Down Payments Shrink toward Extinction

Prior to the recently ended bull market in real estate, it was traditional to make a 20 percent down payment when taking out a home mortgage loan. Because of inflation, however, lenders began letting consumers commit less cash up front. This trend may contribute to riskier borrowing habits.

In the heyday of the 20 percent down payment, the median price of a home in the U.S. was around $125,000-about half of what it is today. As home prices surged, down payments almost doubled, making it more difficult for buyers to put down their 20 percents to qualify for home mortgages. Lenders, who were seeking ways to retain their business volumes, relaxed their down payment rules, and began allowing such liberal lending vehicles as 100 percent home loan financing. As a result, the real estate market behaved like the bulls running at Pamplona.

Reality check

The recent real estate downturn has been a reality check for both lenders and consumers. A large number of highly leveraged loans are turning into foreclosures. In many instances, the easy credit that banks extended has translated into homeowners who are financially overextended and banks strapped with bad loans. 

• According to data from the National Association of Realtors, almost half of all first-time buyers between 2005 and 2006 financed the entire transaction through 100 percent mortgages.

• Of those who made a down payment, 30 percent put down 10 percent or less.

• The average first-time buyer leveraged approximately 98 percent of the purchase, a statistic that many economists find alarming in a time when the savings of the average American is lower than it's been since the Great Depression.

• Repeat home buyers-thanks in large part to large profits they reaped through selling previous homes-typically made down payments of more than 15 percent, a statistic that underscores the fact that real estate is still one of the best investments someone can make. 

In a rising market, 100 percent leverage can pay off; but it's a potentially risky strategy. If you're considering a home loan mortgage, don't view the down payment as your enemy. If you can make a substantial one, it may turn out to be a safe and sound investment that saves you tens of thousands of dollars in interest. Down payments can provide you with three things: (1) positive returns in the future because of possible equity appreciation; (2) peace of mind knowing that you aren't overextending your finances; and (3) the convenience of lower monthly mortgage payments.