Thursday, February 16, 2006 | Not so long ago, it was very much standard practice to make a down payment of at least 20 percent when purchasing a home.

But those days are behind us. Thanks to “piggyback loans” and other financial innovations, home buyers are effectively able to make whatever down payment they choose. Often – by which I mean, very often – buyers choose not to make a down payment at all.

The extensive use of zero-down mortgages may be a convenience for many homebuyers, but it puts the local housing market at substantial risk.

For an idea of how many buyers are putting down how much, take a look at the accompanying chart. An amazing 35 percent of 2005 San Diego home buyers put no money down at all.

This is not necessarily a bad thing unto itself. There is, after all, nothing sacred about 20 percent down payments. But given that home prices in many areas of San Diego have been fairly flat over the past 12 months, many buyers who made no down payment still owe around 100 percent on their homes. That’s a lot of people with no substantial equity to speak of. And to this number, we can add the immeasurable hordes who have utilized cash-out mortgage refinancings or home equity lines of credit (HELOCs) to drain their homes of equity.

All in all, a significant amount of homeowners effectively owe 100 percent on their homes. And that’s a problem, because none of these people have “skin in the game.”

In the down-payment days, home owners were encouraged to weather whatever financial storms they could in order to hang onto their houses. To do otherwise would result in the loss of their down payments and all the equity they’d accrued over the years.

Now, between zero-down loans, cash-out refinancing, and HELOCs, there are a lot of home owners out there who don’t have any such incentive. They have very little invested in their homes. If any of these homeowners run into financial trouble, they will, unlike the 20 percent down-payer of old, have little reason to stick around.

It simply doesn’t make financial sense to try to tough it out. If you have 5 percent equity in your house, and it costs you 6 percent in agent fees alone to sell, you are losing money by selling. If housing prices decline, you are losing even more. At some point, the most economically feasible thing is to hand the keys over the bank, who will then sell your home as a foreclosure. Home foreclosures can be tragic for the homeowners, but more to this article’s point, a large number of foreclosures are quite negative for the housing market as a whole.

The scary part is that it seems almost inevitable that many homeowners will run into financial troubles. The preponderance of adjustable-rate mortgages (ARMs) exposes borrowers to higher monthly payments once their loans begin to reset. Given the rather inexorable rise of short-term rates over the past year, ARM holders with loans that reset anytime soon are likely to see substantial payment increases.

Even worse off are holders of interest-only and negative-amortization loans, which basically allow the borrower to get lower payments up front in exchange for higher payments later on. These borrowers will eventually have to start paying off principal in addition to taking the hit on higher interest rates. The head of the U.S. Office of the Comptroller of the Currency recently estimated that such borrowers could see their payments increase 50 percent or even 100 percent.

The pain of mortgage resets could be compounded by job losses, which are unfortunately somewhat likely due to the economic dependence on housing that I discussed a few week’s back.

The fact is that, in many of these situations, taking on the burden of increased payments will seem like a less appealing option than simply walking out of a property in which the ostensible “owner” has no equity.

Zero-down mortgages sure have made for a fun housing market over the past few years. But they also make for a dangerous combination with looming mortgage payment shocks and housing-related job loss. There are too many players with no skin in the game, and should times get tough, some of those players could send things from bad to worse.

Rich Toscano is a financial advisor with Pacific Capital Associates and Girard Securities; he also writes about San Diego real estate at Piggington’s Econo-Almanac. Contact him at

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