In: Finance
There have been times where mortgage institutions have allowed borrowers to put very little down. Sometimes as low as 1%. What are some foreseeable outcomes of very low down payments? Why does this suggest that historically, 20% down payments are the norm? Why do many people believe the financial crisis of 2008 was because of too many low down payment houses?
House Value – Year 1 (Purchase) |
Money Put down by purchaser (Down Payment) |
Bank Loan (Mortgage) |
Tax Rate |
Interest Paid to Bank (10% loan – @ tax bracket) |
House Value at point of sale (after 3 years) |
Net Return on house investment (increase in house value – payments to bank) |
Return on Equity = Net Return / Money put down |
$100,000 |
$100,000 |
50% |
$120,000 |
||||
$100,000 |
$50,000 |
50% |
$120,000 |
||||
$100,000 |
$20,000 |
50% |
$120,000 |
||||
$100,000 |
$1,000 |
50% |
$120,000 |
Please fill in the blanks in the table.
Some forseeable outcomes of very low down payments would be:
Why 20% down payment is the norm
Following reasons can be attributed to 20% being the norm:
2008 Financial crisis
It will not be wrong if we say that 2008 Housing market fall down was caused by low down payments. As banks were selling all their loans to customers at low down payments and high interest rates however the same was done without any prior background check or after checking borrower's ability to repay the loans. It all created a fake spiral which lead to 2008 financial crisis.
Table