Posted by Leonard Steinberg on February 6th, 2013

Is the stupidity that helped cause the previous recession returning? It appears so, although this time no downpayment mortgages will initially only be available to the wealthy.  It’s 100% financing—the same strategy that pushed many homeowners into foreclosure during the housing bust. But Banks say these loans are safer: They’re almost exclusively being offered to clients with sizable assets, and they often require two forms of collateral—the house/apartment and a portion of the client’s investment portfolio in lieu of a traditional cash down payment. Will co-ops allow this? Certainly not. But most condominiums do allow 100% financing.

In most cases, borrowers end up with one loan and one monthly payment. Depending on the lender and the borrower, roughly 60% to 80% of the loan can be pegged to the home’s value while the remaining 20% to 40% can be secured by investments. On a $2 million primary residence, for instance, the borrower could get a $2 million loan, which would require a pledge of assets in an investment portfolio to cover what could have been, say, a $500,000 down payment. The pledged assets can remain fully invested, earning returns as normal, without disrupting the client’s investment goals.

While these affluent clients may be flush with cash, this strategy allows them to get into a home without tying up funds or making withdrawals from interest-earning accounts. And given the market’s gains combined with low borrowing rates in recent years, some banks say clients are pursuing 100% financing as an arbitrage play—where the return on their investments is bigger than the rate they pay on the loan, which can be as low as 2.5%. Some institutions offer only adjustable rates with these loans, which could become more expensive if rates rise. In most cases, the investment account must be held by the same institution that’s providing the loan.

So is this healthy or the breeding grounds of trouble? This era of ‘free cash’ will end soon and all had better be prepared for it. When you read about 110% (or more)financing you can be certain we learned nothing from the past and are heading down a dangerous road. We aren’t there yet, but it appears human’s desire for extreme risk never disappears.