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With good credit, zero down can put
you in a house, but know the risks


100% financing availableJust when you thought it couldn't get any easier to buy a house, the mortgage industry polishes up its silver platter again.

For the first time, a large number of lenders have begun offering 100 percent home loans at near-market rates to conventional borrowers. These no-down-payment deals, which are targeted toward people with good credit but not a lot of cash, are the industry's latest attempt at keeping business humming in the face of rising interest rates.

Borrowers face significant risks
Yet, just like the 97 percent mortgages that preceded them, these loans expose borrowers to significant risks. Because they have no equity, consumers could end up owing more than their homes are worth with even the slightest downturn in property values. Though the loans carry only a slight bump in the interest rate, they come with significantly greater private mortgage insurance, so the monthly payments will be tougher to make. As a result, experts caution that most consumers who pursue 100 percent mortgages will have little or no margin for error should even minor problems arise with the economy or their own finances.

"The reason underwriting guidelines ease up periodically is because everyone becomes generally confident and comfortable," says James W. Kemish, president of Power Mortgage Corp. in Delray Beach, Fla. And right now, "the stock market is doing well. The economy is doing well. Everyone is feeling good and people are paying their bills.

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"But, of course, there's a little warning in all of this," he adds. "The business cycle is not dead, and be it a year from now or 10 years from now, when there's a little bit of a change in the real estate market, you could see a lot of lenders singing the blues."

20% down an outdated notion
By now, the notion that somebody should have to put 20 percent down for a home seems as outdated as bathtub gin and the Model T. During the past two decades or so, borrowers have slowly but surely been allowed to pay less at closing, and the pace of that decline has accelerated in the late 1990s.

At the same time, penalties and costs associated with not paying as much up front have declined. This is in part because the two agencies that buy many of the loans lenders make, Fannie Mae and Freddie Mac, have shown a willingness during the past couple of years to purchase mortgages with less money down than ever before. Their entry into a market tends to drive down pricing and eliminate any interest rate premium that lenders would otherwise charge to compensate for their increased risk. In the spring of 1998, for instance, the agencies began purchasing 97 percent loan-to-value loans.

"We've been buying lower and lower down payment mortgages, and we will buy 3 percent down mortgages at this time," Fannie Mae spokesman Clyde Ensslin points out.

Zero downs available for the average person
Still, most 100 percent financing programs that were available before last year were aimed at specific areas or customer groups. A local bank might have offered them to low-income borrowers or people willing to buy in neighborhoods targeted for revitalization, for example, as part of a public-private partnership. But conventional customers, by and large, didn't have the same choice.

In 1999, though, that's no longer the case.

"Now there are many zero downs for just the average person," says Steven Parrish, owner of the Seattle mortgage brokerage Parrish & Associates. "Fifty percent of the lenders probably have some type of zero down product that will accommodate just about anybody."

The big push came from a private mortgage insurance company called United Guaranty, a subsidiary of American International Group Inc. Last year, it created a program labeled Borrower Advantage that allows consumers with minimum credit scores of 700 to finance 100 percent of a home's purchase price and, in some cases, part of the closing costs, up to a maximum loan-to-value ratio of 103 percent. The loan didn't really catch on until this spring, however, when companies that buy loans from mortgage brokers and hold them in their portfolios began pitching it aggressively.

"We felt we could insure the loan at 100 percent or more, provided the borrowers had good credit," says Terry Howard, director of product development at Greensboro, N.C.-based United Guaranty. "We felt like this would be a good product to offer to the market because you see a lot of people out there who are just getting started or are up-and-coming professionals who have the money to make the monthly payments but just don't have the down payment."

How the loans work
In many respects, 100 percent loans work just like regular mortgages. Borrowers can choose a number of different products, from 3/1 adjustable rate mortgages to 15- and 30-year fixed-rate ones. There are no additional closing costs and they are available in loan amounts up to $240,000. Some programs have even higher thresholds.

At the same time, most cost more than conventional loans. Borrowers should expect to receive a rate that's at least one-fourth of a percentage point to one-half of a percentage point higher than the rate a conventional loan with the same term would feature. Because private mortgage insurance companies charge more money the less a borrower puts down, 100 percent loans cost much more per month than other mortgages, too. A $100,000 loan might have an annual PMI premium of $970, or about $81 a month, according to Howard.

Borrowers who get this type of mortgage could run into other problems, too, because they have no cushion against hard times. If a manufacturing plant were to close in the neighborhood or property values were to decline, somebody could end up owing more than the house is worth.

Walking away and leaving house keys in the mailbox -- the way some Texas homeowners did during the 1980s oil-driven market collapse -- might get rid of the mortgage burden. But it would also leave a foreclosure stain on the borrower's credit report. Even if property values only slipped rather than collapsed, someone selling such a home could still end up having to pay money at closing to settle the mortgage balance. That's because payments during the early years of a home loan go mostly toward paying off interest rather than reducing principal.

"You'd want to make sure that you have good, stable income and that you feel comfortable with your job, that it's going to be there for a while," says Sue Huber, senior vice president at SunTrust Banks Inc.'s Crestar Mortgage division. The company plans to roll out its first 100 percent loans sometime in the next month.

"When you commit to something like that, you want to make sure you can afford to make those payments because you don't really have any equity in your home at all."

Stark reality due for stock market
There's another problem with full financing that lenders are starting to note: Many borrowers ask for 100 percent loans because they don't want to cash in their stock market portfolios to come up with a down payment. As long as stocks keep rising, they can always cash in later and prepay some of their balances under that strategy. But some think consumers who do so are just sticking their heads in the sand.

"While the stock market equity changes from day to day, the debt on their house doesn't," says Kemish, the Florida mortgage broker. "They're locking themselves into a significant amount of long-term debt and they're doing it with the hopes that their market investments never go down.

"A word to the wise would be: 'Nothing, no market cycle, has lasted forever.' "

For now, experts think 100 percent loans are here to stay. Though neither Ensslin at Fannie Mae nor Freddie Mac spokesman Douglas Robinson would say whether the agencies plan to start buying no-down-payment first mortgages, industry officials speculate that it's only a matter of time. That would likely fuel even more growth in a part of the mortgage marketplace that's already exploding.

"A lot of the reason this is showing up is that rates have gone up," says Crestar's Huber. "And, everyone is scrambling to find something new they can sell out there that's better than what the other guy has."

-- Posted: Sept. 2, 1999
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