If you can't afford a house -- don't buy one

America needs more low-down-payment loans.

That seems to be the opinion of our government, anyway. The government agencies that drive most of the housing market are pushing for lower down-payment standards on mortgages, easing the 20 percent requirement that has become standard for much of the market.

The Center for American Progress approves: "We shouldn't obsess about down payments," said Julia Gordon, director of housing policy. "Research confirms that low-down-payment loans to lower-wealth borrowers perform very well if the mortgages are well-underwritten, safe and sustainable."

This depends, of course, on what you think "perform very well" means. A low-down-payment loan made to someone with a good credit rating and a low debt-to-income ratio will perform better than a low-down-payment loan made to someone with terrible credit and a lot of debt. But it has a higher default risk than a mortgage made to a similar borrower with an adequate down payment, because when you start out with little equity, you're apt to find yourself in foreclosure if you get into financial trouble.

I'm with Arnold Kling, a member of the Mercatus Center's Financial Markets Working Group at George Mason University, which favors a free market:

"There is simply no way to make low down payment lending stable in any environment otherthan in a rising house price environment. The [Center of American Progress's] study says it covers the last decade. If you made a low down payment loan in 2001, there was enough of a price increase after that you're probably fine. But it only works in that environment and it creates this cycle of a boom as house prices are rising, and then once they stop rising everybody crashes. You get this epidemic of foreclosures. It destabilizes the entire market."

Is there a good public-policy reason to encourage people to make a heavily leveraged bet on continued upward movement in home prices? Presumably, the argument is that many homeowners have done very well out of this over the past 50 years; rising home values sowed the seeds of many a college education and retirement fund.

You also end up with a much more unstable housing market. When a huge segment of the market has negative equity or has equity too low to cover the substantial costs of a sale, then in any economic downturn, you are going to end up with a lot of foreclosures. Those foreclosures will, in turn, depress both the housing market and the broader local economy. Which again, we should all know, because we just went through this very process. So why are we so eager to return to this situation?

Because, I think, most of us still haven't managed to shed the idea that buying a house is a good way to get some unearned bonus wealth. Too many people managed to do just that for too many years. We think of 2008 as an aberration, rather than reversion to the mean. And that's a costly mental error.

The long, steep increase in American home prices from 1946 to 2008 was driven by a whole lot of trends that are hard to repeat: the invention of the 30-year, fixed-rate, self-amortizing mortgage, which allowed people to pay more for a house by lowering the monthly payments. The securitization revolution, which lowered mortgage risk by bundling the loans into large, diversified portfolios, thereby lowering rates. Rising inflation, which pushed up the price of houses. Falling inflation, which lowered interest rates and monthly payments still further and allowed people to pay even more for those houses. The credit-scoring revolution, which allowed banks to offer loans to more people, increasing demand for the existing housing stock. And in dense coastal areas, you also had the rise of NIMBY zoning laws, which made housing scarcer and therefore more expensive.

The problem is, these things have already happened. Most of them cannot happen again — interest rates can't really go much lower. NIMBYism will go on, but the expectation of rising land values is already priced into the current value of the houses. If anything, it's overpriced; I have a lot of conversations with Washingtonians who expect our housing market to follow a path like Brooklyn's did, despite the notable absence of hyperwealthy financiers and international billionaires who want a pied-a-terre in our modest burg.

So I'm unimpressed by the argument that it's unfair to lock financially marginal buyers out of this wondrous investment product. It's unlikely that current homebuyers are going to experience the kind of windfall that their parents and grandparents did, if for no other reason than the fact that too many of them are still expecting that sort of windfall and factoring that expectation into what they're paying for a house.

You can afford a sizable down payment to cushion you from the effects of local economic downturns or you have a super-stable job, such as working for the government or your father-in-law, that makes you unlikely to ever miss any payments.

You can afford the maintenance as well as the payments, insurance and property taxes.

You have good disability and/or mortgage insurance to make sure that you do not miss any payments even if you break your back and can't do your job anymore.

You are pretty sure you do not want to leave your area or move to a larger, more expensive home anytime in the next five years.

Your payment is a reasonable percentage of your take-home pay (I shoot for under 25 percent; anything over 35 percent is far too risky).

You can afford other forms of savings, rather than counting on your house as a piggy bank for future needs. In general, if declining home prices would send you into a hysterical panic about your financial situation, you are buying too much house.