Both houses of Congress are debating whether to require higher down payments, something that will guarantee housing prices will plunge and from which recovery may take perhaps decades. Congress is debating a proposal that Federal Home Administration (FHA) loans require homebuyers have a 20 percent downpayment (i.e., upfront cash equal to 20 percent of the purchase price) for qualifying mortgages. This will cause a new housing price crash.
Should this pass, what will it mean for you?
If you are a struggling wannabe first-time buyer, it means you will need at least $60-75,000 for a modest house in a "marginal" or far-away suburb. This means Putnam, New London and Somerset counties...and if you have no idea where these places are...well, that's the point.
Easily, this will depress the number of prospective buyers, at all price points. A new, and sharp, depression in demand will cause another plunge in prices, independent of the other factors like rising interest rates, a foreclosure glut, oversupply of vacant and never-sold homes and the shadow inventory of homes ready to be dumped on the market.
Such a 20% requirement could be catastrophic. Real estate prices will plunge -- although I am sure the government will find a way to artificially prop them up. Just like in 2010 with the short-lived tax break. But that only delayed the real price drop (which is a function of buyer interest, affordability and access to credit, none of which were helped or addressed).
It would also do nothing to stop a repeat of the abuses of the mortgage/housing boom. Democrats in Congress want to argue (because they cannot honestly believe) that the housing bubble and ensuing foreclosure wave, evictions and home equity erosion were caused by homeowners not putting down enough money up front at purchase. This approach blames the buyers, when the fault lies with the banks' risky underwriting practices.
You will not hear that argument...because that requires blaming the bankers.
While the size of a down payment is predictive of default risk -- and it is believed that homeowners will be less likely to abandon homes when their own money is at stake -- the hard reality is that the size of down payments had nothing to do with the housing bubble and other abuses.
It was the banking industry which altered its underwriting practices, abandoning risk control in order to gain market share and capture lucrative fees by throwing mortgages at bad credit risks. In fact, the mortgage products which became popular in the last decade were not by themselves the problem. These products, loans like the no-income, no-asset mortgage (the so-called "liar's loan"), the negative amortizing mortgage, and the interest-only loan offering a teaser of lower monthly payments to homeowners, were by themselves not risky.
The risk was in presenting, pushing and underwriting such loans to people who had no business being offered -- or taking -- any mortgage, of any amount and at any terms.
There were homebuyers whose income could not support any reasonable mortgage. These were the people who would have defaulted even if they made a 20% down payment and had the safest loan out there -- a 30-year fixed rate conforming loan. (Arguably, a shorter loan period like 15 years would be even safer.)
Horribly bad credit risks were given mortgages in the last decade. Illegal immigrants got mortgages as banks issued large loans to people with an individual taxpayer identification number ("ITIN"), not a social security number. The banks made money on each loan and then sold the loans to investors, shedding the default risk. The banks made money then...and now the Democrats in Congress want to shield them from all blame for the banks' bad business decisions of the past.
Banning certain mortgage products and requiring higher mortgage rates is just a deceptive, Machiavellian way to give the banks a pass.
Small down payments were not a cause of a bubble. But increasing required down payments will cause a new housing price crash.
Eric Dixon is a New York lawyer, strategic analyst and business consultant. Mr. Dixon can be reached for comment or consultation at 917-696-2442 and by e-mail at edixon@NYBusinessCounsel.com.