How to buy a home in 2009

04.29.09
By Randy Johnson

The housing industry has constantly been in the news for the past year. Everyone is aware that there are lots of problems. Specifically, foreclosures are at record levels and housing prices in most markets have declined. But every problem creates opportunity, so how does the current situation affect first-time homebuyers? Let’s look back in history to get some perspective.

Historically, the number of home purchases has been tied to the affordability index, or the ability of an average-income buyer to afford an average-priced home at the current average interest rate. Housing prices have usually gone up year after year, as has income, but during my career I have seen interest rates go from a high of 16 percent to the current rates under 5 percent.  

Factors that this index does not measure are the down payment requirement and the underwriting criteria used by lenders. In my career, the down payment requirement has gone from 20 percent down to 10 percent, and from there down to 5 percent and even as low as zero. As these numbers change, so do the fortunes of first-time homebuyers.

Additionally, lenders – particularly subprime lenders – relaxed their standards so much that virtually anyone could get a loan. Who even thought of the affordability index in times like those? We are now suffering from a hangover for that extended binge. So what is going on in the minds of lenders today? Well, financial responsibility and caution is one major change.

Financial responsibility is learned behavior. Kids often do not have the ability to earn money until Mom and Dad set them up with an allowance. Smart parents tie chores to the allowance. The kid has to do something constructive to earn the allowance. They are, or should be, taught to save money from the allowance to be able to buy what they want in the future. More importantly, they learn that they can’t have it today! What they should end up learning is that financial responsibility is a matter of choice.  

Sadly, this is not always the message the kids get because many parents are financially irresponsible. We didn’t become a nation of credit abusers without kids learning the financial behavior they see around them: Material spending accompanied by little or no saving, and often much credit debt.

The old industry maxim used to be that borrowers had to have “demonstrated habits of thrift.” That means that they could show that they had developed the habit of saving money on a consistent basis so as to accumulate a down payment. The experience was that people who did that turned out to be good risks for a mortgage.  

Of course, you know people who not only don’t save, but they can’t even live on their take-home pay. When they run out of cash, they pay for things they want and need by running up their credit cards. Such people do not “demonstrate a habit of thrift,” and to make matters worse, sometimes they are downright financially irresponsible.

In my twenty-eight years in the mortgage business, I have had people from all across the financial spectrum come to my office. As a result, I have been able to see this thrift phenomenon first hand, to see what people have done financially to land them wherever they are. There are a lot of contrasts.

I can get a good impression pretty quickly about people just by looking at a few characteristics. Some have chosen to save money every month while others never have much cash available at the end of the month and may carry burdensome credit card balances.

On the other hand, there are those people who stay in the old apartment that costs $600 per month less than a bigger one in a more up-scale part of town. Some people choose to buy the hottest new car, while others do with a ten-year-old clunker. Each choice, paying lower rent and not having a car payment, gives these “savers” more money to stick into a savings account. Maybe it’s $1,000 per month; after three years, they have $36,000 for a down payment.  

Until the subprime fiasco, the mortgage industry served as a strict teacher, the kind who rapped you across the knuckles with a ruler if you didn’t learn your lessons. Thus if you made a succession of poor choices over the years and on top of that you didn’t have a down payment, the mortgage industry wouldn’t let you join the Homeowner Club.

In the past five or six years we have engaged in an experiment to see what happens when you throw those old rules away. The results have not been good. It wasn’t just homebuyers but a ton of people on Wall Street and all over the world who got hooked on leverage, making big bets with other peoples’ money.

There are examples at every turn, where people who in yesteryear would never have qualified were buying homes with 100 percent financing. And if the gamble didn’t work out, they just walked away – or the lender took the house away himself. The current high level of foreclosures is no doubt tied to the large numbers of these imprudent loans.

Consequently, the mortgage industry has eliminated the zero down loans, and rightly so. Today, FHA loans require only a 3.5 percent down payment, but for conventional financing, you need 5 percent. In some fragile “declining market” areas like California, Arizona, Nevada, and Florida, you may need 10 percent down.

So if you are an aspiring homebuyer, you should know that it is back to “ole time underwriting.” You ought to sit down and commit to some goals about how you can come up with sufficient money to make an acceptable down payment on the home of your choice. Maybe that won’t be this year, but it will happen sooner the earlier you start.

The good news is that for those who are prepared to act, prices are lower than they have been in years. Coupled with the lowest interest rates in over thirty years, great homes that many people couldn’t even consider a couple of years ago are highly affordable now.

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Home prices are lower than they have been in years.