, it looks like free money. The borrower didn’t have to earn it, and the house itself will pay it back. It makes HELOCs and houses very desirable.
Lenders enabled the housing bubble, but people needed a reason to provide the demand to pay stupid prices to inflate a housing bubble. As I documented, the Desire for Mortgage Equity Withdrawal Inflated the Housing Bubble.
In order for home price appreciation to motivate people to pay stupid prices and inflate housing bubbles, they need a way to access this appreciation. The more immediate and plentiful this access to money, the more motivated buyers are to borrow and cash out. Mortgage equity withdrawal is the doorway to appreciation; it makes houses very desirable and very valuable.
Texas shows the way
To test this premise, we need to find a market with limited access to mortgage equity withdrawal and compare the home prices there to a market like California’s where there are no restrictions at all. There is such a place: Texas.
I know Texas. I spent two and one-half years living in College Station studying real estate. Texas, along with California, was a big player in the Savings and Loan disaster. They inflated a commercial real estate bubble of epic standards, and even its residential real estate was volatile during that period. Texans are certainly not immune to the temptation to take free money from lenders. However, the delivery mechanism of the Savings and Loan disaster was through commercial lending whereas the delivery mechanism during the Great Housing Bubble was residential lending. Texas has different laws governing residential lending, and these laws prevented a housing bubble there.
I go on to discuss an article by Alyssa Katz, The Lone Star Secret. In the article, she discusses the situation in Texas:
A cash-out refinance is a mortgage taken out for a higher balance than the one on an existing loan, net of fees. Across the nation, cash-outs became ubiquitous during the mortgage boom, as skyrocketing house prices made it possible for homeowners, even those with bad credit, to use their home equity like an ATM. But not in Texas. There, cash-outs and home-equity loans can’t total more than 80 percent of a home’s appraised value. There’s a 12-day cooling-off period after an application, during which the borrower can pull out. And when a borrower refinances a mortgage, it’s illegal to get even $1 back. Texas really means it: All these protections, and more, are in the state constitution. The Texas restrictions on mortgage borrowing date back to the first days of statehood in 1845, when the constitution banned home loans entirely.
“Delinquency and foreclosure rates are significantly lower in Texas,” boasts Scott Norman, the president of the Texas Mortgage Bankers Association. “The 80 percent loan-to-value limit—that’s the catalyst for a lot of this.”
That’s were the lockbox comes in. If a house is supposed to represent financial security, it should be a place of money storage, not an endless ATM machine spitting out spending money. The Texas experience shows that if you deny people access to this money, the housing market is more stable, and everyone has tangible ownership in their property with real equity. That is the real American dream.
Over $500,000 in Mortgage Equity Withdrawal and four year’s squatting
The former owner of today’s featured property went Ponzi in 2004 and never looked back. She started well. She paid $590,000 putting $118,00 down and borrowing $472,000. However, on 12/20/2004 she refinanced with a $703,800 first mortgage and went Ponzi. She compounded her mistake on 12/7/2005 by refinancing with a $791,700 first mortgage.
She kept spending equity with a $150,000 HELOC in 2006 and a $200,000 stand-alone second on 12/12/2006. All told, she extracted $519,800 before she quit paying in early 2009. Since she was so far underwater, the bank let her squat for 4 years.
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25471 EVANS POINTE Dana Point, CA 92629
$840,000 …….. Asking Price
$590,000 ………. Purchase Price
9/3/2003 ………. Purchase Date
$250,000 ………. Gross Gain (Loss)
($67,200) ………… Commissions and Costs at 8%
$182,800 ………. Net Gain (Loss)
42.4% ………. Gross Percent Change
31.0% ………. Net Percent Change
3.5% ………… Annual Appreciation
Cost of Home Ownership
$840,000 …….. Asking Price
$168,000 ………… 20% Down Conventional
4.38% …………. Mortgage Interest Rate
30 ……………… Number of Years
$672,000 …….. Mortgage
$164,910 ………. Income Requirement
$3,357 ………… Monthly Mortgage Payment
$728 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$175 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$4,260 ………. Monthly Cash Outlays
($842) ………. Tax Savings
($904) ………. Principal Amortization
$269 ………….. Opportunity Cost of Down Payment
$230 ………….. Maintenance and Replacement Reserves
$3,012 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$9,900 ………… Furnishing and Move-In Costs at 1% + $1,500
$9,900 ………… Closing Costs at 1% + $1,500
$6,720 ………… Interest Points at 1%
$168,000 ………… Down Payment
$194,520 ………. Total Cash Costs
$46,100 ………. Emergency Cash Reserves
$240,620 ………. Total Savings Needed