Down-payment insurance deserves a look, but a careful one

A home is often the largest investment a consumer will ever make, so any measures to reduce the risk involved in buying or selling deserve careful attention.

The big risk is that a major price decline will wipe out the homeowners' equity, leaving them owing more than their house is worth. That happened to many just a few years ago, and millions of homeowners are still "under water" as a result.

I decided a long time ago that the best way to prevent a recurrence of this episode was to offer home buyers property-value insurance, and I spent some time advising a well-connected group of entrepreneurs on a program that would do that.

After several years of effort, however, the program was scrapped. Various legal and operating barriers turned out to be just too formidable.

Recently, however, I came across a new program called +Plus offered by the Dallas-based firm ValueInsured, with which I have no connection. The +Plus program offers to insure the down payment of buyers when they sell their homes after two but before seven years from the date of purchase. That won't help homeowners who are still under water, but it is designed to protect new homeowners who purchase the insurance when they purchase their homes.

Down-payment insurance is a far cry from property-value insurance, but down-payment insurance is available while property-value insurance isn't. Some protection is better than none, and home buyers will have to decide whether the limited protection is worth the price.

The following are the major limitations on the insurance coverage:

A limited calendar window. To collect the insurance, the owner has to sell the home in two to seven years. The program seems to be aimed at those buying their first homes and who view them as "starters" and expect to upgrade in time.

A 20 percent down payment is the maximum loss. Coverage is limited to the down payment, which cannot exceed 20 percent of the purchase price. If you put down 25 percent, the additional 5 percent is not covered.

The difference between purchase price and sale price is the maximum loss. This means property improvements are not covered. For example: the purchase price is $100,000, the down payment is $20,000, the owner invests $5,000 in improvements, and the house is sold for $85,000. The insurance coverage in this case is the purchase-price reduction of $15,000 rather than the down payment of $20,000.

Purchase price times the percent reduction in the house-price index of the state is the maximum loss. If in the case of a house purchased for $100,000 with 20 percent down the price index for the state declined by only 10 percent, the insurance coverage would fall to $10,000. This means coverage is limited to price declines that are widespread. A price decline that is limited to a city isn't covered unless it is the major city in the state. Price declines that arise from neighborhood or block deterioration would not be reflected in state price indexes and are, therefore, not covered.

Premiums vary by state, sale price, and down payment. On a $200,000 home with 10 percent down in an average state, the premium would be about $840. That one-time premium is 4.2 percent of the maximum possible claim of $20,000.

Home buyers have to decide whether the protection is worth the premium charged. If they have to pay in cash at the settlement table, my guess is that few will. If lenders package the insurance with a lender rebate that covers all or most of the cost combined with a rate increase large enough to offset the rebate, the prospects are better.

Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. http://www.mtgprofessor.com.