Here's the Catch!
All the rage just a few years ago and instrumental in helping many first-time homebuyers become homeowners, zero-down mortgages have become far less attractive recently as home values in many markets have plummeted. House foreclosures are setting new records with each passing month. Industry experts and policymakers are laying much of the blame for our current economic mess at the feet of home mortgages like zero-down mortgages.
For the most part, this blame is well-placed, as many mortgage lenders were seduced by the possibilities of making a lot more money on zero-down mortgages and relaxed their lending standards to get it. And through zero-down mortgages, people who had no money for a down payment were also seduced by the possibility of owning a home at a time when house values were at an all-time high.
There's more than one catch to a zero-down mortgage
Zero-down mortgages allow people to buy homes with no money down, but there are hidden costs that must be paid before they can move in. Usually, the buyer must pay closing costs of up to five percent of the home's value, including legal fees, real estate fees, land transfer taxes, and countless other costs that quickly add up. Here are some of the other catches of zero-down mortgages:
- Higher or variable interest rates. People who choose zero-down mortgages pay for the convenience through higher and often variable interest rates that end up costing them a lot of extra money. This factor makes this type of mortgage very attractive for lenders but not very beneficial for the homeowner.
- Credit rating liabilities. By taking on a zero-down mortgage, your credit rating could take a hit because you're starting out with no equity in the home. Furthermore, it may be many years before you have any home equity. From the lender's perspective, you've taken on a lot of debt, and your debt-to-assets ratio has suddenly become much larger. You therefore represent a higher risk of defaulting.
- Much higher costs over time. Zero-down mortgages seem attractive in the beginning, but you end up spending a lot more money for the house over time, because you're financing the entire purchase price. An amortization table illustrates how mortgages usually front-load interest payments so the buyer can see how little of their monthly payment is applied to the principal in the first several years of the loan. Essentially, the buyer pays a lot more for the convenience of using someone else's money to purchase the house.
Although having a good credit history may allow you to pay a slightly lower interest rate for a zero-down mortgage, these financial instruments are still a dicey proposition for the reasons listed above and many more. Even though a zero-down mortgage may initially sound like a good way to buy your first home, you and your credit rating will be much better off if you save up for a down payment and avoid the credit catastrophe of a house foreclosure.
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