Saving precedes borrowing
By far the most common barrier to first-time homeowner is the down payment, so it will come as no surprise that many government programs offer low down payments or down payment assistance — to say nothing of the friends, relatives, and above all parents who offer up gifts (or their close counterpart, the informally-soft loan, “pay me when you’re settled”).
Indeed, down payment assistance and bargain interest rates compete as the programs of choice to stimulate homeownership.
But how low should down payments go? Is there a bottom limit?
I think there is, not for the money itself, but for what it signifies.
Aside from the risks of using too much high-leverage hard debt, it proves that the applicant has saved — past tense.
The older I get, the less impressed I am by future-tense verbs (”tomorrow I shall X”) and the more by past-tense verbs (”For several months or years I have Y-ed”).
How many times have you heard someone complain, “I can’t save, I have too many credit card bills”? Yet savings and paying debts are precisely the same actions:
- Savings is a set of monthly payments to a future financial goal.
- Debt paying is a set of monthly payments to a future financial goal.
Indeed, as between saving and debt payment there are only three differences:
- The debtor gets money first, makes payments second. The saver reverses the order.
- Debt collectors are more insistent than the inner voices exhorting one to save.
- Debt costs more than savings earns, so any given set of payments is worth more if saved than if used to retire borrowing.
Numerous studies show that those who have a down payment do better than those who do not:
Findings confirm that the amount of money held in liquid assets such as bank accounts, certificates of deposits, and mutual funds is a reliable predictor of homeownership. However, the largest impact on the probability of becoming a homeowner was associated with savings of less than $1,000, while larger amounts of savings had a diminishing effect on the probability of purchasing a home. This indicates that small amounts of down payment assistance can be effective in a renter’s decision to purchase a home. For example, in a computer simulation, a grant of only $1,000 to a low-income home renter, as an incentive to purchase a home, was estimated to produce a 19% increase in the number of homebuyers.
However, this may be because of lower loan-to-value (less of that very risky hard debt) or it may also be that the down payment is useful not only in itself but also because it demonstrates a committed history of savings.
Savings also teaches financial literary, which is an essential step on the road to financial management.
By the way, anyone can save. In Kibera, Africa’s largest slum, I met the co-op members and saw their savings books whose moist limp lined sheets showed the painstaking weekly entries of tiny amounts, but with a moving consistency.
“A penny saved is a penny earned.”
Indeed, savings circles or co-ops — which seem to have existed in every culture throughout the ages — are the historical antecedents of mutual associations, credit unions, building societies, and eventually banks.
How fitting that Ben is on the largest bill still printed by the U. S. Treasury, which might do well to learn to save, not run multi-billion dollar deficits!
