The notion of buying a home with no money down is understandably alluring. But what looks sexy in a lender’s advertisement does not always translate into what is best for your financial well-being.
What is a zero-down loan? Also known as 100 percent financing, zero-down loans require no down payment to purchase a home. For those with little to no cash in savings, these loans are touted as a windfall for those who could only dream of owning a home.
During the real estate boom from 2003 to 2006, zero-down mortgages were widely used to assist aspiring homeowners to join the growing homeownership club. Buyers with no cash, bad credit and unstable employment were able to purchase a home — in addition, some obtained “no-doc” loans in which income and debt were not even disclosed — all in the name of getting a fair share in skyrocketing real estate values.
But anything that goes up must eventually come down.
Many zero-down borrowers quickly found themselves underwater when home values plummeted — meaning they owed more on the loan than the house was worth. They couldn’t sell the property and completely pay off the mortgage. And if a job loss occurred, they couldn’t keep up with the inflated mortgage payments. Zero-down loans come with higher interest rates and other “funding fees” wrapped in to cover a lender’s risk on underwriting them.
Other than Veterans Affairs and U.S. Department of Agriculture zero-down loans, 100 percent financing loan products completely disappeared after the market crash. Underwriting requirements got stricter, and it became almost impossible for cash-poor buyers to purchase a home. Buyers with foreclosures or short sales on their credit reports were cut off completely.
As a real estate agent, buyers who lost their homes during the crash have been asking me for the past eight years whether they will ever be able to purchase a home again.
Today, I can finally say yes. We are at 360 degrees in the cycle. Underwriting requirements to qualify for a loan have eased. I have also recently seen an increase in advertisements from lenders pitching creative loan programs, such as zero down.
Some of these creative loans include (1) zero-down payment, with extra fees for this privilege wrapped into the loan, and high interest rates; (2) piggyback loans, which consist of a first mortgage at market rate plus a second mortgage at a much higher rate (the funds provided by the second mortgage are used as the down payment); and (3) grants.
Don’t be fooled by the term “grant.” This is not free money. The bank gifts money to the borrower to use as a down payment. The borrower, however, pays fees that are wrapped into the loan to pay back the down-payment assistance.
“These programs are wonderful for those who can’t afford to buy,” said Michael Chelst, branch manager of Norcom Mortgage’s office in Greenbelt, Md. “More people can buy homes now.”
That’s the good news. But there is a darker side to these loans.
“It’s a double-edged sword,” Chelst said. “These loan programs are more expensive.”
Chelst also said that when more people can buy homes, prices go up. Higher prices help sellers. But it hurts those who are trying to enter the market.
Tobias Peter, a senior research analyst at the conservative D.C.-based think tank American Enterprise Institute’s Center on Housing Markets and Finance, does not support the current easing of credit requirements and the increase in alternative financing options.
In a recent blog post, Peter said that the effort “to close the growing affordability gap has added yet more fuel to the house price boom, especially at the lower end of the market. It will hurt first-time buyers and those with limited resources as they will have to stretch further to afford homeownership or be forced to remain on the sidelines.”
That sentiment has not stopped a growing number of aspiring homeowners to attempt to take advantage of these programs.
“I get lots of leads from buyers on Zillow and Trulia,” said Juan Umanzor, a real estate agent based in Bethesda, with a high percentage of his clientele in Prince George’s County, which experienced a high foreclosure rate during the recession. “Most of them ask about zero-down financing.”
Umanzor encourages his clients to buy now. “Interest rates are low and values continue to go up.”
However, when working with a client, Umanzor said he offers very clear upfront advice.
“Steer clear of interest-only and negative-amortization loans,” he said. “Anyone who advises a client to get one of these loans does not have their client’s best interest in mind.”
Next, Umanzor said, he explains how to calculate the financial viability of a zero-down loan.
“Think of your property like an investment,” Umanzor said. “Compare the mortgage payment for a home to the potential rental price. If you can rent the property and cover your mortgage payment, then you should be fine.”
According to Umanzor, if you lose your job, you can rent out the property temporarily to avoid a potential foreclosure.
This investment calculation also works in a down market, Umanzor said. “When values go down, the rental market typically gets stronger.”
Umanzor encourages his clients to hold off on buying until a property is identified that meets this investment criteria, even if the property will be a primary residence.
Many buyers who call to inquire about zero-down loans may ultimately end up in another loan program.
The number of zero-down loans issued today are significantly lower than we experienced in the market boom, but lenders still see them as a way to entice people to stay in the market.
“These advertisements are really just a way to get people in the door,” Chelst said. “The majority of buyers turn them down when offered other options.”
It is not just lower income communities that are motivated by zero-down loans. There are zero-down loans specifically designed for high-income earners with student debt.
A few local banks offer medical professional loans. These loans are designed in particular for doctors who have high earning potential. They have little cash saved and high student debt, but they are already earning substantial salaries, and their incomes will continue to increase. Thus, banks consider them low-risk borrowers.
“Even with zero down, my clients were overqualified to purchase based on their salaries,” said Katri Hunter, a Washington-based real estate agent who recently represented buyers — both husband and wife are doctors — using a medical professional loan. “I was concerned that we did not have a competitive offer based on the down payment, but we won the property despite there being other bids.”
Zero-down loans are typically not a good option for people who have money to put down, as the fees and rates are higher.
In addition, some markets make it impossible to use zero-down loans to purchase a home. In the Manhattan market, where I am also a licensed real estate agent, most co-op and condo buildings require a buyer to provide a minimum of 25 percent down. Some buildings require much more.
I am an example of the successful use of a zero-down loan.
I purchased a rowhouse in the U Street neighborhood in 2002 using a zero-down, no-doc loan when those programs were plentiful. I wanted to use little to no cash (hoping to hold on to money for other investments), and I had self-employed tax status — typically a deadly combination when trying to get a loan. I sold the property in 2005 for a substantial profit — one of my best investments to date.
Ask yourself the questions below before signing loan documents that include little to no money down.
- If you lose your job, could you still handle the mortgage payments?
- Home values go up and down. In a down market, your mortgage balance will most likely be higher than the value of the home. Do you have the stomach to withstand the anxiety of a down market until values go up again?
- Consider all the costs of owning a home, such as unexpected repairs, maintenance and utility costs. The mortgage payment is just the beginning of what it costs to own a home.
- Could you cover the monthly mortgage payment, repairs and maintenance by renting the house temporarily or long-term?
- When you sell the home, there are costs and commissions to pay. If the value of the property is down, these costs will come out of pocket. Will you have the cash to cover it at settlement?
- Most important, don’t purchase a home believing that you can sell it in the short-term and make a killing. Those days are gone. And I miss them dearly.
Zero-down loans can be a blessing or a curse. Do your homework and crunch the numbers before jumping in the market.
Jill Chodorov Kaminsky, an associate broker with Long & Foster in Bethesda and a licensed real estate agent with CORE in New York City, writes an occasional column about local market trends and housing issues. Jill can be reached at email@example.com.