Beware The Low-Down, No-Down Real Estate Deal

By now, it should be clear to even the most casual observer that real estate is by no means a completely safe investment.  In fact, recent experience has shown that real estate is far from it – for millions upon millions of people, buying a house has turned out to be the worst investment they ever could have made.

Underwater

You see, in the boom days, it was common to extol the idea of “leverage” as one really great reason to get into real estate.  For example, you could buy a property with virtually nothing down, and leverage 100% of the purchase price.  This was seen as a big benefit of residential real estate investment, since the price appreciation would be based on the value of the property, not on the value of the cash you invested.  The opportunity to highly leverage your real estate purchase meant that you could potentially make a great deal of money on your initial investment when you went to sell the property.

Unfortunately, being highly leveraged in a property is not without its drawbacks.  Being highly leveraged is the same as having little equity in the property.  If the property value should decrease, it wouldn’t be long before you owed more on the property than it is worth.  You would become under water on your mortgage.  Once you are under water on your mortgage, it becomes difficult to get out of the mortgage.

There are a number of ways out of this regrettable situation, however none of them will be particularly appealing.  One simple way to solve the problem is with cash; a borrower can simply pay down the debt with cash and re-finance to a lower principal loan.  Easy, right?  Of course, very few borrowers will have sufficient cash to make this approach work.  More commonly, borrowers will either:

• a) walk away from the debt (that is, they get foreclosed on)
• b) do a short sale (satisfy the debt by selling and paying back less than the amount owed)
• c) re-negotiate with the lender to get a loan modification that may include some principal forgiveness (such that the bank writes down the value of the debt to present market value) – or
• d) simply just continue to make payments on a debt which exceeds the value of the home.

All of these options are filled with some degree or another of pain, and no homeowner relishes the thought of owing more on the property than it is worth.

Today, it is not as common as it once was to get 100% financing.  However, it is possible to get 100% financing, depending on the property and your circumstances.  VA loans and USDA loans are two options, and there are some “down payment assistance” options which can be used in combination with, for example, a FHA loan which requires only 3.5% down, such that the effect is the buyer is extended 100% financing.

The question you should ask yourself is:  do I want to leverage myself to this extent?  Let’s put aside the risk that by being so highly leveraged it’s pretty easy to get underwater with your mortgage thereby making it very difficult for you to sell if you need to.  A higher debt-to-value ratio will mean, of course, higher mortgage payments.  Your payments will be higher of course because the debt is higher – but your payments will also likely be higher for two other reasons:

1. your interest rate will likely be higher, and
2. you may need to pay mortgage insurance.

Before signing your loan papers for one of these low-down/no-down, highly-leveraged loans, think about the considerable risk that you are exposing yourself to, and also think about how much it’s really going to end up costing you.  There are good reasons to wait and save for a substantial down payment on whatever home you end up buying.  Just because you don’t need to save up doesn’t mean you shouldn’t.