Decades ago, buying a home was a pretty consistent experience for most people. A homebuyer would save 20 percent of the value/purchase price of the home. The 20 percent would be the “down payment,” and the 80 percent to complete the purchase was loaned by a lender to the homebuyer, who paid back the 80 percent over a couple decades.
Lenders would find investors who would loan the money to the banks, so that the lenders could loan more money directly to homebuyers. Over time, some of the largest investors became federal agencies commonly known as Fannie Mae and Freddie Mac.
The risk to investors was minimal, because home prices were relatively steady, typically increased over time and were perceived to unlikely to decrease more than 20 percent, if at all.
As the demand for home ownership grew, more people without the requisite 20 percent wanted to purchase homes. Lenders did not want any more risk, so private mortgage insurance (commonly called PMI) began to be used to ensure that the investors’ risk (in the event of foreclosure and a decrease in the home’s value) was limited to the 80 percent (sometimes 75 percent) threshold. PMI essentially paid off the riskiest 20 percent in the event of a default by the borrower.
Then, in the years immediately preceding the housing crisis, people made general assumptions that home prices would continually, consistently and aggressively increase every year. If so, why would investors not be willing to loan more than the 80 percent? Lenders saw that as an opportunity to help even more people who had not saved the typical 20 percent.
In these situations, a traditional loan was used for the traditional risk, usually capped at 80 percent. A second loan was for the remaining 20 percent. If the prices of homes increased as aggressively as expected, the investors’ risk, even on the 20 percent loan, would eventually be no greater than the traditional risks associated with the 80 percent loan. This pre-recession time period was when lenders often promoted, promised and advertised “no money down” home loans.
Of course, we know that the economy collapsed. Job losses led to home foreclosures. The foreclosures understandably coincided with home prices decreasing, often significantly. As the economy worsened, foreclosures increased, investors lost money and the economy worsened. It was a self-perpetuating abyss.
As an understandable result, lenders and investors became much more conservative.
Recently, though, in attempts to help the economy, particularly in economically distressed areas in our region, the federal government has attempted to expand its role as an investor, agreeing to invest in riskier home loans. Fannie Mae and Freddie Mac recently announced that they will invest in home loans for people with lower incomes, lower credit scores, and down payments as low as 3 percent. Depending on geography, if a person’s income is too high, the programs might only apply to a first-time homebuyer.
Those interested in these more flexible home loans should reach out to their local lender (bank, credit union, etc.) and ask about eligibility for the “Home Ready” and “Home Possible” programs.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at Lee@LeeSchroeder.com or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.