What follows is strictly a lay person's perspective, and therefore some of it may be wrong or apocriphal. But it may also be helpful to other lay people on this journey.

Historical Background

• Encourage lenders to make home loans
• Provide a federal program of home loans
• Provide a tax break for home ownership

• If you can make a down payment of 20% on the price of a house, you should (assuming a good credit rating) be able to get a home loan for a 30 year fixed rate mortgage
• During the life of the loan, all interest paid during a given tax year reduces your net taxable income by the amount of the interest

Second, watch carefully to see how your rent compares with a mortgage payment. I'm in the top tax bracket, so any interest I pay on a mortgage reduces my income taxes by roughly 36% of the interest paid. In the early years of a mortgage, virtually everything you pay is interest, so a mortgage payment of, say, $2000 a month could reduce your yearly tax burden by $500 to $600 a month, making it equivalent to a monthly rent of $1500 a month. In California, where a decent rental is tough to find for less than $1500 a month, that means anyone earning a decent income should be thinking seriously about home ownership.

The hard part, of course, is coming up with the 20% for a down payment. In California the average home costs roughly $350,000, so that would mean coming up with $70,000 plus closing costs. For most of us that's a prohibitive amount to save up over any reasonable period of time.

And that's the problem with the 1930s approach to home ownership: getting over the hump of the down payment.

Modern Loans

Coming up with savings on top of rent thus becomes a big challenge. And lending policies have changed to reflect that. Now it is possible to get a mortgage putting down only 10%, or even only 5% of the purchase price.

There's a catch, though. If you have less than 20% equity in a property, you are required to carry Personal Mortgage Insurance (PMI). PMI is a lender's way of protecting a riskier loan. You pay an extra monthly charge -- typically around 6-7% of your monthly mortgage payment -- but the lender is protected should you default on the loan.

If you go below 10% on the down payment there are other complications. You can either go with a single loan which, in addition to PMI, will likely be at a higher interest rate or for a less than 30 year mortgage (either 15 years or 20 years). Alternatively, you can do a "piggy back" loan: you take out one loan for 80%, and a separate loan for 15%. On this scenario, you pay no PMI, but do pay a substantially higher interest rate on the 15% loan. In terms of cash flow, these two scenarios work out very similarly.

The Magic of Refinancing

Thus, if you can get started on home ownership at all, even if it's a stretch financially, there's a good chance that in addition to equity you add through monthly payments, you'll gain equity through overall increase in property value. This can take you from 5% or 10% equity to 20% equity much faster than you might think. At that point, you should think seriously about refinancing.

Refinancing your loan will enable you to drop the PMI. It will, all other things being equal, get you a lower interest rate. And once you are established at 20% or higher equity, it will open up possibilities like a home equity line of credit.

Fixed and Variable Rates

In this case, you should think seriously about making your initial loan an adjustable rate mortgage (ARM). ARMs are typically 1/2% to 3/4% lower interest rate than a fixed rate, which can help ease some of the burden from other costs of a greater than 80% mortgage. There are some complications to beware of, though. Not all loans at more than 80% allow ARMs, and if home loan rates are volatile, or steadily increasing, then an ARM can stick you with a much higher interest rate than you'd bargained for down the road.

Other Costs

Property taxes can be handled in two ways. Either you can pay directly, on either a quarterly or annual basis (depending on local regulations), or you can set up an escrow account out of which taxes are paid. I highly recommend the latter. In this scenario, the prorated monthly tax rate is added to your mortgage payment, and then the mortgage company pays that amount into the escrow account. You can also have home owner's insurance handled in the same way, leaving you with one regular payment to remember instead of three. The only time you wouldn't want to do this would be if you have a large income payment that comes irregularly, such as a bonus, stock options, or royalties.

Manufactured Homes, a Mixed Blessing

Years ago "manufactured home" was a polite way of saying mobile home, a cheap trailer with aluminum sides, tin roof, and questionable construction. The mobile home was (and often still is) the housing option of choice for struggling working class and lower income families. At a fraction of the cost of regular houses, and licensed through the Department of Motor Vehicles rather than subject to property tax, mobile homes were/are often the only way these families could own a dwelling of their own outright.

There are problems, however. The quality of construction in mobile homes has traditionally been suspect. And by being classified as temporary housing they avoid the property taxes, but also are ineligible for the "mortgage deduction" that is the big tax break for home ownership.

Over the years manufactured homes have become a distinct type of housing, separate from mobile homes. They follow the standards and requirements of constructed homes, but are largely prefabricated rather than built on site. To my mind, that's an advantage: you get something uniform and consistent, rather than subject to the whims and skills of a local contractor.

But the financial services industry, and the government agencies that oversee housing, don't see it that way. They have been slow to recognize manufactured homes as a valid and quality form of home construction. This has consequences.

First, this is entirely an American problem; Europeans are much more accepting of manufactured homes as a housing solution.

Here in the United States, however, you will get a lower appraised value, and be subject to more stringent financing requirements, if you choose to go with a manufactured home for a new home. The difference in appraised value appears to be about 15% to 20%, given houses on equal sized lots, of comparable square footage, and with the same number of bedrooms.

I still think manufactured homes are better value overall. But you need to think through the financing much more carefully if you're going to go that route.

Our Case

In Summer of 2002 we started looking into getting a new house built, specifically a manufactured home. What we wanted was going to cost around $155,000, which, added to the $115,000 still owed on the original mortgage, meant we needed to refinance and borrow $270,000. In Fall 2002 we got a projected appraised value on the project of $280,000, which just wasn't enough to make it work. That would have required us to borrow more than 95% or put additional money in, and we just didn't have the cash to put in at that time.

Instead we postponed construction plans, and refinanced on the original mortgage. We had the original house and property appraised, and it came in at $186,000 -- roughly a 50% appreciation in two years. That enabled us to cash out some equity, pay off debts, and refinance claiming at least 20% equity, thus dropping the PMI we had been paying. Our new rate was 5.5% on a 30 year ARM. Our payments dropped by almost $300 a month. That new found cash flow went towards paying additional equity on the new loan, putting less pressure on the needed appraised value when we were ready for the construction project.

We waited six months, and looked at the construction project again. This time the projected appraisal came in at $300,000, enabling us to just squeak by and do the loan if we went to the 95% maximum we could borrow. Interest rates were already going up -- we were looking at 6.25% for a 30 year fixed rate -- so we figured even though it was a stretch we'd better go for it.

At the absolute eleventh hour the situation changed yet again. We had the foundation in place, all three sections of our manufactured home sitting on the foundation, with only the on-site assembly remaining. Our mortgage broker called us to let us know that for the kind of loan we'd be able to set up, and given that it was for a manufactured home, we'd have to either come up with 10% equity, or reducde the loan term to 20 years. I'm not opposed to a 20 year loan. We'd like eventually to roll this over to a 15 year mortgage so that the house can be paid for when I reach retirement age. But that's a scenario for two to five years down the road. Right now it would have meant too much in monthly payments. That meant that instead we had to come up with the 10%, and instead of coming in with $7000 in cash to cover the closing costs we had to come in with just over $20,000 in cash.

Fate smiled on us. The stock market has been good this summer, and for the first time I had stock options that were worth real money. We cashed them in, closed the deal, and now have the house of our dreams on a 30 year mortgage of $270,000. We don't have 20% equity, so we have to carry PMI, but we did get a 6.25% interest rate.

The plan now is to wait two years and see where interest rates and property values stand. At that point if all goes well property value appreciation will put us above 20% equity, and interest rates won't be too far from where they are now. If so, we refinance for the last time, take a 15 year mortgage, drop the PMI, and be all set. If all goes well.