Are 0% Loans Good, Bad, or Does it Depend?

Here's a chance for all Free Money Finance readers to chime in on what they think about a very interesting topic. But first, let's start with some background.

On Monday, I wrote a post titled 43% of First-Time Home Buyers Put No Money Down. As a no-debt sort of guy, you can imagine what I thought of this trend. My reaction was:

Yikes, yikes, and triple yikes!!!!!!

Then I went on to give my formula for how I recommend buying a house.

Shortly after posting, I received a comment from David at Pacesetter Mortgage who said:

Dear FMF,

Sometimes the headlines can be deceiving. The information you quoted is very true. It comes from a recent NAR report just out.

The good news, behind this article, is that American Home Ownership is at the highest it has ever been! The low/zero down payment loans are a big part of this.

Certainly in some parts of the country where prices have been skyrocketing, a zero down loan would be a bad idea.

But in other parts of our country, like the Midwest and Michigan, this loan is a very valuable tool for the first time homebuyer.

I say all this to suggest that we don't throw the baby out with the bath water.

Just like everything else, a professional to help sort this all out is a good thing to have in your life.

I also wish you the greatest of success with your new Blog Network. I have been watching your success for some time and have enjoyed your work.

To which I responded:

David -- Thanks for the kind thoughts, I appreciate them.

Under what circumstances would it be advisable for someone to take out a 0% down loan? I can't think of any.

To which he responded:

Dear FMF,

Let's say that you and your wife are both 28 years old, have your college degrees in hand and have been working in your new professions for a year or so.

Let's further assume that between the two of you the household income is $80,000 and the debt you have is one car loan, some student loans, and a small credit card balance.

Here is the quandary: Continue to pay $900/month for rent and save a downpayment or get a zero down loan and begin to build equity through appreciation and have Uncle Sam help you make the payments with your new tax deduction.

First of all, please understand that I am not thinking "nationally" in my answer. My answer would be different to someone in California then it would be to someone in Michigan.

Everything we do has risk! Making a rent payment has risk in that you are spending money with no hope of return.

Here are some critical criteria that must be met:

1.) You must be willing to commit to the house for 3 years to break even and 5 years to have a return.

2.) I always advise pre-payment on these loans if affordable to shorten the 5 year investment return.

3.) Have a good Realtor! You must understand Location, Location, Location.

4.) In years 3-5, assuming market rates co-operate, a refinance MIGHT be in order to remove the second mortgage and/or PMI insurance that went with the loan. Typically after 2-3 years there has been at least 10% appreciate to accommodate this.

5.) Don't make large improvements to a home unless you intend to stay longer than 10 years. Cosmetic improvements are a plus.

The "Zero Down" mortgage is not a new product. I have been helping young families with this strategy for many years.

This all works because of primarily two things:

1.) Leverage. The young couple in my example would probably buy a $140,000 home in our market that would conservatively appreciate to $175,000 in 5 years.

2.) Tax Deduction. Uncle same is going to pay around 25% of their interest expense. The State of Michigan may also chime in with some tax relief for property taxes.

Michigan Bonus Reason - we are in the midst of a strong buyers market. Having seen this in the past, I would suspect that a $175,000 value in 5 years will make my assumptions on the low side.

I have certainly also met with young couples where I suggested that they continue to rent. Everyone's situation is different and applying a "zero down loan is bad" logic to everyone is not healthy either.

I have been doing this for 20 years and have leant nearly a billion dollars to my clients. I can't think of one young couple that this advice has hurt. As a matter of fact, they all thank me later on down the road.

Again, my point was not to throw the baby out with the bath water. The Zero Down Loan is good for some, and horrible for some.

When I have a disciplined young couple in my office with good credit, can commit to the items above, and who really desire to own their own home, then I am happy to show them how to make it work.

I hope this is taken with the spirit in which it is intended!

I then asked if he'd mind if I posted this and asked FMF readers for their thoughts. He was game, so here it is.

So, it's your turn to weigh in on the subject. What do you think? I'll give it a couple days, then respond with my own thoughts.

Comments

[Steve Mertz]

David-I agree with you. Yes there are risks but given the right location, timing and temperant of the buyers it can be a great start to playing the money game. Steve

[KLAUSS]

Although I put down 10%, I feel 0% down is a fine idea for a first time home buyer. Being 23, I new my income would grow a little, but if something went down job wise, I had a cushion. I had more money but the full 20% standard would have strapped me a little. I would had to have bought all the furniture/repairs I needed basically on credit with no cushion in case I lost a job. I realize having those costs essentially rolled into a mortgage is still "credit" but it can be paid off over a longer period of time or shorter if I had the extra cash and tax deductible. Not bad. Go fixed or go home!

[KLAUSS]

Although I put down 10%, I feel 0% down is a fine idea for a first time home buyer. Being 23, I knew my income would grow a little, but if something went down job wise, I had a cushion. I had more money but the full 20% standard would have strapped me a little. I would had to have bought all the furniture/repairs I needed basically on credit with no cushion in case I lost a job. I realize having those costs essentially rolled into a mortgage is still "credit" but it can be paid off over a longer period of time or shorter if I had the extra cash and tax deductible. Not bad. Go fixed or go home!

[BullishBear]

I've been told by a lawyer that she gives the advice that if you can't put the full 20% down, don't put anything down at all (something to do with PMI if its less then 20%, but no PMI if you pay nothing down). Anyone care to shed light on this?

[FMF]

BullishBear --

Check this out and see if it answers your question:

http://www.freemoneyfinance.com/2006/01/how_to_get_rid_.html

FMF

[Blaine Moore (Run to Win)]

My loan consultant was trying to get us to do a 0% down offer because my fiance and I both have really high credit, and would not need PMI with what he was offering. We have some fairly unique circumstances, however, and don't think that that is a good idea for us.

[klauss]

If your credit is really good, you can get a second mortgage so no one loan is more than 80% of total value. The second loan in some cases can be under 100 basis points higher than the 1st loan. Pay extra on that loan first. No PMI in this situation.

[D-Day]

My husband and I pretty much fit the profile for the recommended types of people for a zero down loan, and after going around and around with this question for months, we've decided to go ahead and do what it takes to get a house as soon as we pay down a little more credit card debt. For us, the major factors are 1) that real estate in our area is expected to keep growing strong and we're afraid that if we wait to save up to buy, we're going to be gradually priced out of the neighborhood we like, 2) our rent is going up, and since we're expecting to hit a higher tax bracket next year, we'll get more bang for our mortgage deduction buck (we'll see increases in insurance, maintainance, and repair costs, but rent and mortgage will be about the same), and 3) our quality of life will increase as we'll be able to buy our own home in neighborhoods closer to friends and family.

want to get some appreciation on our asset, 2)

[John Koontz]

A zero down loan was the only way my wife and I were ever to get into the California market. Five years ago, we were both one year removed from college. Two graduate degrees and very good jobs, but homes were appreciating over $10k/month. There was no way were going to ever save up for a decent down. We did an 80-20 loan (80% first, 20% second) to avoid PMI. We were able to refinance in one year to get rid of the second. We now have over 50% equity and are pretty happy about our decision. Not happy because we think we're rich (like many of the false beliefs out here - we know it's all paper, and it only benefits us if we move somewhere with lower housing costs), but that we were able to quickly get into the market that was heading north fast. Today, with the current market conditions, my thoughts are a little different, but at the time it cetainly made sense.

[Bad credit financing companies...]

Yes...I'm bad with money. I admit it. I first started looking for a good debt consolidation company in 1995. I was beyond broke and our debt was more than out of control....it was insane. My wife was working for two companies and sleeping about 4 hours a night. I was working for a company in Seattle and another company in Portland and we still couldn't keep up on the endless bills and interest payments. We gave up seeing each other a regular basis and were slaves to our mounting debt. We had a mortgage payment of $2,500 per month, two car payments for $500 each, a line of credit for $20,000 and 4 credit cards just getting worse each month as the interest piled up. (I won't even tell you the balances on the credit cards)

My wife Jill finally said, "It's like we ceased to be married the way things are going.....we never see each other". I was sick of it too. We decided to sell the car and truck, crack down on our spending, and begin searching for a debt consolidation deal with the local banks. The companies we looked at locally were fairly good but it seemed like we would be subject to massive interest payments and a long drawn out payment schedule. We needed to find a consolidation company that specialized in debt management alone. We didn't want to use a general finance company that spread itself too thin, in order to compete in every single financial market.