Op-Ed: Misleading Products Proliferate In An Already Tough Housing Market
By JOHN GIBBS
Commonly considered a bellwether for the nation’s economic health, the housing market remains in decline as June home sales slowed to their weakest pace since December. Mortgage rates, often considered the culprit for the slump, remain elevated for a 30-year fixed mortgage.
Despite many economists’ predictions of lower rates midway through 2024, the Federal Reserve has been at a standstill, leaving only vague clues about a possible interest rate cut.
Given these grim conditions, it is no surprise that some in the mortgage industry are putting forth various apparent cures that purport to offer consumers an escape from high homebuying costs. Buyers are now enticed with tantalizing low-down payment or zero-down payment mortgage options. While these products, such as a new United Wholesale Mortgage offering, do bear a thread of truth to their billing, a comprehensive analysis shows that they are a potential mine field which may endanger less-well-off buyers who are the specific target of these programs.
In UWM’s case, they are looking to woo first-time homebuyer families earning at or below 80% of the median household income for a given geographic area, with a zero down payment provision that applies to the first 3% percent of the down payment or a maximum of $15,000.
What buyers don’t realize at first, however, is that the retracted down payment is converted into “a silent second mortgage” – essentially a separate loan that, if not paid off, hangs in the balance in perpetuity until the house is later sold, refinanced, or foreclosed upon.
This creates what is known as a “balloon payment” to be made by the buyer in lieu of the traditional practice of making the down payment when the mortgage is first issued. Ordinarily, refinancing a mortgage (usually a few years after the mortgage is first issued) is a common way that homeowners can cut their loan interest rates, and therefore reduce monthly expenses. But when owners have a significant balloon payment due at the time of refinancing, the financial benefits of the refinancing may be canceled out.
Such a financial scheme of passing off the down payment to a later date does not benefit a buyer any more than trying to rearrange the deck chairs on a ship in the hopes of making it more seaworthy.
Another common complication of zero-down loans is that sellers may be reluctant to accept a buyer’s full financing proposal. This is because if the agreed-upon sale price is higher than what the home appraises for – which happens often in a seller’s market such as we have now – then mortgage lenders will not lend for more than the appraised price.
This means that the buyer will have to pay any portion of the sale price above and beyond the appraised price, in cash. Sellers are likely to conclude that a buyer making a zero down payment will not have the cash available to pay this difference. This puts homebuyers making zero down payment at a disadvantage in the eyes of sellers.
For those zero-down buyers who do come to a deal with a seller, another obstacle is primary mortgage insurance. PMI is an insurance product meant to reduce lender risk and is required of buyers when a down payment of less than 20% is made, and must be paid up until the borrower reaches 20% equity. This means that the less money one puts down, the more one will pay in PMI every month, and the longer one will have to pay it.
This makes homeownership more expensive for zero-down buyers. For example, while the total PMI a buyer would pay over the course of a $400,000 home loan with a credit score of 680 is approximately $45,000 with 5% down, it would jump to $71,000 with zero down – a nearly $26,000 increase – with none of that money going towards building equity.
Conceptually, the idea of supporting the average Joe and Jane homebuyer with cost breaks has a nice ring to it. But, as is often the case with ideas that sound good on the surface, UWM’s offering may end up producing more harm than good when rubber meets the road.
The opaque complexity of many zero-down products, with their hidden second mortgages, looming balloon payments, higher monthly costs, and lower attractiveness to sellers, doesn’t serve consumers’ best interests and often leads to higher default rates, and therefore may be of questionable long-term value. As such, this most recent product offering may end up as a publicity tool serving marketing and promotional purposes, rather than something which helps consumers and the market.
John Gibbs is the former assistant secretary for Community Planning and Development at the United States Department of Housing and Urban Development.