Reuters Money

Are big down payments better for home buyers?

Ouch!

My friendly neighborhood blogger, Felix Salmon, took after me big time for my post about why it doesn’t pay to wait while you save up for a down payment. Here’s a sample: “Linda’s on a roll here and manages to come out with one of the most astonishing pieces of personal-finance advice I’ve seen.”

My astonishing advice? You’re better off getting into a house now, while mortgage rates are near historic lows and housing prices are down sharply from their highs. Instead of spending five or more years paying rent and accumulating a down payment, borrow more now, and keep your savings for yourself.

Sorry, Felix, I stand by my piece. Remember, my job is to write about what’s good for the consumer, not the bankers and brokers. And, for a young person who wants to own a house, the numbers say it’s better to squeeze together your 3.5 percent down payment and lock in a 30-year fixed rate loan now, at 4.87 percent (with deductible interest).

Got extra money? I’m guessing a nice balanced mutual fund will do better than 4.87 percent over 30 years.

Felix and I don’t totally disagree. Neither of us think it’s a good idea to run out and buy more house than you can afford. You still have to make the monthly payments, even if a crisis hits and you lose your job or your health.

And if you banked your cash instead of tying it up in your house, doesn’t that give you more leeway to pay your bills while you sort out your finances?

Saving up for a big down payment? Sucker! (Corrected)

Remember the Red Queen’s warning to Alice? “It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast.”

That must be what it feels like to be saving up for a down payment on a home these days. Washington policymakers are entertaining several proposals that would raise the minimum down payment required for loans backed by Fannie Mae and Freddie Mac. Lenders are raising their own minimum cash requirements — the average down payment on new loans for home purchases is now around 27 percent, according to the Mortgage Bankers Association of America. Meanwhile, the Federal Housing Administration, the chief source of low down payment loans, is raising the fees it charges folks who only have minimal amounts of cash to the table.

Trying to save just the standard 20 percent? That could take you 14 years if you’re an average middle-class family looking for an average middle-class house, the Center for Responsible Lending reported recently. If you save $250 a month, it would take nine years to save a 10 percent down payment and six years to save a five percent down payment.

And that doesn’t seem to pay. If you think about the cost of paying rent for five or more years, you may be better off jumping into a home with a low down payment now. That’s true even if you have to spend more money on fees and mortgage insurance to get one of those low down payment loans. While nobody can predict interest rates with certainty, it seems unlikely that the mortgage terms you’d face down the road would be as favorable as they are now, with the Federal Reserve holding short term rates close to zero, and the government still backing loans via Fannie Mae and Freddie Mac.

Even if you have the money for a bigger down payment, there can be good reasons to save your cash. Mortgage rates continue to skirt all-time lows: Why not put your money to work for yourself and borrow as much as you can reasonably afford, on a monthly basis, at today’s rates? You can put the money you’re not paying into a down payment to work elsewhere. If home values rise, you will have done your best to leverage a small down payment into bigger equity. If they fall, you’ll have less skin in the game, and that could put more pressure on your banker to improve your loan terms lest you walk away.

The most popular source of low-down payment loans is the Federal Housing Authority, which backs loans that cover as much as 96.5 percent of a home’s value. To get one of those 3.5 percent down payment loans, though, borrowers have to pay one percent up front and annual mortgage insurance premiums. Beginning on April 18, those premiums will rise 0.25 percentage points, to 1.1 percent for borrowers who put at least five percent down, and to 1.15 percent for borrowers who only put 3.5 percent down.

That may seem like a big price to pay, but the FHA plan buys you a couple of advantages. An FHA loan may get you into the house years earlier, while rates and housing prices are low. And the actual mortgage rates for FHA loans are lower than traditional loans. Consider these figures calculated by Keith Gumbinger of HSH.com, a mortgage research firm, on the purchase of a $250,000 home:

What mortgage brokers don’t tell you: Hidden penalties abound

There’s a host of information a mortgage broker or banker won’t tell you up front that may increase the cost of your financing.

You could pay much more on a mortgage than your initial quote rate based on a rating system used by government mortgage insurers Fannie Mae and Freddie Mac. Brokers and bankers rarely tell you this coming in the door. They want to lock you in to a loan as soon as possible. With rates rising, this is really important to know.

In the wake of the biggest real estate meltdown in American history, the devil’s in the details when you apply for a loan. This hidden rating system will penalize you with a higher rate if your credit score is low or you apply for certain types of loans. It’s being employed by Fannie Mae and Freddie Mac, the government’s captive mortgage entities, which account for about 80 percent of new loans now.

As of January 1, mortgage brokers and bankers have to tell you that you may not get the best rate if your credit report is flawed, although they may not give you essential details up front on what else could bump up your finance rate.

You need to ask about how you will fare in the Fannie/Freddie “risk-based pricing” regime, which is basically a computer-run scoring matrix run by your banker. Here are some factors that could raise your cost of credit:

• Credit scores (based on the FICO system) below 740.
• High loan-to-value ratios (the percentage of the property’s value that’s mortgaged). The more equity you have or the more money you put down, the lower your rate.
• Adjustable-rate, Interest-only or 40-year loans.
• Cash-out refinancings.
• Investment properties.
• Condominiums and cooperatives.
• Manufactured homes.
• Multiple-unit properties.

The risk-based pricing program evaluates the type of loan, your credit score and loan-to-value ratio and determine what “add-ons” will boost your quoted rate, if any.

Is there a screaming buyer’s market in distressed homes?

Ready to hurdle back into the housing market? There hasn’t been a greater inventory of distressed homes in recent memory, so you will find some deals.

With prices dropping to a seven-year low and housing starts down, this may be a screaming buyer’s market. Yet you’ll need to keep your optimism at bay because it will be difficult to see any appreciation in the near future. There are also plenty of headaches in buying a distressed property.

But the supply is there, as a combination of  unemployment and bad loans continue to force ever more homeowners into foreclosure, and defaulted properties are continuously being put up for sale. A recent report by the research firm CoreLogic found that there are more than 4 million unsold housing units on the market now, which translates into a 15-month supply in normal times. There’s also something called an invisible “shadow inventory” — homes with defaulted mortgages that haven’t hit the market yet.

With the visible and invisible inventories combined, CoreLogic estimates a 23-month supply of unsold homes (as of August, their most recent measurement period). That’s up from a 17-month supply a year ago.

Inventories tend to be highest in Maryland, New Jersey, Illinois, Florida and Georgia, according to CoreLogic. The states that were bubble basket cases — Arizona, California and Nevada — are also in the top-25 in terms of unsold homes,  and join states that you wouldn’t suspect such as Alabama, Indiana, Maine and South Carolina.

If you’re looking for a home, should you be buying now? It may make sense if your credit rating is solid, your income stream reliable and you are willing to jump through hoops from lenders willing to scrutinize every detail on your mortgage application, but bargain hunters should beware. There are some convoluted rules that apply to buying distressed properties that you make not like. If you don’t have the patience, this is not the market for you.

As you’ve probably seen, in some foreclosures it’s not clear who owns the mortgage. Many notes got shuffled when loans were sold to investors. So you might have to wade through several legal layers to find out if you can buy a home free and clear of title questions.