Wells Fargo Sows the Seeds for Next Foreclosures Crop

Risk Of No Down Payment Mortgages

There is longstanding and overwhelming statistical proof that zero down payment home buyers default on mortgages at a far higher rate compared to home buyers who make a down payment. This matter has lately received more attention than in the past due to the large number of foreclosures related to zero down payment purchases during the housing bubble years. In 2005, for example, nearly half of all home purchases were made with zero down payment mortgages.

Zero Down Payments = Foreclosures

FHA Delinquency Crisis

Could FHA’s rising delinquency rate be due to FHA incorporating risky practices that have become standard in the mortgage industry? Since industry experts often cite 100% financing as being a major factor in the mortgage meltdown, let’s take a look at borrower down payment sources:

The delinquency rate clearly rises in tandem with the increase in non-profit funded down payments.

In 2005, HUD commissioned a study entitled “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations”. Later that year, another report titled “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance” was completed by the U.S. Government Accountability Office. Both studies concluded that seller funded down payment assistance increased the cost of homeownership and real estate prices in addition to maintaining a substantially higher delinquency and default rate.

No Skin In The Game
The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home.

Instead, the important factor is whether or not the homeowner currently has or ever had an important financial stake in the house. Yet merely because an individual has a home with negative equity does not imply that he or she cannot make mortgage payments so much as it implies that the borrower is more willing to walk away from the loan..

No Down Payment

Courtesy: WSJ

Wells Fargo (WFC) Initiates Down Payment Assistance Program

Ignoring the overwhelming evidence of high default rates on zero down payment purchases, Wells Fargo this week announced a major nationwide down payment assistance program (DAP) to be used for down payment and/or closing costs on FHA, VA and conforming loans. Incredibly, the program is being advertised as a means of helping low to moderate income applicants achieve the “American dream” of home ownership. Based on the historical evidence, Wells Fargo is sowing the seeds for the next major crop of foreclosures. Incredibly, this is being done even as the current foreclosure crisis grows in intensity.

Approving mortgages that immediately put new homeowners at a high risk of default is financial lunacy and a disservice not only to the homeowner but to a nation already in financial chaos due to defaulting homeowners.

Down Payment Assistance Programs (DAPs) Help More Low- and Moderate-Income Borrowers Achieve Home Ownership. Refer your low- to moderate-income applicants to local housing agency contacts and help them achieve home ownership by using one of these Downpayment Assistance Programs (DAPs) approved for use with a Wells Fargo Wholesale Lending first mortgage. DAPs provide financial assistance for qualified borrowers and, depending on the program, may be used for debt reduction, down payment and/or closing costs on FHA, VA and Conforming Conventional loans.

Disclosures: None

Comments

[Roger Knights:]

Maybe a little bird whispered, "Things could get much worse for you."

Jul 09 08:46 AM

[greedcanbgood:]

While I agree for the most part, zero-down programs were a natural consequence of meteoric rises in home prices. Coming up with the down payment of 20% or even 10% became more unrealistic as time went on. Now, the issue here is whether or not this is a chicken/egg scenario. I would submit that appreciation began and continued somewhat before zero-down programs became popular.

I don’t agree however with your assertion that the reason that these are/were going bad simply because borrowers had no “skin in the game.” They had plenty of skin – a good percentage of their income and their home. That’s quite a bit of skin if you ask me. No, what happened in these cases is that with zero down programs (that were often part and parcel to negative amortization and similar low initial cost loan programs) borrowers knowingly, unknowingly or ignorantly purchased homes that were WAY beyond their means.

Jul 09 10:01 AM

[Radardoc:]

Greed,

You said:

"Coming up with the down payment of 20% or even 10% became more unrealistic as time went on."

I strongly disagree. If coming up with a significant down payment is unrealistic for you, you can't afford the house. Just because the prices are high in a given area does not mean banks should reduce lending standards or we can dream up some "right" for everyone to own a home.

Renting does not make someone a failure or a bad person. If they can't buy a house, it just means they can't buy a house. Keep saving for the down payment. I would really like that 700 series BMW too, but I can't afford it.

The only thing lowering the lending standards does is feed the bubble that got us here in the first place.

Jul 09 11:39 AM

[greedcanbgood:]

Radardoc -

Using the "old" (and conservative) rule for mortgage qualification (28/35 - Your mortgage payment can't be more than 28% of your monthly gross income and all your debts can't exceed 35%), that means that in 2004 the average US Household (annual income of $44,473 according to the US Census) could afford mortgage payments of approximately $1,038 per month (6.25% interest rate – a little generous, but in the ball park). That’s a total mortgage amount of approximately $168,550. Assuming that the requirement is a 20% down payment, this average person would have to save approximately $42,138 for a down payment on a home for $210,688. According to the WSJ, in June of 2004, the average home selling price was $263,200. That means that our fictitious household might be able to afford a home slightly below average.

Enter “reasonable” 100% financing.

Your same borrower, assuming they have no other debt, could finance the $42,138 down payment at 8.50% for 20 years and have a monthly payment of about $353. Their total debt load? $1,391 or about 37.5% - just a hair above the “old rule” and WELL under 40%.

So what would it take for that borrower to save the $42,138. Again, we presume they have no debt but let’s say for the sake of argument that they can sock away twice the 2nd mortgage payment or $706 every month (thus a rent payment of $685). That means that at the (then) aggressive rate of 1.25% average money market rate, it would take them about 5 years to save that kind of money.

So they could buy the house (maybe) now or wait 5 years to save for a down payment. Ironically, the average home selling price today is almost what it was in June of 2004 so the value of the home would have returned to about the same place (meaning that the comparison is if they would have done 100% financing or waiting to save). So at the end of 5 years, our household would have a new house with about 20% in equity or a house with about 8% in equity. Obviously, the save would be in slightly better shape but clearly, 100% financing wasn’t an unreasonable or unrealistic option and certainly NOT an issue with regard to what one can or can’t afford.

Jul 09 01:54 PM

[Mr. Ed, Jr.:]

Maybe Wells Fargo needs to buy some time by writing new paper. Having something on the books that does not say "non-performing" might make them appear to be solvent for a couple years.

Jul 10 01:20 AM

[johngonole:]

Warren Buffet is a huge investor in Wells Fargo. He is already calling for a second stimulus. The bankers are simply going to enrich themselves further. We should have stopped bailing out bankers long ago. Its the same as saying don't feed the animals. The industry has and will continue to do business assuming that short term profits over long term risk will always be the easiest way to enrich themselves because after all the government will always bail them out. While it may not be a conspiracy the bankers are in fact enslaving all Americans via government debt. Wells Fargo is not going to stop. Pile it on. I've basically lost all respect for Buffet. He might come off as this folksy grandpa figure but he is basically a shrewd oppurtunistic business man. My bet is he is going to make out pretty well with all this financial crisis stuff.

I won't do anymore business with Wells Fargo thats for sure. Enough is enough. I suggest that we put the free market back into play. If you don't like the way your banker is doing business move your money. After all its all FDIC insured. That means that if we place the money with good men and women than FDIC cost us all less. If we let the bastards play with our money it will cost us in all likelihood more than we have. Just look at this last mess.

This stuff has happened before and it looks like it will happen again and again.

Jul 10 02:08 AM

[johngonole:]

greedcanbegood you are missing the point. With zero down falling house prices cause the owner to be way underwater with negative equity. They walk away and the taxpayers end up paying.

Jul 10 02:09 AM

[John Preston:]

Wrong, Bill.

The mid-1980's asset bubble in residential real estate, which became the 1990/92 recession...and part fo the RTC legacy, was fueled by large down payments...25% down got you a hall pass on the general qualification documentation requirements....

Based on the false logic in the WSJ article...and the non-questioning readership, too many are focusing on the wrong elements of the credit process.

Jul 10 08:55 AM

[John Preston:]

One more thought....

The servicing issues related to the seller funded down payment gift process does not correlate to foreclosure....

A down payment is a one time event...money is put into the deal....from savings or a gift

Monthly payments are made...well, monthly, usually out of income, and, at times, out of remaining liquid assets.

Job stability....and less income leverage....are far more crucial to the monthly payment process than is the down payment....

Jul 10 09:01 AM

[greedcanbgood:]

johngonole -

No point missing. If you look at the timing, in June of 2004 that average home purchased by my fictitous family wouldn't have been worth much less and not necessarily a negative equity position.

What I think you're talking about is people who purchased at or near the peak walking away because the hit to their credit bureau is preferable and won't last as long as sticking it out and waiting for their home to appreciate to where it had been when they purchased it.

Jul 10 09:43 AM

[Old Rick:]

Why do I smell a rotten ACORN somewhere in this deal? WFC is a big TARP recipient, ACORN has the ear of the President. And thus it follows............

Jul 10 10:18 AM

[Allan Frain:]

It is as if they figure the taxpayer will cover any losses down the road. In this regard--nothing has changed. Their CDSs are in the form of campaign contributions.

Jul 10 10:28 AM

[Old Rick:]

Greed sez: "Your same borrower, assuming they have no other debt, could finance the $42,138 down payment at 8.50% for 20 years and have a monthly payment of about $353. Their total debt load? $1,391 or about 37.5% - just a hair above the “old rule” and WELL under 40%.
----------------------...
This works for your "non-realworld" example greed, but what happens when to the payment when you add the $5K closing cost to the price? What happens to the payment when you add the $200/mo prop tax and the $100/mo insurance to the bill since both of those have to be escrowed in the zero down scenario? Doesn't look near as good does it?

Jul 10 10:31 AM

[johngonole:]

Greedcanbegood,

Yes the second half of your response is my point. The whole point of requireing a down payment is to provide a solid backing for the loan. Home mortgages are cheaper than car loans because the loan is backed in theory by something worth at least as much as the loan verus a car with is depreciating. A reasonable down payment protects the bank who is making the loan from home depreciation which historically has been very small and in most cases none at all. But when prices in housing started to move up 10 - 20% per year (In some areas this started before 2004) banks should have at least required a 20% downpayment because the home prices exceeding inflation had never happened to such an extent before let alone over a 5 year period. Instead banks speculated on the home pricing boom and lowered down payment requirements. The downpayment isn't about helping the home owner afford the monthly payment. Its about providing the basis for the lower interest rate home loans generally receive. So I guess we agree but were looking at it from different perspectives. Lower downpayments should have triggered higher interest rates. Somehow the bank has to adjust the risk of loans versus what is backing the loans. I think we can all agree that those issuing loans completely underpriced risks.

Jul 11 01:20 AM

[CBTeas:]

low/no down payment programs were all part & parcel of the idea that underwriting standards were slipping to help the housing game keep rising. homebuilders wanted to build more and more homes and this shell game only worked as long as prices kept going up at an accelerating rate. everyone made rules to keep the game going.

for you to try to parcel out one piece as good and another as bad is crazy. it was all bad and all fed on itself. you don't realize how many people also lied about incomes or applied for "no doc/no income verification" loans during this same time frame. you act as though income was some sort of litmus test. what planet were you living on?


On Jul 09 10:01 AM greedcanbgood wrote:

> While I agree for the most part, zero-down programs were a natural
> consequence of meteoric rises in home prices. Coming up with the
> down payment of 20% or even 10% became more unrealistic as time went
> on. Now, the issue here is whether or not this is a chicken/egg
> scenario. I would submit that appreciation began and continued somewhat
> before zero-down programs became popular.
>
> I don’t agree however with your assertion that the reason that these
> are/were going bad simply because borrowers had no “skin in the game.”
> They had plenty of skin – a good percentage of their income and their
> home. That’s quite a bit of skin if you ask me. No, what happened
> in these cases is that with zero down programs (that were often part
> and parcel to negative amortization and similar low initial cost
> loan programs) borrowers knowingly, unknowingly or ignorantly purchased
> homes that were WAY beyond their means.

Jul 11 12:25 PM