Today’s minimum down payment homebuyers are in big trouble

Leaping interest rates and falling prices have any reasonable homebuyer walking backwards out of the closing room. And yet, some more adventuresome homebuyers are still rolling the dice — and buying with very little cash in their pocket.

Nationwide, the share of mortgaged homebuyers who purchased during March through July 2022 included:

• 21% who put down more than 20%;
• 20% who put down 20%
• 21% who put down 10%-19%;
• 9% who put down 6%-9%;
• 16% who put down 3%-5%; and
• 12% who put down less than 3%, according to Zillow.

The majority of 2022’s homebuyers put down less than 20%, with an alarming 37% putting down less than 10% of the purchase price.

Meanwhile, home prices have fully reversed course from their May 2022 peak.

Here in California, home value losses have ranged from a precipitous 4% below the peak in San Diego’s low tier to a staggering loss of 10% in San Francisco’s high tier over the course of just three months, through August 2022.

While California home prices remain a tenuous 7% higher than a year earlier for low-tier prices, 9% higher for mid-tier prices and 12% higher for high-tier prices, this year-over-year spread is narrowing rapidly, quickly to turn negative in 2023.

For those who completed a mortgaged purchase in 2022, the 28% surveyed who put down less than 5% are already saddled with negative equity — and the number is growing.

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Underwater upon closing

No down payment? No problem!

This saying was commonly tossed around by real estate agents, brokers, institutional lenders and mortgage loan originators (MLOs) during the Millennium Boom years, when prices were leaping and wanna-be homebuyers were wringing their hands in anticipation.

The end result was a buildup of low- or even no-down payment mortgages — many of which were adjustable rate mortgage (ARMs) — which quickly took a turn for the worse when the housing market tipped upside down beginning in 2006.

Due to the necessary mortgage regulation changes instituted following the post-Millennium Boom housing crash, the mortgage market situation is not quite as dire today. But there are still several concerning parallels which can be drawn between the present-day low down payment buyers and their predecessors who ended up defaulting and losing their home through foreclosure or short sale following the Great Recession.

Today’s minimal down payments are a natural result of dwindling savings rates alongside two years of skyrocketing home prices.

The national personal savings rate has dipped to a decade’s low in 2022, at just 3.5% as of August 2022. Today’s savings rate has plummeted by necessity, as households struggle to make ends meet under pressure of the highest consumer price inflation since the 1980s.

But even though today’s homebuyers use of low down payments is easily anticipated and even backed up by a good reason, it’s bad news for housing market stability.

As home values continue to nosedive heading into what is becoming the 2023 recession, low down payment homebuyers who go under contract today will be underwater by the time they sign on the dotted line. Further, even homebuyers with a moderate down payment who buy today will find themselves underwater in a matter of months.

Underwater homeowners are unable to sell their home when unexpected circumstances necessitate they rid themselves of their asset. These include a job loss — as is common during a recession — a required relocation or household change. Their only solution is to:

• negotiate a short sale with the lender; or
• exercise their put option and allow the lender to foreclose.

Watch for all homebuyers who put down less than 20% during 2020-2022 to slowly but surely fall underwater in the next two years.

Home prices are falling like dead weight heading into 2023, slumping below pre-pandemic levels by 2024, and not finding a bottom until around 2025.

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