Zillow and its one percent down payment for homebuyers
by Zain Jaffer
Zillow, the popular US home rental and sale online marketplace, recently announced in August 2023 their plan to let prospective buyers begin their home ownership journey with as little as a one percent down payment. Normally most developers require a three percent minimum downpayment. In Zillow’s case, it will just add the two percent portion of the downpayment and add it to the loaned amount. If the buyer has three percent saved for a downpayment, Zillow can also kick in the two percent to make their downpayment at five percent.
There are pros and cons to this arrangement, and as with any major financial agreement, it requires careful decision making on the buyer’s part. Note that this article only discusses some factors that a buyer needs to consider. Each home purchase has its own set of different pros and cons that need to be considered.
It goes without saying that owning a home is part of the Great American Dream. In addition, buying a home is how most people accumulate wealth since the home is an asset that may sell for a higher price in the future. The future selling price of course depends again on various factors, but in general in a healthy housing environment it is not unusual to make money on a house sale.
There is also the fact that rent is an expense. If you add up all the years you have been paying rent, it is all just an expense on your part. On the other hand, with a home you are building up your equity.
Owning a home is not just a financial decision. It is also where most of your family memories will be made. For many, that is priceless.
Unfortunately these days the decision to buy versus rent is not as simple. It does not mean that you should not buy a house and just rent instead. But it is a decision that needs careful thought. There’s also the factor of family to consider.
As you know, the Fed began hiking rates in 2020, and this has resulted in mortgages that are now in the 7-8% per annum range. Prior to the hikes, most mortgages were in the 3% per annum range. So if a buyer has a larger down payment amount saved as equity, the total amount paid to the seller over time is less.
So in effect the Zillow one percent downpayment (effectively three percent) or the three percent downpayment (effectively five percent) may sometimes end up costing the home buyer the most over the long term. Especially at high interest rates.
Take note that most of the personal savings accumulated during the COVID pandemic has been depleted. Credit card expenditures has now surpassed $1T. Credit defaults are increasing. For those who have student loans, payments will resume in October 2023.
Just so you have an idea, let’s assume that the 97% loan (with your 1% downpayment) at 7.5% interest now is for a house valued at around $500,000. Buyers who have the cash of course get the best terms, as they can even possibly haggle down the $500,000 asking price. But for most buyers, a mortgage is the only option.
Using any mortgage calculator (like mortgagecalculator.org) with factors such as property tax and insurance kept constant for both options will give you the following:
At the current 7.5% mortgage rate, a buyer would be paying around $3,674 per month for 97% of the cost of the house for thirty years. At the end of the thirty year period, the 97% loan on the $500,000 house would have been paid out by $1,352,130. That is more than double the cash price of the $500,000 house. If house prices are depreciating in that area, then that is another major factor to consider.
If the buyer (or with their spouse or partner) manage to increase their income, a good option would be to pay off the loan early. So it is more of grabbing a specific house when it is on the market, then paying off the loan as early as possible to avoid the full interest charge going to maturity.
Another factor to consider is the ratio of debt to income, which should ideally be only 30% or less. If a buyer’s after tax monthly income is in the $5,000 range then the 3% mortgage rate is already just above half of their take home pay. That’s already way above the recommended debt to income ratio. The 7.5% mortgage is not really doable for this buyer in this situation because of other expenses and discretionary spending needs.
Plus buyers need to remember that aside from their discretionary expenses, food and grocery, fuel, electricity bills, it’s not just the mortgage that needs to be paid monthly. As a home buyer, the buyer becomes responsible for insurance, home repairs, and property taxes. As a renter, these costs were shouldered by the landlord. For inexperienced new homeowners, the cost of home repairs may sometimes come as a surprise to them.
Now if a buyer is making enough to the point that they are spending left and right on things and services with no long term value for them, then buying a house is a good idea, but they should do it with as big a downpayment as they can, to minimize interest charges.
The move by Zillow may be helpful for families who really want to own a home, have identified the home they really want and can feel an emotional attachment with it, and can be in a stronger financial position not too long in the future to pay off the loan before full maturity, then it may be a good move.
If a buyer is not really sure about the house and is just attracted by the one percent down payment option (with the two percent thrown in), then they should still think twice about signing up for that thirty year commitment. They should just continue to rent until they find something they really want and continue to save equity for a larger downpayment.