An under-reported study conducted by the St. Louis Fed reveals a very different narrative with regards to the causes of the recent housing crisis. Researchers studied national foreclosure demographics to determine if predatory lending played a crucial role in the recent housing collapse. Economists were able to hone in on two demographics that made up a large share of foreclosures, but the findings were quite the opposite from what you’d expect.
The two wealthiest socio-economic demographics made up the largest share of foreclosures during the housing bust. These individuals had the highest average salary, highest level of average educational attainment and the greatest amount of financial promise. How do the most promising Americans lead a foreclosure tsunami?
No doubt the reasons for the Great Recession will be argued for decades. However, judging from the political narratives that have already taken hold, you probably never would have thought low closing costs were a major contributor.
All first-time homebuyers should be thankful for those giant, upfront cash requirements banks establish as a requirement for a mortgage. I know. It’s a lot of money and a massive one-time expense. I’m certain that there are plenty of people who think it’s overly burdensome or even unfair. However, there is a very good reason the bar is set so high.
First of all, coming to the closing with a hoard of cash is a benchmark for soon-to-be homeowners. Like a test, banks make the initial investment requirements large to see if you have the ability to come up with the money. If you struggle saving for down payments and origination fees, how can you expect to weather a mortgage payment and additional costs associated with homeownership?
Additionally, by putting up a large chunk of your own cash when buying a house, you are putting skin in the game. If you paid no costs at the time you bought the house, what would you lose if you decided to never make a mortgage payment? Putting your own money on the line makes it harder for you to walk away from the house. It does one more thing, too:
The motivations above are effective enough to decrease your chances of foreclosure.
Now that I’ve explained the importance of closing costs in preventing foreclosure, you should know that many homebuyers no longer pay them out of their own pockets.
Many opt to bargain for the seller pay their closing costs instead of asking for a price reduction. A survey by a California realty firm listed seller paid closing costs as the most common concession offered to buyers in purchase agreements. Nearly 66% of all home sales included these provisions. HUD found that homeowners with FHA loans where sellers paid closing costs were three times more likely to end up in foreclosure.
If it’s not the seller paying the closing costs, it is mom and dad. The same California realty survey reported that on one in four homebuyers receive assistance from their parents to pay closing costs.
I commiserate with prospective home buyers that large initial cash requirements are a tough nut to crack, but an important one to tackle on your own.
So if paying large sums of money through closing costs is somehow good, requiring two or three times the current minimal down payment must be extra good for prospective homebuyers?
New financial regulations enacted by the recently passed Frank-Dodd bill aim to make it more costly for homebuyers with less than a 20% down payment to obtain a mortgage. While I’m clearly a proponent of going it alone in obtaining money for your closing costs, I think the new regulations are taking this concept too far.
It isn’t necessary to raise the amount of money people need to pay at closing. Homebuyers just need to pay the rates, as they currently are, on their own.