Posts Tagged ‘down payment’

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Down With The Payments

February 22, 2008

Most people think of mortgage companies requiring a down payment as a way to protect the lender. They even require you to buy insurance if you cannot make the 20% down payment requirement. Standing on the outside watching the mortgage meltdown, I see things that could have been prevented if only people had made significant down payments.

WARNING: MATH AHEAD!

Say I bought a house four years ago for $500,000, not too unreasonable for the Washington, DC area. If I borrowed the entire amount with an ARM and a low teaser rate hoping to refinance into a fixed-rate mortgage and my house lost 10% of its value bringing it down to $450,000, I would be stuck with an upward-adjusting interest rate on a $500,000 loan and an increasingly bad financial situation. However, if I had made a 20% down payment, I would have only owed $400,000 on a house now worth $450,000. That would have given me room to refinance and let me prevent a larger jump in payments.

So:

$500,000 – $0 down payment + rising interest rate – drop in house value = you are screwed

$500,000 – $100,000 down payment + rising interest rate – drop in house value = you may be able to pull it off

The other side to the 20% down payment coin is that accumulating enough money to make that down payment requires you to be fiscally responsible enough to gather that money. This is something that has been neglected recently with 80/20 loans, piggyback loans, and/or loans for 100% of the value. They allow people with enough income but not enough discipline to get loans they are unable to keep up with.

Equity is something you should start with in a house, not hope to accrue through a rise in property value and a long history of payments.

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