Michigan Loan Experts

Why Banks Are So Fixated on 20% Downpayments. Is It Enough?

Why do banks like to see a home buyer make a downpayment of at least 20%?  Basically it's Two reasons.

1. Statistically speaking people who put down 20%, or who have 20% of equity in the property, were highly unlikely to go into foreclosure.  Banks don't like to foreclose so that seemed the safe amount to require people to put down when buying.
2. If the bank does foreclose then a 20% discount from the 'market value' was what the home usually ended up selling for.  If the owner had 20% equity then the bank typically didn't lose much, if anything on the subsequent sale.

Well now were awash in a tidal wave of foreclosures.   There is significant anecdotal evidence that the 20% rule isn't helping banks right now.

Looking at some recent bank sales the prices are going anywhere from 30-70% of the past sale.  So even if the buyer did put down 20% and the property sold at the high end the bank is still at a 10% loss on the property.  Having PMI would still put the bank at the same loss since PMI typically only insures the lender to the equivalent of a 20% downpayment.

In other words, banks in Michigan are taking losses on loans and on the underlying collateral, too.  This trend is part of the reason that several lenders have over the past year simply decided to pull out and not lend anymore in Michigan.  The lenders who have stayed are doing more rigorous reviews of appraisals.

Absorbtion Rate Primer

Absorption Rate is a real estate term for the length of time required to sell all of a given stock in a given area. 

Savvy real estate agents use it to show sellers how quickly homes are selling in a neighborhood.

Absorption Rate calculation is simple:

• Take the number of homes on the market
• Divide it by the number of closed home sales in the last month.

For example, if 100 homes are on the market now and 9  homes closed in the past 30 days, the absorption rate is 100/12, or 8.33 months.

 

In this example what it means is that with just the homes on the market now it will take over 8 months to sell them all.  A very high number indicates a very buyer friendly market.

"Repair Credits" could kill your sale

The Southeastern Michigan market being what it is, potential buyers usually shun any homes that need repairs and go straight for homes ready to move in.  So many houses are available that the buyers can afford to be extremely choosy on what to buy.

There are times though when a house with warts is still the one buyers want, but rather than just making a simple offer the buyers make an offer contingent on repairs being done.

At this point the concept of a 'repair credit' comes into play.

The seller may agree to the buyer's demands, but making repairs to a roof or anything else usually isn't convenient if the seller still occupies the house. 

A repair credit is a dollar amount written into the contract to be used to cover the costs of the requested repair.   

The repair credits offer a way for the seller to pay for the work without needing to pay before closing; the money is taken directly from the sale proceeds at settlement.

From my experience, most real estate agents, buyers and sellers, if left to write the contract without loan officer input, do it in such a way that the underwriters will red flag the property for additional review and possible denial.  Even if it goes to closing the loan officer will usually have a more difficult time with it, which usually causes more stress to everyone.

Fact: Unless its specifically a renovation, construction or some type of rehab loan - Lenders do not allow concessions for home repairs to be line-item credited on the final settlement statement. 

This is for two reasons:

1. The lender has no way of knowing that the repair will actually be made by the buyer
2. The lender has no way of knowing whether or not the repair is actually needed

A construction or rehab loan will escrow the money and have inspections to ensure the work is both needed and completed before releasing the funds, but without the protection of an escrow held by the lender those two problems raises the red flag we call "Appraisal Fraud". 

Michigan is one of the states with the highest incidents of mortgage fraud.  Appraisal fraud, where the value of the home is grossly inflated to its true value, is typically a part of most fraud.  In terms of financial crimes, mortgage fraud is one of the highest enforcement priorities for the FBI Michigan Field Office with numerous arrests made over the last two years.

So what's a honest home buyer and seller to do..

There are two correct ways to account for funds for a repair:

1. Depending on loan program you can usually be given between 3-6% in seller concessions.  Check with your loan officer to determine the amount allowed and in the contract make no mention of any repairs but just add this clause: "seller agrees to provide buyer with $xxxx amount in seller concessions". (Always consult with an attorney for the exact wording you should use in your specific situation, but this is the general idea of it)
2. Reduce the sales price by the amount agreed upon.  So if the seller wants 150,000 but the home needs 10,000 in work then drop the price to 140,000.

With either of these ways to handle the repair credit the seller gets the money he wants and the buyer avoids any potential problems with unnecessary fraud flags.

Subprime Troubles Add Downward Pressure to Housing Market

While people with good credit can enjoy still low interest rates the households with damaged credit face ever decreasing opportunities to obtain financing.  From 2001 to 2005 subprime mortgages went from 5% to 20% of new mortgages originated.  Many of those people were first time homebuyers that helped fuel the surge in housing prices.

With subprime mortgages being less available the number of potential buyers for homes in difficult real estate markets decrease as well.  Michigan has been in a housing downmarket for over a year, but according to Realty Times, housing markets nationwide are suffering with problems with subprime lenders being one of several causes.

National banks that once bought the loans of subprime lenders and resold them on Wall Street are now refusing to buy 100% financing deals or loans with a 'stated income' borrower.

The rapidly dwindling choices for damaged credit borrowers has just increased the burden for Michigan homeowners wanting to sell their homes. 

Just a month ago a buyer with low credit scores but still having a good job could get 100% financing.  Now with lenders raising their standards that same buyer would only qualify for 90% in most cases and perhaps be fortunate enough to get as high as 95% with some now hard to get underwriting exceptions.

Homeowners trying to sell need to really adjust to a realistic price if they don't want to continue owning their homes.  They also need to see what level of support they might be able to provide a buyer if they're trying to sell to a first time buyer that can only get a subprime loan.