Big Down Payments Are Risky For California Home Buyers

If you're thinking of buying a home in California, you might not want to sink everything you have into the down payment.  In fact, it probably makes more sense to keep more money SEPARATE from the house equity, even if you have to pay private mortgage insurance or a higher interest rate.

Banks are asking for higher down payments since the credit crunch started.  Wanna know why?  It lowers the bank's risk.  If higher down payments lower the bank's risk to market fluctuations, than who assumes that risk?

You got it; YOU DO ! 

Consider this article from the Arizona Republic:

Joan Shaffer is turning in the keys of the north Phoenix Tatum Ranch home she bought with her daughter in late 2005. They put nothing down on the home, took out a loan that let them pay less than they owed each month and now their loan is $200,000 more than the house is worth.

"We paid $585,000. It was the peak of the market, but no one told us," said Shaffer, a real-estate agent from Colorado. "We would probably have to spend the next 20 years trying to get right on the mortgage. That's crazy."

Housing has become volatile this decade.  The pendulum like economy the information age brought us  has increased that volatility.  While walking away from a mortgage obligation is the last thing you want to do, the comfort of having cash in the bank supercedes the desperate feeling that the bank has all your money tied up the collateral.  If you've noticed, banks aren't keen about letting existing homeowners borrow more through a cash-out refinance.

"Homes have gone from being a place to live to a disposable investment for some," said Jay Butler, director of realty studies at Arizona State University's Polytechnic campus. "It used to be that paying the mortgage was the top priority. Now, it's keeping the credit cards."

He said one reason is some homeowners think that with all the foreclosures, there will be programs to help them when they buy again.

It usually takes three years of perfect credit payments after a bankruptcy before someone's credit score is high enough to buy a home. Recently, people could buy a home again two years after a foreclosure.

Market risk is transferred to the party that has the most money in the investment.  While the profit lies absolutely with the title holder (you) the rsk of a large market drop rests with the lienholder (the bank).  Loan workouts or renegotiations are being pursued by banks in order to save that investment.  A higher loan amount allows the home owner to pursue an arbitrage strategy with the saved down payment money, increasing his liquidity, tax advantages, total return, and ultimately...safety of principal. 

I want to be clear here.  I'm not advocating that ANY homeowner simply "walk away" from a mortgage obligation.  I'm pointing out the logical conclusion that if lower down payment are more risky to banks, then they are safer for the borrower.