the most common leveraged purchase

[Jeffrey Levin]

While the 3% downpayment loans make housing more affordable for people for
whom the principal barrier was inability to amass the requisite savings (and
didn't have rich parents who could give them the money), the flip side is
that they increase the amount of borrowed funds, and therefore increase the
mortgage payment.  Since banks make loans based on "qualifying ratios" (the
maximum percentage of income they will allow you to devote to your mortgage,
property taxes and insurance), the higher the loan, the higher the income
you must have.  Add to this the fact that at 97% Loan to Value, you are
required to purchase mortgage insurance (which insures the bank, not you),
which can add another 1/4% to your effective interest rate.

These 3% loans work best for moderate to middle income households with
adequate incomes but inadequate savings.  They don't do nearly as much for
low income folks for whom homeownership is clearly out of reach.

Jeffrey Levin <jlevin at pacbell.net>

-----Original Message-----
From: Greg Nowell <GN842 at CNSVAX.Albany.Edu>
To: lbo talk <lbo-talk at lists.panix.com>
Date: Tuesday, September 29, 1998 4:25 PM
Subject: the most common leveraged purchase


>Jim Levine's post is clear.  There's no way to
>understand leverage until you work through a
>demonstration like that.
>
>In a recent course I used housing as an example.  You
>can buy a house with 20% down or as little as 3%.  If
>you buy a house at 100k and put down 3% and the market
>goes up next year, your return on the $3,000 down is
>$3,000, which is 100%.
>
>The person who put 20% down gets $3,000 increase on
>$20,000, which is 15%.
>
>The situation is complicated by various taxes and fees
>which interfere with the investment's liquidity.
>Moreover one tends to live in one's house so the
>cost-of-interest is mixed up with the quality of life
>issue.  But nonetheless, many people do realize the
>"downside" of a leveraged position when they find out
>that the housing market declined (as in Boston c.
>1990).  If you put $3k down on a $100k house which you
>sell at $90k, you'll have to cough up an additional $7k
>to get out of the house--the equivalent of a 200%
>margin call.

<snip>


>For good or for bad, the old saw that houses aren't
>affordable because you need a 20% down payment is
>history.  You can get into a house for as little as 3%
>of sale value, although I would think that fees of
>various kinds would double or triple that.  But it's
>still a lot less than 20%.
>