Why sellers are prioritizing high-downpayment conventional loans over FHA, VA, and USDA loans.

The reason high-downpayment conventional loans are being prioritized over VA loans, FHA loans, USDA loans and others is because it gives the buyer more flexibility in purchasing a home.

We’ll break that down, but the primary theme here is that sellers are choosing the right candidate over the highest offer because banks are denying more loans than ever.

Lack of inventory has created a complex problem: prices are exceeding what any reasonable comps can support.

Even if you’re bullish on the future of the market, you need to have fair comps (also known as “comparables,” or recently sold properties that are similar to one another).

Why are comps important if a buyer is willing to pay more? Isn’t the value of any item the price someone is willing to pay for it? Yes and no.

The real problem sellers are facing.

The reason sellers cannot accept any and every offer is because the bank isn’t going to approve it. Even when a buyer has a pre-approval letter from the bank, the bank still needs to validate the collateral behind the loan.

If the bank cannot substantiate the value of the home, then they are essentially loaning a buyer more money than the home is worth. This means the buyer is immediately upside down on the mortgage and the bank is straight back to 2008.

At the beginning of 2021, a seller asked us to put together a Lease Purchase for them (something we frequently do for homeowners who prefer to do it themselves). The reason we declined to take the deal was because we could not come anywhere close to substantiating the price they wanted for the home. This would be putting a tenant buyer in lower likelihood scenario of success.

So the problem here starts with banks being willing to loan you more money than a home is worth. This makes sense right? Well, let’s discuss a couple of the protagonists and antagonists in this story.

Appraisers are in a bind.

When someone sells their home to a buyer who needs financing (ie. not buying on terms or all cash offers), the bank requires a formal appraisal of the home to verify the value of the home.

These appraisers show up and begin the science and art of valuing a home. They need to place your home on a spectrum of value compared to what other homes have sold for in the area.

Since there’s no inventory and homeowners are getting offers for more than their home is worth, the appraiser is the one who surprises the parties by informing them that the value of the home is far less than is being paid. There’s only so much subjectivity that an appraiser are able to allow here (and FHA appraisals tend to be even more astringent). The value of a home needs to be backed against what other homes in your area are selling for. If there’s not a reasonable case to be made for the value being asked for then the appraisal comes back lower.

When the bank sees the appraisal, they deny the loan.

Are the “Zillow” companies part of the problem?

Buyers, investors and sellers alike are becoming increasingly frustrated with companies like Zillow who appear to be using higher home prices to increase their own profits.

The idea being floated by many is that because Zillow is now purchasing these homes AND becoming an iBuyer (meaning they are a middleman in taking a fee for facilitating sales), an increase in home values will bring them more business. The way to draw out more sellers (and also increase their own position in the real estate market) is to drastically overstate home values. Whether or not this is the case is probably only verified through a legal investigation.

Until that stops, companies like Zillow will be drawing out more and more sellers to the market through inflated prices that the bank is struggling to lend against.

Ok, so why are higher down payments preferred right now?

Down to the nitty gritty: how does this all relate to the type of loan sellers want? What do they care?

Great question. When someone has 20-25% to put down on a home, that means that this buyer can always convert to a lower down payment loan (eg. FHA loan) in order to satisfy the needs of a bank.

Huh…?

Yes. Think about this. A bank is not going to lend more the value of the home. So if the bank denies someone’s loan due to the price of the home, then the buyer can now increase their loan amount and just throw more money into the deal to cover what the bank will not. Now, the bank can loan the money because even though the buyer overpaid, the bank doesn’t care because they still have lower loan to value ratio on the house.

Mortgage Rates are Another Story

Since the pandemic started last year, mortgage rates have fluctuated tremendously and to the point of reaching historical lows. At the same time, because many have taken advantage of this to buy a home, it’s really important to be informed on the latest because this allows you to compare offers when applying to different mortgage lenders, and hopefully save money. While planning for a home purchase you can estimate what could be your monthly payment based on different scenarios and rates so you can budget accordingly.

Summary

The reason sellers and realtors are preferring high-down-payment conventional loans right now is because it gives the buyer the ability to convert to a lower-down-payment loan and ultimately pay more than the value of the house.

Too many sellers are watching the sale of their home fall through because the bank wont support the value of the house. If you have cash to buy a home or you can work out terms with a buyer/seller, then this is the best way to go to ensure the sale of your home.