100% Financing in a Down Real Estate Market
8/06
As an attorney who handles hundreds of real estate closings a year, I am consistently amazed at how many banks are allowing borrowers to finance the entire cost of their homes. In some cases, banks are also financing the closing costs as well. In most cases, the bank will provide a standard 80% loan and then give the borrowers a “piggy back” loan in the form of a 20% equity line.
With 20/20 hindsight, we can see that four or five years ago, this was a great deal. If you purchase a home in Putnam County in the year 2000, chances are it is worth double that amount today. If you did it with 100% financing (somebody else’s money) it was a really good deal as you would now have substantial equity where you had none to begin with.
If you are considering buying a home with 100% financing today, you have to consider a few factors. First and foremost, we are clearly in the early stages of a downturn in the real estate market. While no one can predict the future, indications are everywhere. Not a single real estate agent, mortgage broker, title representative or attorney with whom I have spoken has told me they are busier now than they were a year ago. While summers are typically busy for attorneys, title companies and lenders,(most people with school-aged children wish to close after the school year ends in June and before it starts up again in September), the summer of 2006 has certainly been slower than the past several years. Real Estate agents, who typically are about 2 months ahead of the curve (when deals are first put together) are predicting a slow Autumn.
The tide appears to be turning from a strong Seller’s market to a Buyer’s market. You no longer see a house listed for sale where buyers are lined up and bidding over the asking price. Buyers are no longer waiving mortgage contingency clauses and home inspections to buy a house. Houses are also staying on the market for longer periods of time before being sold.
Everyone wants to own a home, particularly young couples just starting out together. The lure of easy money has got a very strong appeal; if a bank is willing to give someone all the money they need to buy a house, most people will consider it. You also need to consider that real estate is an investment. As with any other investment, there are risks involved.
Over time, real estate has always been seen as a safe investment. It used to be said that real estate appreciated at about 3% a year. In Putnam County, we have recently seen appreciation of 50%, 75% and even 100% over a few short years. Most people will agree that we will not see that kind of appreciation any time in the near future.
If you look back about 20 years ago, real estate values were also at all-time highs in the mid to late 1980s. However, people who bought in the late 80’s were not happy in the early 90s when their property values decreased. This was particularly true in the co-op and condo market in Westchester, Putnam and Dutchess. Someone who purchased a condo for $150,000.00 in 1985 was lucky if they could get $90,000.00 in 1992.
When I started practicing law in 1989, there was a phenomenon in real estate known as the “short sale.” This is where people owed more on their home than what it was worth. In some cases, banks would take whatever the borrower could sell the house for and in some cases the banks would go after the borrowers for the difference. Other times, borrowers were mailing in their keys to the bank and just walking away from their homes. Couples going through divorces at that time were not splitting up their assets, they were splitting up their respective shares of the marital debt incurred through real estate losses.
While the downturn in this market may not be as drastic as it was fifteen years ago, you still have to consider that, with 100% financing, you may immediately owe more on your home than it is worth. The way mortgages are amortized, equity is slow to build in the early stages of your loan. If you buy a home for $600,000.00 with 100% financing and the market dips about 10%, at the end of one year you would probably owe $599,000.00 on a home worth only $540,000.00. If the downturn in the real estate market continues, your negative equity will continue to grow. 100% financing is great in an up market where you can use someone else’s money to build equity on your own; however, it can backfire on you in a down market.