If Low Downpayments Are More Risky To Banks, They Must Be More Safe For Home Buyers

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Bloomberg's Caroline Baum says that the banking system's exposure to mortgages is quite high because 43% of first-time home buyers made no down payment in 2005.

If low downpayments are more risky for the banks (as Baum points out), it must be less risky for the homeowner.

As we've said a few times: 100% financing is quite safe for a home buyer.

For homeowners, 100% financing is safe because the home buyer has zero skin the game with respect to the home.  That "downpayment money" may have been earmarked for more important things instead, including:

• Disability insurance because there is a 1 in 4 chance that an injury will render somebody unable to work/earn money for 90 days -- just long enough to default on  a home loan
• Life insurance because a family earning two incomes may be able to afford a home, but the same family with one income may not fare as well
• Furniture because bean bag chairs and M.C. Escher posters are so college
• Savings accounts because life is an endless road of surprises that includes job losses, illness, car repairs, and other money-spending events

All of these options can be more appealing to home buyer than making a downpayment.  Especially if the bank is willing to allow it.

100% financing, though, can be risky to the bank holding the mortgage notes.  If the homeowner defaults, the bank stands to lose more money than if the home owner had some stake (in the form of a downpayment).

If banks are at risk, as Baum says, the key to protecting them is to make sure that homeowners can continue to make make their payment.  That comes through careful financial planning and responsible borrowing.

If homeowners bite off more than is chewable and subsequently default en masse, the system could crumble.

Source
Think Banks Have No Exposure to Mortgages? Think Again
Caroline Baum
Bloomberg.com, Monday, April 17, 2006

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