Finding Funds for a Down Payment

A soft second loan, sometimes called a silent second, is subordinate to the first mortgage, whose payment is deferred or forgiven until a specific date or the resale of the property.  This would mean that buyers would not have to contend with regular payments thereby keeping their debt-to-income ratio lower and more affordable.

While normal lending institutions may not be open to such types of financing, family and friends may be.  In some cases, these relatives and friends may be inclined to make a gift to help buyers get into a home.  Instead of an outright gift, if the person makes the loan, they have options to be repaid at some point in the future or in other cases, they could forgive the debt but don't have to make that decision today.

There are more than 2,000 down payment assistance programs nationwide.  State, county, and city governments run many of them.  Other programs could be from churches, employers, non-profit organizations, regional Federal Home Loan Banks, federally recognized Native American tribes and their sovereign instrumentalities or public agencies.

Various local or state Housing Finance Agencies have used "soft second" mortgages for down payment and closing costs to eligible borrowers.  For example, the Indiana Housing and Community Development Authority offers down payment assistance in the amount of 3 to 4 percent of the purchase price of the home at zero percent interest with no monthly payments. The loan is fully forgiven after two years if the borrower remains in the home.

In a more mainstream application, let's say that a parent or other relative was willing to help a buyer with their down payment and possibly, closing costs to purchase a home now.  However, they will need the money for their retirement at some determinable point in the future, possibly, five to ten years.

The sales contract would disclose a "soft second" together with the terms which could include interest and due date such as ten years from execution of note or when they sell or refinance the property whichever comes first.   It would also specify that no payments would be made until the maturity.

The mortgagor of the "soft second" may also retain the right to forgive the loan.

The lender of the first mortgage must be aware of the intended soft second and it should be mentioned in the sales contract so it can be underwritten by the lender appropriately.  Failure to disclose a soft second to the lender is illegal and borrowers who fail to do so could be prosecuted.  Mortgage fraud is classified as a Class C felony under federal law.

Both liens would be recorded for public record for the safety of all parties concerned.

Since this procedure is not commonplace, the advice is to run this concept past your lender prior to writing the offer.  With full disclosure in the contract and the proper terms to satisfy underwriting, you should be able to structure a transaction to get a qualified buyer without a down payment into a home.

Some things to consider in the second mortgage note is a firm due date far enough down the road that it isn't going to trigger risk issues.  An example would be ten years or when the property is sold or refinanced, whichever comes first.  Specify an interest rate and arbitrary payments which would give the buyer the option to make payments if they wanted.  By doing this, the underwriter can calculate payments and amount owed at the term.

In today's economy, there are a lot of companies that have rich cash reserves, as well as plenty of individuals also.  Once buyers have identified a friend or relative to become the lender on the second mortgage, your agent will help you find a lender for the first mortgage who is willing to participate.

The buyer will become pre-approved and the process of finding the home can begin but not until the other steps have been finished.

"Do you feel lucky? Well, do ya?"

You may remember the famous line in the Dirty Harry movie when Clint Eastwood has just had a shootout with bank robbers and is standing in front of the lone surviving thief who is considering going for his gun. Harry with his gun pointed at the bad guy says to him ""Did he fire six shots or only five? Well, to tell you the truth, in all this excitement, I kinda lost track myself. But being this is a 44 Magnum, the most powerful handgun in the world and would blow your head clean off, you've gotta ask yourself one question: Do I feel lucky? Well, do ya?" 

Our economy has had a long recovery from the great recession, due in most part to the housing crisis of 2007-2009.  Then, the Pandemic hit in 2020 which tanked the worldwide economy but the surprise to homeowners happened to be housing.  2021 became a red-hot market with prices going up by 21% nationally. 

In 2022, mortgage rates have increased by four percentage points and haven't been this high since 2008.  Inflation, at the end of September, reached a 40-year high at 8.2%.  The Fed recently said they'll continue raising rates until they can get inflation near their target of 2% annual rate.

People who own homes have seen their values go up dramatically and so has their net worth. Due to the extremely low inventories and the maturing millennial market, there is a lot of pent-up demand for housing.

This leads us to the scene in the movie.  You may be considering buying a house now but at the same time, you're thinking "Have prices and mortgage rates hit the top of the market so they'll start coming down or will they continue to go up, making it cost more to get into a home?"

The facts are that the U.S. is the strongest economy in the world.  The housing bubble of 2007 was created by over-inflated property values and predatory lending practices.  Those conditions don't exist today.  There is a housing shortage in America due to not enough homes being built to keep up with demand and people staying in their homes longer.

Homeowners have record amounts equity in their homes and foreclosure rate hit a historic low at the end of 2021 even though it edged up a bit in spring of 2022 as reported by CoreLogic.

Homes are expected to continue to appreciate but not as fast as they did in 2021.  The revised predictions for 2022 appreciation vary from Fannie Mae at 16%, Freddie Mac at 12.8% to NAR at 11.5%.

NAR Senior Economist Nadia Evangelou recently said "Mortgage rates are a heartbeat away from the 7% threshold. According to Freddie Mac, the 30-year fixed mortgage rate rose to 6.92% from 6.66% the previous week. While inflation remains elevated, mortgage rates will continue to move up, making homeownership even further out of reach for many."

If the home you could buy this year for $500,000, will cost you $550,000 next year and the mortgage rate goes up from 6.5% to 7.5%, the payment will go from $2,844 to $3,461 based on a 90% mortgage for 30-years.

If interest rates are temporarily high based on the Fed's position to lower inflation, a home could be purchased at today's price and refinanced later when the rates come down.  5/1 adjustable rate mortgages allow a borrower to lock in a lower initial rate for five years which would allow a person to find the best time to refinance.

So, back to the movie scene... "you've gotta ask yourself one question: Do I feel lucky? Well, do ya?" 

When will the market turn?

Housing affordability has declined dramatically in 2022 due to continued rising home prices and a three-percentage point jump in mortgage rates.  Based on the popularity of Google searches for "housing bust" or "housing bubble", it could be surmised that buyers are anticipating relief, but they are probably not going to see it anytime soon.

Home price appreciation is moderating and is down from the 20% level experienced in 2021.  Some of the major industry prognosticators are estimating anywhere from 9% to 14% for 2022.  Interest rates are expected to continue to rise through the end of 2022 and could be at 7%.  Freddie Mac 30-year fixed-rate mortgage was 6.66% on October 6, 2022.

Even though homes currently for sale increased to 3.2 months in August 2022, it isn't that much more than it was for the same month in 2021 when it was at 2.6 months.  Most markets are still entrenched in favor of sellers because a balanced market between buyer's and seller's is at six month's supply.

While buyers may be feeling that a new home is no longer affordable, there are several affordability indexes that provide a baseline for objective measurement.  The National Association of REALTORS� produces a monthly index.  Affordability is determined by indicating a median income person/family can afford to purchase a median priced home with a 20% down payment based on a 25% qualifying ratio for monthly housing expense to gross monthly income. 

The index is structured so that a value of 100 indicates that a family with the median income has exactly enough income to qualify for a mortgage on a median priced home.  When the index is above 100, the family has more than enough to qualify.

The NAR Housing Affordability Index for 2019, 2020, and 2021 was 159.7, 169.9 and 152 respectively.  It was 143.1 in January and by April had decreased to 108.1 and the preliminary number for June is 98.5.  The decrease in the index is directly affected by rising interest rates and home prices outpacing family income.

Home sales were seasonally adjusted in August to be 4.8 million which is down .4% from the previous month and down 19.9% from August 2021.  Lower sales are partly a function of a smaller pool of eligible buyers and concerns about a variety of economic conditions.

This may not sound like good news for buyers whether they are labeled first-time or move-up, but it is an objective view of the market.  It has become more expensive to buy a home now and will continue to increase in the future. 

Getting into a house using whatever devices are necessary can at least put the momentum on your side.  Homes are appreciating faster than inflation and the fact that leverage improves the growth rate due to using borrowed funds to buy the home is also to the buyer's advantage.

So, getting back to the original question "when will the market turn to make homes more affordable?"  It may not be a dramatic change but more likely, a subtle one.  Prices will moderate by still appreciating but not as much as in 2021.  Inventories will increase slightly but won't affect price because the low supply has been almost a decade in the making and it will take time to reach balance in the market.

Mortgage rates are not as low as they were, but they never were before in the history of the U.S.  Millions of people had mortgages in the 1980's that were as high as 18.5%.  Buyers financed the homes at the going market rate, sometimes with creative financing, and refinanced the properties later when the rates came down and the values had gone up.

Real estate is still a great hedge against inflation, and many times, the largest and best investment individuals have.  The Federal Reserve Survey of Consumer Finances found that homeowner's net worth is 41 times greater than renters.

Another Tool to Improve Affordability

The rapid rise in mortgage rates during 2022 coupled with continued appreciation of home prices have limited the number of buyers in the market which is reflected by the lower number of home sales currently.  "It's a fact that many households are impacted by higher mortgage rates as they no longer earn the qualifying income for the median-priced home." Nadia Evangelou, NAR Economist

One of the things that agents are doing to help buyers lower their house payments is to suggest an adjustable-rate mortgage.  The rates on these types of loans are tied to indexes that reflect the current market rates and produce less risk for the lender.  The payments adjust on the anniversary date based on the index plus margin named in the note.

While many people think that they only adjust upward, they also adjust downward when the index indicates it.  For the week of September 29, 2022, the Freddie Mac 5/1 ARM was 5.03% compared to the 30-year fixed-rate of 6.70%.

Another tool that experienced agents are using to address affordability issues are interest rate buydowns.  In recent years, there have not been many buydowns used because interest rates were already very low, but now, more people are considering them again.

A buydown is prepaying the interest on a mortgage at the time of closing to lower the payment for a specific period or for the term of the mortgage.  Obviously, it would be more expensive to buydown the rate for the whole term of the mortgage.

Either the seller or the buyer can buydown the rate and it would be specified in the sales contract.  From a practical perspective, sellers in the recent past haven't had to consider this option because of the high demand and multiple offers that were commonplace.  Now that sales have slowed, and both inventory and market time is increasing, some sellers want to make their homes more marketable and are seeking a competitive advantage.

A common temporary buydown is called a 2/1 which reduces the payment in the first two years of the loan by calculating the borrower's payment at 2% less than the note rate for the first year and 1% less than the note rate for the second year.  Years three through thirty, the payment would be the normal payment at the note rate.

A buydown is a fixed rate, conforming mortgage that the borrower must qualify at the note rate to indicate that borrowers will be able to afford the mortgage after the first two years of lower payments.

As an example, on a $400,000 sales price with a 90% mortgage at 5.54% interest for 30-years, the normal principal and interest payment would be $2,053.08.  By using a 2/1 buydown, the payment for the first year would be at 3.54% interest, 2% lower than the note rate, making the payment $1,624.61.  The second year, it would be at 4.54% interest, 1% lower than the note rate, making the payment $1,823.63.

The buyers' payment would be $428.47 lower each month for the first year and $220.45 a month lower for the second year.  The total savings would be $7,787.04 which becomes the cost of the 2/1 buydown.  This amount must be paid at the time of closing by either the seller or the buyer.

 

2/1 Buydown Example	1st Year	2nd Year	3rd ... 30th Years
Interest Rate	4.7%	5.7%	6.7%
Principal & Interest Payment	$1,867.10	$2,089.44	$2,323.00
Monthly Savings	$455.90	$233.56
Annual Savings/Total Savings	$5,470.80	$2,802.72	$,8,273.52

The most prevalent providers of buydowns in the past have been builders.  It is a concession like paying closing costs or upgrades for the buyer.  As sales have started to slow, some builders in particular price ranges and areas are currently considering this benefit to close more sales.

To summarize: a buydown is a fixed-rate mortgage where the interest is pre-paid for a period to help the borrower with lower payments for a time.  A 2/1 buydown allows the buyer to have significantly lower payments in the first two years which will give them time to settle into the house while they can be confident of what the payment will be in years three through thirty.

The pre-paid interest is deductible for the buyer, even if the seller pays for it.  This is something that the buyer will want to talk about with their tax advisor when they are doing their income tax for that year.

If you are selling a home, talk to your listing agent about this option to increase marketability.  If you are a buyer, discuss this as an affordability option.  If your agent isn't familiar with buydowns, ask them to research it with a trusted mortgage officer.  Buydowns are legal and have been available for decades.  The determining factor may be whether the market has softened enough that sellers are willing to consider them.