California is facing an affordability crisis in housing. Homes are pricey, making down payments a hefty burden, especially for young families hoping to purchase their first home.
So, what’s the latest initiative from California?
Enter the idea of entering the mortgage industry with an authority to borrow $25 billion. It seems that when housing costs soar, the solution proposed is to allow people to take on even more debt.
Welcome to Proposition 37.
The $25 billion mortgage experiment
On the ballot this November, California voters will decide on a proposal that allows the California Housing Finance Agency to issue up to $25 billion in revenue bonds aimed at financing down payment assistance.
Here’s the basic mechanism. Buyers can put down as little as 3%. The state-backed program would then provide a second mortgage that covers up to an additional 17%. The remaining 80% would be financed through a traditional mortgage.
Sounds great, right?
But there’s a catch. That 17% isn’t a gift; it’s just another loan. And isn’t this the same kind of approach that contributed to the 2008 financial crisis? It almost feels like history might be repeating itself by encouraging people to take on more debt than they can handle.
Let’s do the math
Consider this: buying a home in California for $800,000.
With a standard 20% down payment, you’d be looking at an initial outlay of $160,000, borrowing $640,000. Under Proposition 37, you might only need to come up with $24,000 up front, while the state would cover another $136,000 through a loan.
Your initial mortgage remains at $640,000. Sure, you’ve lowered your upfront cash requirement by that $136,000, but your overall mortgage debt has simultaneously increased by that same amount.
Assuming a hypothetical interest rate of 6.5% for the first mortgage and 7% for the second, over 30 years, your monthly payment would rise from about $4,045 to $4,950. That’s nearly $900 more each month. And keep in mind, property taxes, insurance, and maintenance costs aren’t included in that figure.
Congrats, you managed to get into a house with less cash down.
But now you have a larger monthly obligation. Actual interest rates for this program aren’t established yet, so those figures are just illustrative.
The government isn’t giving away $25 billion
To clarify, Proposition 37 doesn’t entail a $25 billion giveaway funded by taxpayers. It utilizes revenue bonds that would be repaid with the mortgage payments of the borrowers, not from California’s general funds.
California’s independent legislative analyst estimates there won’t be any direct costs to state or local governments. Proponents of the measure argue that by assisting buyers in financing newly constructed homes, it could incentivize builders to increase supply.
That’s a valid economic argument. But it raises a significant question. Does simply helping people borrow more money lead to lower home prices?
Not necessarily. In fact, it could push prices even higher, as seen during the COVID-19 period.
You can’t finance your way out of a housing shortage
Picture a neighborhood with 100 families wanting to buy 80 homes. Now, if you increase access to bigger financing options for more families, how many homes are there to buy?
Still just 80.
Unless construction ramps up, increasing purchasing power can exert upward pressure on prices. It’s simple economics.
California needs more houses—not just more inventive financing methods for the expensive ones. The focus should be on facilitating construction.
Streamline permitting processes. Tackle construction costs. Allow for more housing in desirable areas. Those steps would directly address the underlying shortage.
More borrowing mainly addresses the down payment aspect. These are not the same issues.
The question California should answer
Many families earn good incomes and can afford monthly mortgage payments, yet they struggle to compile six-figure down payments. A carefully structured loan program could assist some of them in becoming homeowners sooner.
However, enabling buyers to qualify for loans shouldn’t be mistaken for a solution to lower housing prices. And remember, that second mortgage still needs to be repaid.
California’s proposal highlights an important question every potential homebuyer should contemplate before accepting financial assistance: Am I securing a more affordable home, or am I simply discovering a different way to afford the home?
Because these are two very distinct financial consequences. And no matter how creatively financing is presented, one fundamental rule of personal finance remains unchanged.
Borrowing more money doesn’t inherently make something less expensive.
