08 September 2008

The 20 Rule

Update: More thoughts from Arnold Kling.

Arnold Kling thinks you should have to put 20% down to get a mortgage.

"My approach would make it more difficult for many families to achieve home ownership, because many families find it hard to save the money for a 20 percent down payment. I am willing to let those families deal with being renters. As fantasy mortgage czar, I value stability of housing markets and financial institutions more than raising the home ownership rate."

I don't think that's too bad an idea. In the past decade, getting a mortgage was so easy because you could come in with basically nothing down. This encouraged excessive demand, leading to rapid building and resulting in the over-supply of homes. Combined with the general distress in credit-markets, the over-supply has combined with tight credit to drive prices down and set off a chain of events that have caused a lot of economic turmoil.

George W. Bush has been talking about and advocating increasing home ownership for a while now (since at least 2002). Here, here, and here. In fact, he said in a June 18, 2002 speech:

"...I believe owning a home is an essential part of economic security."

and

"The goal is, everybody who wants to own a home has got a shot at doing so. The problem is we have what we call a homeownership gap in America."

Now what is so important about owning a home? How does it increase economic security and why should we care about the "homeonwership gap in America"? As long as people have a roof over their heads then we're doing okay. Whether you are renting an apartment or living in a home with a mortgage on it, you have a place to live. Owning a home isn't for everybody. There's maintenance and taxes that go along with it, in addition to lack of mobility. Renting is just plain better for some people. As far as I know, nobody was complaining about not being able to have the chance at owning a home. Mr. Bush just started blabbing about the American Dream one day and decided to do something that looked patriotic.

If you can't save the money to put 20% down on the home you want to buy then you shouldn't own a home. Some may say this is "unfair" (that's the vibe I get from Mr. Bush's statements and stated goals -- oddly a Republican is talking about social and economic equity, ha!), but life ain't fair. In my opinion, as long as people can afford to put a roof over their head (via renting or purchasing), then we are doing just fine.

Kling opines that the housing market would be more stable if 20% down were required, and I'm inclined to agree. It just makes sense. There's risk there. If you have to put 20% down, that is cash out of your pocket. Even if housing prices decline one day in the future, your 20% is gone and you still owe on a mortgage. I would think you'd be less inclined to walk away and let the bank foreclose. But if you only had to put $2,000 down then you don't have much to lose when times get tough, making you more likely to walk away. In the current situation this "walking away" by a large number of borrowers is causing banks further losses and driving home prices down further, making everything worse off for everybody. The situation might not be so bad, or in existence, if we had stuck with the 20% down principle of lending for homes.

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