Aside from rising home prices and reports of bidding wars, here’s one sure sign the housing market is improving: banks seem to be loosening standards for down payments.
The average down payment in purchases with a 30-year fixed rate mortgage dropped to 16.1% nationwide in May from 17.6% two years ago, according to a report released Monday by LendingTree, an online mortgage marketplace. In some states, like Mississippi and West Virginia, the average down payments are as low as 12%, the survey found.
After sustaining huge losses during the financial crisis when borrowers — many of whom put no money down — foreclosed, lenders raised credit standards, with many requiring 20% down payments. But now that the broader economic picture has improved, some banks are willing to approve mortgages with much smaller down payments. “Lenders have increasing confidence that the loans they’re originating today are less likely to default,” says Doug Lebda, founder and chief executive of LendingTree.
For prospective home buyers, smaller down payments can make it easier to take advantage of today’s lower interest rates and home prices, says Lebda. Homeowners can also use any cash they’re not putting toward the loan to cover other expenses like home improvements and furniture, he says. They might also keep extra money on hand as a cash cushion to cover emergencies, he says.
But the decision to buy a home with less money down could come with consequences. Homeowners with little equity in their property could have a hard time selling their homes down the line if home prices decline, says Keith Gumbinger, vice president with HSH.com, a mortgage information website. They could find themselves owing more than their homes are worth, says Gumbinger, as many have in recent years. This could force them to stay in the home longer than they would like while they wait for home prices to rise.
And even if their homes aren’t technically under water, some people with slim equity stakes in their homes may still struggle to sell the house, advisers caution. They may find that the size of their loan, combined with the costs of selling the house, such as a broker commission and property upgrades, could add up to more than the sale price, says Scott Halliwell, a financial planner with USAA. “When you tell someone to put a 20% down payment you’re trying to help them prepare for the unforeseen,” he says.
Borrowers who put down less than 20% are also typically required to make larger monthly mortgage payments and may pay more in interest, says Lebda. And in a competitive housing market, the buyer offering a smaller down payment, say 5%, might lose out to a competing offer from a person who is willing to pay 20% of the loan up front, says Lebda.
The shrinking down payments are partly due to the growth of mortgage insurance, which is typically required for homebuyers who want to put less than 20% down, says Gumbinger. Insurers became more willing to offer the coverage as the credit quality of borrowers improved. Could this eventually lead to a comeback of no-money down mortgages? “ I would never say never,” says Gumbinger.
© 2013 Market Watch
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