Borrowing all of closing costs Financing: The secondary loan, a little-known financing option, allows homebuyers to borrow for a down payment against other material assets.


Julie and David Betz were diligently saving up for their first home when James L. Stewart, of First Home Mortgage, pointed out a little-known Federal Housing Administration financing option.

It is a secondary loan that allows potential homebuyers to borrow money for a down payment against other material assets, frequently a car or jewelry.

"It's the only loan I'm aware of where the buyer can use [virtually] no money of his own to buy a house," Stewart said.

Betz acknowledges that he was skeptical at first. "If it hadn't been for working with Jim, we'd still be renting," Betz said. "Julie and I didn't want to get our hopes up too high, we didn't know if it would really work, but it did."

The loan looks, at first glance, a lot like robbing Peter to pay Paul.

Of course, like most things, the FHA secondary loan is hardly that simple.

"This secondary loan is for people who have good incomes, good credit, and can afford the mortgage payments, but who, because of the high cost of renting or double car payments, for example, can't save enough for the down payment on a home," Stewart said. "Now, they can borrow the money for a down payment if it is secured by other assets, such as a piano, jewelry or a car."

Or, for that matter, added Stewart, appropriate assets might consist of a collection of rare coins or even valuable baseball cards.

"The people who do this are typically a young couple somewhere in the 35-year-old range," he said. "They often have two good incomes, are renting or living with their parents, and have every other criteria necessary to be homeowners, except the cash.

"It allows people to get out of the cycle of renting and right to the tax benefits of homeownership."

In essence, the FHA secondary home loan allows homebuyers to borrow 100 percent of the costs to purchase a house.

But clearly, Stewart noted, this is not for those with credit problems or for marginal borrowers.

To date, First Home Mortgage, a 9-year-old company with five locations in the metropolitan Baltimore area, has probably completed a dozen such secondary loans.

The Betzes -- she is a schoolteacher; he is an officer with the Harford County Sheriff's Office -- were Stewart's first buyers to take advantage of the loan. "We had a connection with a real estate agent who mentioned that Jim was looking for someone to try it out," David Betz said.

The Harford County couple used a car and jewelry for $8,000 worth of collateral. While Stewart acknowledged that should anyone default on this loan, for example, the assets would be repossessed, he emphasized that such action is unlikely "because the loan is aimed at high-caliber individuals with good credit."

However, the Department of Housing and Urban Development, which oversees FHA loans, is less enthusiastic.

"FHA has always permitted borrowers to use personal assets to raise cash for down payments," said James Kelly, a community builder for the HUD office in Maryland. "This practice does not represent a special program of FHA, nor is it a practice that FHA encourages. Borrowers and lenders should make responsible decisions on this and all aspects of buying a home."

Nevertheless, the Betzes are firm believers in the secondary loan.

"We were renting a house, and as far as our plans went, this put us two years ahead," David Betz said. "I knew we could afford a house, but we just couldn't afford the money for the down payment."

Indeed, the costs associated with purchasing a house can be staggering, even for those who have good incomes and who are fiscally responsible.

First Home estimates the down payment and closing costs for a $100,000 home in Baltimore will total $9,717.

But FHA mortgages allow the seller to contribute funds to cover such "prepaid" items as property taxes, insurance and interest, in this case amounting to $3,637. Couple that with a secondary loan in the amount of $5,000 and the out-of-pocket cost to a buyer is about $1,000.

For such loans, the current interest rate is 16 percent on a five-year amortization, and any bank or credit union can lend the money. First Home today works with several lenders.

But the secondary loan is hardly perfect, and buyers should bear in mind that little in life is free. By using this money, buyers in fact have created another loan. And the interest on the loan is not tax deductible.

"There is a drawback in that you have created debt to buy a house," Stewart noted. "Now there's another loan on top of it.

"I do hear, 'I'd rather wait a year, save up the money and not have a second loan.' "

Stewart counters such thinking by pointing out that, currently, mortgage rates are low and one can find some excellent buys on real estate. And, who knows what the market will be like in a year or two?

"It's not the best scenario, but it's better than waiting a year to buy," Stewart said.

In addition, the loan offers other benefits to homeowners, Stewart said, even those who actually have enough money saved up for the down payment.

Most people, especially first-time homeowners, are faced with additional expenses, such as having to purchase household appliances, lawn mowers, snow shovels or drapes.

Typically, these costs go on credit cards, where interest rates can run as high as 18 percent to 21 percent, compared to the 16 percent rate for the FHA second loan. In that case, taking this FHA loan and using the cash-in-hand to purchase such move-in necessities makes fiscal sense.

Stewart pointed to a well-to-do couple who, nevertheless, decided to take advantage of the loan. "This couple needed $6,000 for a down payment, and they had $18,000," he said. "They took advantage of the loan because they were moving into an older house, which needed repairs, and they decided to renovate with their own money, rather than borrowing the costs needed to make improvements.

"It was cheaper to borrow the $6,000 and use as little of their money as possible to move in."

A year after people take advantage of the secondary loan, First Home offers borrowers the ability to convert it to an equity line, Stewart said.

Still, the secondary loan is not well-known, and First Home is just beginning to make people more aware of it. Stewart is working to advertise the secondary loan to Realtors.

"Right now, we're testing the market and doing some mailings," he said. "We're just mailing to people who live in apartments and mailing to Realtors and builders that we know.

"It's just one more option for people who want to buy a house," he added. "There are very few people who really want to buy a house who can't."

Pub Date: 6/28/98

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