The U.S. government’s reaction to the financial crisis and the real estate meltdown has been another sad aspect of this whole thing. Instead of acknowledging the causes and correcting them, the U.S. government has made matters worse by implementing ill-conceived programs that are only temporary fixes.
Many people couldn’t afford to purchase a home because banks got greedy and allowed poor credit-risk customers to use inexcusable programs such as interest-only loans or option ARMs. The bankers made it worse by allowing these homebuyers to become renters while they work out the details. These buyers were unable to afford more than a small down payment. This should have been a red flag that they should be kept out of the system.
The bank offered house loans without a down payment and FHA (Federal Housing Administration), required only a 3% downpayment. The banks have since realized the error of their ways and increased down payment requirements. FHA raised the down payment requirement from a paltry 3% to a barely more modest 3.5%. FHA loans are a terrible option for note buyers.
Logically, a homebuyer who has put down a large down payment (e.g. A home buyer who puts down 10% or more is less likely than one who has paid little or none. Felix Salmon, the author of Dr. Housing Bubble blog, proved this. The default rate for homeowners with equity greater than 30% was just 1.9%. On the other end, people with less than 5 percent equity had a default ratio of 16%. This is eight times more. The line between 5% equity and 30% equity clearly showed the correlation between large downpayments and low default rates. People who have invested their own money and are able to afford it will be more determined to avoid defaulting. To protect our position, a note buyer like me would prefer to have enough equity in the property.
FHA loans account for almost 20% of single-family home loans due to their 3.5 down payment minimum (source: The Congressional Budget Office). This percentage is significantly higher than it was in the past, and is an order of magnitude greater than what was intended. It is good for the bureaucratic mind that more people are able to purchase houses right now. This is a recipe to disaster for a rational person who doesn’t care about the next election. These new buyers (perhaps 16%?) are a lot. Many of these new buyers (16% perhaps?) will default, which only pushes the problem further into the future.
If owner financing is used, and the note holder intends to sell the mortgage note to a buyer , there are rare times when a downpayment of less than 10% can be justified. Although a 10% down payment is not required right away, it will ensure a stable market for housing and help to prevent taxpayer money from being used again to rescue the house.