Here is where 100 percent financing, also commonly known as zero-down financing, gets dicey: when the offer to purchase features a combination of no down payment and a request of the seller to provide a credit toward the buyers’ closing costs.
Such a combination is not indicative of an escrow doomed to fail. But it absolutely is indicative of an escrow where sellers are bearing considerable market risk by taking their home off the active market pending a closing that may never occur.
If successfully executed, the buyer often will be purchasing with virtually none of their own money in the transaction. They aren’t making a down payment. The seller is paying for their closing costs (or, depending on circumstances, the closing costs are being financed.) Even the earnest deposit likely will be refunded to the buyer, especially if the seller credit covers all of the buyers’ closing costs and prepaid expenses.
The Arizona standard contract allows a buyer to recover their earnest deposit for a number of reasons, including failure to qualify for the loan. So buyers are entering into these purchase contracts with nothing at risk outside the cost of their home and termite inspections. (And many are incredulous that the seller won’t pay for those as well.)
What do the sellers have at risk? As I mentioned earlier, they are bearing market risk – the risk of a market declne during the escrow period. They are making repairs requested by the buyers, repairs that may have not been necessary with a different buyer. And they also are bearing the uncertainty of not knowing whether they’ll really be moving.
Buyers also bear that uncertainty, though they shouldn’t. Not if their agents and their lenders are doing their job correctly.
Again, like yesterday, I’m not offering a blanket indictment of the evils of 100% financing. I have had clients purchase homes in such a manner and, in certain circumstances, it remains a viable option. I’ve promoted zero-down financing on my old blog and with good reason – like nearly anything else, it’s not inherently evil. It’s merit depends on the circumstances under which it is recommended.
The key phrase is “certain circumstances”. A 100 percent loan should not be treated as financing of last resort – when absolutely nothing else will work for whatever reason, go for zero down. Logic would dictate that zero-down financing should require better credit and better debt-to-income ratios given the higher risk involved.
But that’s not what is happening. Instead, it is becoming the last-chance financing vehicle, the last spin on the roulette wheel.
I don’t blame the buyers. In most cases, they are following the advice being provided to them by a lender or an agent (or in some cases, both under the same corporate umbrella) in hopes of making their dream of home ownership a reality.
Sadly, in a lender or agents’ zeal to make a deal happen, the buyers are not being told how unrealistic that dream really may be. And in those cases, no one wins.