An Old Mortgage Product is Making a Comeback – and Alarm Bells are Ringing

These days, it’s hard to go more than a few hours without seeing a headline about the troubled state of America’s housing market. With trillions tied up in real property, and a culture obsessed with homeownership, it’s no surprise that housing is top of mind for many Americans. 

What’s obvious is that we’re facing a housing shortage. Or at least a shortage of housing that most middle-class Americans can afford. State, local, and even the federal governments are all looking for solutions. And for what it’s worth, there has been some downward pressure on interest rates, which dropped below the 7% mark at the end of May for the first time in months.

Private lenders have been quick to address the affordability problem. Focusing on limited cash savings that hold many buyers back, even when they can afford the monthly payments. Rate buydowns, assumable mortgages, and low down payment options are now more common. However, one lender’s solution—a 0% down mortgage—raises concerns.

How it works

Unlike traditional conventional mortgages requiring 3% to 20% of the home’s value as a down payment, or the federally backed FHA loan with a 3.5% down payment for those with lower credit scores and incomes, the 0% down mortgage allows buyers to close on a home without any cash down—up to a point.

Instead of having to come up with the cash for your down payment, you are given an interest free loan of 3% of the home’s value up to $15,000. The remaining 97% of the home’s cost is covered by your mortgage. 

But here’s the catch. If you decide to sell, refinance, or pay off the home early, you have to pay back the $15,000 in full, all at once. Not a big deal given that home values have increased 5.2% year over year as of April 2024. Except, what happens if home values stall, or, like we saw in 2008, begin to decline? 

The answer: you may not be able to afford to sell. And that’s a situation nobody wants to find themselves in. 

The Big Risk

Without a down payment, you start with no equity in your home. It may take years, or a significant increase in home value, to build equity. Including closing costs and other fees, even selling at or slightly above the purchase price can leave you underwater.

And that’s all assuming that prices don’t decrease. Or that you don’t run into any major maintenance issues, which almost as every homeowner will tell you, you will. Being underwater on a home is never a good feeling. Being underwater and owing an additional $15,000 to be able to sell is a nightmare, especially if tragedy strikes. 

Death, divorce, diamonds, diapers, and disaster make up the major reasons that people decide to part with their houses. These scenarios, often referred to as the 5 D’s of real estate, all require immediate action. Nobody wants to get stuck with a loan they can’t repay when they need to sell immediately. 

Alarm Bells

As a result, some industry professionals have begun to ring alarm bells about similarities between these offerings and the NINJA (no income, no job, no assets) type loans that were being offered at the peak of the market right before the 2008 crash. 

Despite this, lenders are pushing back on criticism. Stating that underwriting guidelines have improved significantly from 2008. As an extremely truncated recap of what happened in 2008: loose underwriting guidelines and a lack of oversight allowed hundreds of thousands of under qualified buyers to obtain loans that they couldn’t afford, which were traded on the secondary market as “Prime Loans”. These were often adjustable rate loans, which left many buyers scrambling when rates rose. A little dip in home prices made it difficult to sell and impossible to refinance.  As a result, the real estate market crashed, taking years to begin a full recovery. 

These lenders aren’t entirely wrong. Underwriters have severely clamped down in recent years. Setting stricter requirements for income verification, employment history, credit, and cash reserves. But the optics remain similar for industry insiders. 

At a time when many Americans are struggling to build savings, and rates are sky high, there is a greater risk of default. Homeowners spend an average of 1-2% on home maintenance annually, and insurance rates have risen as much as 24% in areas with severe weather, such as Florida with its annual hurricane season. If a homeowner can’t come up with 3% in cash at the time of closing, it’s unlikely they’ll have it for maintenance or to cover rising costs.

 

When you can’t pay your mortgage, there’s usually only one option. Sell. But with the 0% down payment option, sellers will have to come up with that extra $15,000 before being able to do so. And unless their value has risen significantly, it’s unlikely that they’ll be able to do so. Homeowners in these situations often find themselves facing short sales or foreclosures, and both of those options are bad for lenders and homeowners alike. 

We believe that homeownership should be affordable to everyone. It’s the American Dream after all. But it has to be done in a way that doesn’t put people at greater risk. The 0% down payment loan may not be the solution. 

Positive Signals but an Uncertain Future

Despite the concern, it’s not all doom and gloom. There are plenty of signals for positivity in the housing market. Home prices continue to reach record highs each month, and while there is more available inventory, the average amount of time a home sits on the market before a sale is still historically low. There are fewer bidding wars, but homes are still selling for a high % of their listing price. 

Most analysts do not predict a market crash, and there’s hope for lower rates, with the Fed expected to make at least one cut in 2024. However, home sales are slowing, and prices may stall by year-end if rates do not ease.

Summer is a historically good time to sell, so those on the fence about the right time might consider making some moves. Many buyers are waiting on the sidelines, but there are still plenty of options available for sellers. 

The views and opinions expressed in this article are not financial advice and are for entertainment purposes only. It’s best to speak with a qualified real estate professional or attorney before making any real estate decisions.