Saturday, December 12, 2009, 12:51AM ET - U.S. Markets Closed.

Jack M. Guttentag The Mortgage Professor

Jack M. Guttentag, The Mortgage Professor

The Down Payment Makes a Comeback

by Jack M. Guttentag

Email this Page IM this StoryBookmark this StoryAdd to your Del.icio.us accountDigg this StoryPrint this Story
Very Good (269 Ratings)
3.743496/5
Posted on Tuesday, August 12, 2008, 12:00AM

Over the past 18 months, the mortgage market has changed more rapidly than in any comparable period since the Great Depression. From the standpoint of borrowers, two changes are of paramount importance. The first is an increase in day-to-day price volatility. The second is a tightening of underwriting requirements, with higher down payment requirements the centerpiece. That is the subject of this article.

Underwriting requirements are the rules lenders impose to assure that loans will be paid off, and the down payment has always been the most important of them. The down payment is the difference between the lower of the sale price or property value and the amount of the mortgage loan secured by the property. If you purchase a house for $200,000 that is appraised for $200,000 or more, and you take a mortgage of $160,000, your down payment is $40,000, or 20 percent of value.

Getting Equity

A 20 percent down payment can also be described as a borrower having equity in the property of 20 percent. In the future, equity in the property is measured by the difference between the current value of the property and the current loan balance, both of which are likely to differ from their values at the time of purchase.

One reason the down payment is so important is that it is the single most vital factor affecting loss to the lender. The down payment is a buffer against lender loss in the event of a foreclosure. For example, if foreclosure costs are 20 percent of value and property value does not change, a 20 percent down payment fully protects a foreclosing lender against loss, but a 10 percent down payment provides only partial protection.

Perhaps even more important, borrowers who get into payment difficulties but have equity in their properties usually will sell to avoid foreclosure. By selling, they realize the equity themselves, whereas if they allow the property to go to foreclosure the equity will be partially or wholly depleted by foreclosure costs. Their selling avoids the foreclosure.

Having Budgetary Discipline

There is still another reason why lenders attach so much importance to the down payment. Borrowers who have been able to save the funds for a down payment are less likely to get into payment troubles later on. Saving for a down payment requires budgetary discipline, repaying a mortgage also requires budgetary discipline, and the one carries over to the other. Of course, this assumes that the down payment is saved, not borrowed. Underwriters look for evidence that the funds committed to down payment are the borrower's own.

When a house is purchased, the owner's equity is the down payment, but as time passes the equity is affected by two other things. One is any change in the loan balance. If the mortgage is fully amortizing, then the mortgage payment includes a principal component which reduces the loan balance. If the required payment is interest-only, and the borrower does not add anything to the payment, the loan balance will not change. And if it is a negative amortization loan, the balance will increase rather than decrease, and homeowner equity will decline. In the first few years of a mortgage's life, however, changes in homeowner equity resulting from modifications in the loan balance are usually quite small.

Homeowner equity is also affected by changes in house prices, which can be sizeable. During 2000-2006, house prices in some metropolitan areas rose by more than 20 percent a year. If a home buyer puts nothing down and there is a 20 percent appreciation in his home value over a year, he has as much equity in his property as a buyer who put 20 percent down in a stable market.

Zero-Down in the Go-Go Period

It is hardly surprising that house price inflation during the go-go period resulted in a drastic weakening of underwriting requirements in general -- and down payment requirements in particular. Zero-down loans became increasingly common during this period.

When the market turned and home prices began to decline in late 2006 and 2007, down payment requirements had to be drastically revamped. Just as rising prices generate homeowner equity, falling prices destroy it. There are no zero-down loans anymore, except the VA loan for veterans. FHA loans remain available at 3 percent down for smaller amounts, but conventional loans now generally require 10 percent down, and in some areas it is higher. On top of this, lenders now want most borrowers to have good credit scores and to fully document their incomes.

It easily could be worse, and without the federal agencies (FHA, Fannie Mae, and Freddie Mac), it surely would be. Nobody is forecasting a quick end of house price declines, so down payments of 3 percent to 10 percent don't look like a lot of protection against future losses. Any loan today that is untouched by one of the federal agencies will have a required down payment larger than 10 percent.

Save, Save, Save

Down payment requirements have a critical impact on the capacity of consumers to afford a house. If buying a home is in your plans but you have never been able to save, it is time you learned how. The secret is to make saving a high priority in your budget.

Decide beforehand what part of your income you can afford to save, and create a special account for that purpose. Then, immediately after you are paid, write a check for deposit in that account. If you view saving as a residual -- what remains of your income unspent at the end of the month -- you are giving saving the lowest possible priority, which is a virtual guarantee of failure.

Email this Page IM this StoryBookmark this StoryAdd to your Del.icio.us accountDigg this StoryPrint this Story

Rate This story

Very Good (269 Ratings)
3.5/5
Sign-in to rate!

105 Comments

Showing comments 6-35 of 105<< PreviousNext >>
Sort: first to last

  • sudsy - Tuesday, August 19, 2008, 1:25PM ET  Report Abuse

    • Overall: 1/5

    Hey Jack! Just an FYI Mortgage Professor... there are no longer any Negative Amortization loans in the marketplace... and FHA now requires a 3.50% Down Payment.

  • ron - Tuesday, August 19, 2008, 9:57AM ET  Report Abuse

    • Overall: 4/5

    Best homebuying advice I ever got was to double down on the equity. I've never bought with less than 1/3 down, even when I had to wait or had to get a smaller place than I (technically) could afford. A smaller loan means lower payments and a larger equity cushion. In addition to a better night's sleep, that means a greater choice of lenders and loan programs and better customer service. If you want the VIP treatment from a lender - at any price point - walk in with 40% down.

  • Good Guy - Tuesday, August 19, 2008, 7:55AM ET  Report Abuse

    • Overall: 4/5

    SAVE!! YOU DESERVE IT! (Oh, by the way...a great article.)

  • hoca - Tuesday, August 19, 2008, 7:12AM ET  Report Abuse

    • Overall: 3/5

    Whatever we can do/can be done to encourage/teach/help/force people to save (high priority item) is to the good. Payroll deduction is probably the best fpr most folks. After the first hundred years you just get used to it.

  • BAGDACK - Monday, August 18, 2008, 6:11PM ET  Report Abuse

    • Overall: 4/5

    True that! I been saying this for many years, save save save! Now when most people are broke A$$ from using so much credit to buy things they could't afford. This is when the savers shine.

  • Mike - Monday, August 18, 2008, 2:20PM ET  Report Abuse

    • Overall: 2/5

    "I want it all - and I want it now" - The buyer (who doesn't know any better). "Let's make a killing & Blame it on the buyers when we crash!" - the financials (who knows better). With all of the homes that where lost in the past year - I hope it take 5 to 10 years for this market to come back. Blame the client! You didn't plan, you didn't save, you didn't see that guy stick you in the back when you bought that house! LOL Get Real

  • AdmirableR - Monday, August 18, 2008, 2:02PM ET  Report Abuse

    • Overall: 4/5

    What he is saying is now the "old" checks and balances have been restored. Granted, a little overboard on the caution but it will even out. Face it, what kind of business decision was it to have people "state" their income and not prove it then give hundreds of thousands of borrower's dollars in their behalf to purchase real estate? A sound credit history is still the best predictor of future financial responsibility. The whiners out there are moaning because they can't have their SUV's plasma TV's, lattes, ATV's and save for a down payment too. Beware the next scam du jour: designs on your IRA, 401k and similar retirement plans. Bush almost got away with it when he tried to freeze Social Security [which is NOT a retirement plan] . Learn from the mortgage circus so the next financial scam won't gain traction... The reason your real estate isn't worth what it was is because the Emperor truly had no clothes on and people finally had to admit it

  • Alex - Monday, August 18, 2008, 12:15AM ET  Report Abuse

    • Overall: 1/5

    Do you know why the market is getting worst and worst? Because the media keep talking how bad the market is. If you were a home buyer, after you hear all the problems in the market, do you still want to buy? If there are no buyers in the market, of course the price would fall, and it just like a snow ball, getting worst and worst. I agree lenders need to clean up their book, but I don't think it's a good idea to change all the underwriting guideline overnight. I seen so many people who supposed to be able to get a loan(with good credit even 30% down payment)in the past can't get a loan now, just because they can't prove their income. I think this is a wake up call for all the lender, keep changing the underwriting daily will just keep them out of business faster. Set the right standard, then stick with it, the market will adjust by itself. And have all the media shut their mouth, time to change topic man. I been seeing all these articles about real estate market in almost every single day in past 12 months. I don't know start from when people in this country became so hopeless, this is not the end of the world. And why you want to keep checking on the appraised value of your house people? If you plan to live in this house, then just keep making your payment, who cares how much it worth? You aren't selling it anyway. I am a homeowners, and I have 2 properties, I haven't freak out yet, neither should you. Do what you supposed to do, go to work, pay your bill, live like normal, the market will come back up

  • Jeffrey - Sunday, August 17, 2008, 4:14PM ET  Report Abuse

    • Overall: 1/5

    Once again, this person, who keeps posing as a "professional" obviously has never done any research on the subject. As pretty much every other poster has pointed out, FNM/FRE dropped the political hotpotato of increasing their DP% in declining markets, and its back to 5% nationally and of course, FHA, who is now according to many estimates is guaranteeing up to 80% of new mortgages these days requires only a 3% downpayment with only a fico score above 540. Almost anyone with a pulse has a fico score above 540. The only idiots who are required to put down more are those who simply walk into their local bank. Who does that anymore? No one. Yahoo - Please stop letting this person post articles here, it really looks bad on your part

  • Johnna - Sunday, August 17, 2008, 3:30AM ET  Report Abuse

    • Overall: 5/5

    Information everyone knows, but refreshing to hear anyway. I love the old school values, they made our country great. These values served my father well, will serve my generation and the next generation well if we can get back to them. Requiring down payments is an excellent start to get this real estate mess fixed. Everyone is not entitled to a house, only shelter. Trying to put everyone in a house, plus greed, has cost this society dearly. Now we play the blame game. Memo to the real estate market: Only applicants with down payments need apply! Bravo!

  • lawrences - Saturday, August 16, 2008, 8:35PM ET  Report Abuse

    • Overall: 1/5

    Is Jack retarded or just stupid? Buyers are still able to do 95%LTV, and 100% LTV. The guys at the top knew the market would bust sooner than later. They just wanted to make as much money as they could and then get out. Countrywide?

  • Yahoo! Finance User - Saturday, August 16, 2008, 2:39PM ET  Report Abuse

    • Overall: 2/5

    we all know the real issue here. The problem isn’t gas prices bush’s fault (he did handle several things poorly). Us Americans are used to a certain lifestyle and refuse to change until we hit a brick wall. Even when gas was .99 (2001-va beach) people were not making as much money, it was a different economy then. Homes were lower prices but so were salaries. we all know that when u take out a car or home loan you should put money down to secure a buffer for yourself in the even of a resale. If the lenders put themselves in a situation where they allowed risks to be taken then they should be suffering the consequences they face---a loss. The flip side of that is consumers got into a loan trying to own property they knew they couldn’t afford. Most didn’t lose their jobs or suddenly become ill/disabled without salary. A home is a long term investment if we look at our parents and grandparents. They never moved or bought property every 3 years. Home values typically double every 10 years so we'll see a turn around. in the meantime we can educate our children during these "hard times" more blogs on myspace.com/mravon

  • Yahoo! Finance User - Friday, August 15, 2008, 2:03PM ET  Report Abuse

    • Overall: 5/5

    Pretty funny all the know-it-alls here. Where were you all in 2006 when their was no basis of reality to the mortgage market?

  • Tina M - Friday, August 15, 2008, 2:00PM ET  Report Abuse

    • Overall: 2/5

    Let's not forget the role that HGTV has played in outrageous prices for houses. They have duped buyers into believing that a house should automatically come with new cabinets, granite countertops, tile floors . . . on and on. I have watched numerous couples rip out BRAND NEW cabinets to put in new cabinets of a different color or style. Cabinets are not consumables. Our grandparents would never rip out perfectly good cabinets, much less new ones, just to replace them with some the "liked the look of better". It's shelter people. You can't take it with you. It was never meant to be a status symbol.

  • MattW - Friday, August 15, 2008, 1:55PM ET  Report Abuse

    • Overall: 5/5

    Don't know what's the deal with all these condescending "Duh, we all know this stuff" comments. Apparently, we don't know a thing about basic tenets of personal finance, or at least we don't appl the knowledge. If we did, we wouldn't be in the mess we find ourselves in today. Stop acting like you know everything, because based on the behavior of millions of Americans, we've all got a lot to learn about money.

  • Chris M - Friday, August 15, 2008, 12:11PM ET  Report Abuse

    • Overall: 1/5

    What a waste of 2 minutes of my life. Come up with something NEW. Regardless of the changes in requirements for down payments do you HONESTLY think that American's are going to magically change the way they live and start actually saving, much less save enough to put down 20% on a house? Not a freaking chance.

  • Chris - Friday, August 15, 2008, 10:52AM ET  Report Abuse

    • Overall: 1/5

    yawn... tell us something we don't know...

  • Larry - Friday, August 15, 2008, 7:19AM ET  Report Abuse

    • Overall: 1/5

    I saw only one comment about "affording" versus "Qualifying." Why not talk about that? Help the Yahoo'ers that read your articles understand how to afford a home, not save money for a down payment? A family that save $10,000 for their $50,000 home purchase sounds great. Too bad they still cant afford it if their total debt to income ratio is above 45%. Counter with a family that puts 3% down and has a debt to income ratio of 30%. Who is more likely to lose their home? Talk about that next time. It will help your readers more.

  • Yahoo! Finance User - Friday, August 15, 2008, 1:47AM ET  Report Abuse

    • Overall: 1/5

    Even in 1987 I only put down 5% on a home and paid PMI on the other 15%. To now require everyone to put down 20% dooms the housing market to years of continuing decline since probably less than 1% of America even saves money today.

  • Yahoo! Finance User - Thursday, August 14, 2008, 9:43PM ET  Report Abuse

    • Overall: 2/5

    No skin in the game? Let me tell you something. When you have worked hard and built up a 750-800 credit score, you have skin in the game, even if you have bought your home at 100% financing. As Mr.G's last article points out, that's why there is PMI. Let's just separate the wheat from the chaff and stop slamming everyone who used 100% financing to buy thier homes. Many of us are excellent credit risks, much better than the deadbeats who bought half million dollar homes on 20k a year incomes. When you've built up a credit score like mine, believe me, you don't walk away. My home means a lot to me, as does the privelege of having earned the right to pay my mortgage. It serves no purpose at this point to punish everyone else like me - a 20% down payment is a tall order, and people who have the brains to get out a calculator, ignore the banks, and buy what they can AFFORD should still be given 100% financing. It's not like 10, 20, 30 years ago: the sweetheart company retirement deals don't exist anymore. Saving 20, 30, 40 or 50K is very difficult in this day and age. And when you've shown that you are funding your retirement and investing in your future , you shouldn't have to cash it out for a down payment. Heck, I'm paying less for my mortgage, taxes and PMI than I was for rent. Now others can't benefit like I did? Because of the Community Redevelopment Act, where people took advantage of and ROBBED the sysytem? Now everyone else has to pay while they get their mortgages "re-worked". Aw, come on, give me a break!

  • Love2Fly - Thursday, August 14, 2008, 2:30PM ET  Report Abuse

    • Overall: 5/5

    Great to see underwriters getting tougher, they should've never gotten easy, but hek!! that's greed. When I build my house in 2000 I was a rookie in the financial and real state talk (and I still am to some degree), but I still had common sense to put 20% down just to avoid PMI (I did not know about the foreclosure benefit). And yes, they are responsible people that cannot put 20% down, but I think they are only 5%; the other 95% are irresponsible.

  • tippers14 - Thursday, August 14, 2008, 10:36AM ET  Report Abuse

    • Overall: 3/5

    Amazing that what has always been common sense is still common sense. The dumbasses that borrowed way beyond their means assuming that house prices would increase forever got exactly what they deserved.

  • Brian - Thursday, August 14, 2008, 10:18AM ET  Report Abuse

    • Overall: 3/5

    Common sense: - If you saved money, you're likely able to actually budget yourself - Down payments get borrower's "skin in the game" Uh... is this really a surprise to anyone? We're a nation of people that have no clue how to delay gratification and save for the future. Me? My wife and I both work. We bought a home we could afford on just one of our incomes. We max out our 401Ks and IRAs. We pay extra each month on our home. We are very capable DIY folks and have done several projects on the home, increasing the value of our home above the amount we invested. We evern have a 12-month "emergency fund". Maybe I should write an article.

  • Kirk J - Thursday, August 14, 2008, 10:15AM ET  Report Abuse

    • Overall: 4/5

    A little too simplified, even for Yahoo. Several comments have noted the near impossibility to save 20% for a home when prices were rising 10% a year. This is especially difficult for single-income households that cannot afford to compete for a modest home in an area with decent schools. There is much research on this problem presented elsewhere.

  • Yahoo! Finance User - Thursday, August 14, 2008, 7:15AM ET  Report Abuse

    • Overall: 3/5

    A previous comment says: "I like many many Americans bought a home with 100% financing. It is my home and I paid over $8,0000.00 in closeing cost to do so. I have never missed a payment and yet I am still not in a great equity position I still am a homeowner." Sorry to break the news pal. You are not a homeowner. You rent money from the bank to live in a home and will be doing so for the next 30 years. You are losing money every day as the value of your home decreases.And on top of it you are paying property taxes, hoa fees and paying for repairs and maintenance. And when you sell - if you can find another sucker, I mean buyer - you will lose another 6% in selling costs. Well done.

  • Yahoo! Finance User - Thursday, August 14, 2008, 7:09AM ET  Report Abuse

    • Overall: 2/5

    No way man. You mean I can't buy a $750K house with $0 down on my $25K a year salary anymore?

  • Bob - Thursday, August 14, 2008, 6:49AM ET  Report Abuse

    • Overall: 1/5

    Next round is on me. Very intuitive for a 3rd grader.

  • Fen - Thursday, August 14, 2008, 5:58AM ET  Report Abuse

    • Overall: 5/5

    I used to sell mortage loans 5 years ago. When the negative amortization mortgage came out, I thought who in the world will buy into this. Well, we are a nation of big dreamers. Even though I refused to do business as such, I saw how mortgage industry really took off with subprime loans and 0 down. This article should have come much earlier to bring people to the basics.

  • GRAVITY - Thursday, August 14, 2008, 2:07AM ET  Report Abuse

    • Overall: 5/5

    mattpanek wrote: "Do people really need an article telling them to only buy things they can afford?" Have you seen the foreclosure rate lately matt? I'll do you one better though: Before the tech bubble burst a number of years ago, bright, educated young professionals starting internet business's were paying about $350 to attend a seminar titled 'Why it's important to turn a profit.' No kidding.

  • Yahoo! Finance User - Wednesday, August 13, 2008, 11:15PM ET  Report Abuse

    • Overall: 5/5

    If you take on an adjustable rate mortgage, and it never occurs to you to do the math and figure out if you can afford the payment after the interest rate adjusts, you have to be on the far end of stupid. Even a squirrel with a brain the size of a grape can plan ahead enough to store food for the winter. The mortgage crisis was caused by stupid borrowers who used interest only loans and negative amortization loans to access greater sums of money than they could otherwise get in order to bid house prices up to idiotic levels. Even if you are sensible enough to plan ahead and figure out what you can really afford in the long run, you still have to compete against these idiots. Think about it. If you have a house for sale, and a few sensible buyers offer you $400K, and a couple of idiots who are willing to take on negative amortization loans get in a bidding war and the highest bidder offers $700K that he can barely afford at the introductory rate, who are you going to sell it to?

Showing comments 6-35 of 105<< PreviousNext >>

More from Jack M. Guttentag

The Mortgage Encyclopedia

An authoritative yet concise guide to the mysteries of mortgage finance, arranged alphabetically from "A-Credit" to "Zero Balance." Includes information that will help you decide whether to use a mortgage broker, learn if you can avoid mortgage insurance, and much more. Reach for this indispensable guide and get the fast, accurate information you need!

Order your copy now!

Find out more about The Mortgage Professor.

More from Yahoo! Sources

  • CNN Money
  • Consumer Reports
  • Kiplinger
  • The Motley Fool
  • Business Week
  • Wall Street Journal

Historical chart data and daily updates provided by Commodity Systems, Inc. (CSI). International historical chart data and daily updates provided by Morningstar, Inc. Fundamental company data provided by Capital IQ. Quotes and other information supplied by independent providers identified on the Yahoo! Finance partner page. Quotes are updated automatically, but will be turned off after 25 minutes of inactivity. Quotes are delayed at least 15 minutes. Real-Time continuous streaming quotes are available through our premium service. You may turn streaming quotes on or off. All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.

Yahoo! Answers is provided for informational purposes only, and no Q&A is intended for trading or investing purposes. Yahoo! shall not be responsible or liable for the accuracy, usefulness or availability of any Q&A information, and shall not be responsible or liable for any trading or investment decisions based on such information. View Complete Answers Disclaimer.