20% Down Seems Like Ancient History

Does anybody remember the old days when home buyers actually made sizable down payments — often 20% or more — when they bought their first house?

New national survey research reveals just how dated and quaint that concept has become in today’s market, thanks to rocketing home prices that have far eclipsed buyers’ incomes and savings.

From mid-2005 to mid-2006, according to a statistical sampling of a representative group of 7,548 purchasers, nearly half of all first-time buyers financed the entire transaction, obtaining mortgages in the full amount of the home price. Also, 30% put down 10% or less.

The research was conducted by the National Assn. of Realtors, using information on home transactions supplied by Experian, a major credit and realty data firm. The median down payment of first-time purchasers, according to the study, was just 2%. In other words, the median-sized mortgage for first-timers represented 98% of the home purchase price.

The highest loan-to-value ratios for first-time buyers were in the South, where the median mortgage amount was 100% of the sale price. In the West, the median was 99%, in the Midwest 98%, and in the East, 96%.

By comparison, the typical repeat home buyer nationwide invested a median 16% as a down payment to purchase a replacement home — typically from the proceeds of a prior sale — and financed the remaining 84%.

Where did first-time buyers obtain even the relatively modest down payments they made? Seventy-three percent of the survey respondents said at least part came from savings accounts, and 22% said relatives or friends chipped in as well. One out of 10 said their down payment came from liquidations of stocks or bonds.

The biggest down payment resources for repeat buyers were the profits they made from their prior sales. Sixty-two percent of repeat buyers depended on those resources. But 40% also took money from savings accounts to help swing the deal, and 6% sold stocks or bonds. Just 3% got help from relatives or friends.

Besides high prices, a key reason for the relatively high levels of leverage being used by both first-time and repeat buyers has been the explosion of low-down-payment options .

Before the mid-1980s, the plain-vanilla, 20% down mortgage was virtually the only game in town. Now, 100% financing — often using a first mortgage of 80% or 90% of the home value combined with a second mortgage or credit line for 20% or 10% — is commonplace. So are 5% and 10% down payment conventional loans with private mortgage insurance, and 3% down payment Federal Housing Administration (FHA) loans.

Although all these minimal-down plans have been highly successful in pushing the homeownership rate in the United States to record heights — currently just under 69% — they’ve achieved this in an atmosphere of steadily appreciating home prices and values. The possibility of low or no appreciation hasn’t been a concern for buyers using minimal down payments in most parts of the country since the mid-1990s. That’s because if you could obtain a loan that got you into a house with almost no money down, there was no problem: Appreciation — sometimes at double-digit annual rates — would take care of you from then on.

But that’s no longer the case. Buyers who made small down payments in 2005 and 2006 face a starkly different prospect: They started with minimal or no equity, and they may still be in the same position. Worse yet, they could be temporarily “upside down” on their mortgages, with a principal balance greater than their current home value.

People who bought in hyper-appreciating markets could be vulnerable financially if they have to sell on short notice because of a job transfer or they can no longer handle the monthly payments.

Bottom line: Leverage in real estate slices both ways. A minimal investment can produce impressive returns if the appreciation tide is rising. But it can also expose you to a negative-equity situation when the tide recedes.

The jury is still out on how well highly leveraged recent buyers from 2003 to 2006 will handle a period of slow growth in their home values. Can they hang on until appreciation returns and raises their equity holdings? The mortgage and real estate industries — to say nothing of the Wall Street bond investors who’ve financed trillions of dollars worth of these loans — are banking on it.