Coming by a down payment acceptable to today’s mortgage lenders is altering the outlook for homebuyers in this post-Millennium Boom era, following 30 years of ever relaxing mortgage qualification requirements. While 100% financing came to be regarded as the standard during the Millennium Boom, today’s homebuyers in need of purchase-assist financing are again making down payments, but in amounts significantly less than 20%.
It seems many homebuyers are receiving help from family and friends in order to meet minimum down payment requirements. Since most lenders require homebuyers to have some money in the bank after closing, gifts that allow homebuyers to make a down payment without depleting their savings can be vital.
first tuesday take: Receiving a down payment donation helps homebuyers meet minimum down payment requirements and agents close more deals, but gifts are detrimental to the public’s perception of the need for personal savings in relation to the acquisition of a home. Personal savings rates declined steadily in the 30 years prior to the Great Recession. They then rose during the Great Recession (as is always the case in recessions), but fell again in 2011. Thus, the ability to meet the traditional 20% down payment requirement has dwindled. [For more information on savings and down payment requirements, see November 2011 first tuesday article, The 20% solution: personal savings rates and homeownership.]
The inconsistency between the financial responsibility of owning a home and the low initial investment is problematic, evidenced by the chaos within today’s real estate industry. By financing a down payment with gift donations, homebuyers do not establish enough personal skin in the game, their stake in ownership. Skin in the game is crucial, as it fosters an imperative sense of loss if a homeowner fails to make payments on their own. Thus, the less a homebuyer initially invests of their own wealth when acquiring a home, the more likely they are to default in payments. [For more information on the benefits of requiring a greater fiscal risk, see March 2011 first tuesday article, Whose skin is in the game?]
Meeting the standard 20% down payment (not in gift funds) requires the homebuyer to have undertaken the instructive process of accumulating ample savings. That savings process gives homeowners the appreciation of the wealth they will store in their homes and the principal amortization through mortgage payments required for long-term homeownership. Although providing a friend or relative with a financial donation may help them with making their initial down payment, that same gift is a barrier to expectations by other future homebuyers about the need to first save to become a homeowner later on down the road.