Claims of being able to purchase property with no money down aren’t exactly a scam, people can and do purchase property with no money down all the time. In fact, if you are a real estate investor and your goal is to
flip property or make money from it in some way that doesn’t require you to have equity in the property, then a no-money down purchase is a smart thing to do. You don’t want to tie up a liquid asset such as cash in an illiquid asset such as land, you want both the cash and working for you.
The problem these claims usually just serve to lure people in financially precarious positions into an even more risky situation. That is these programs tend to attract people who can’t afford to make a down payment, not people who are choosing to not make a down payment as part of a business strategy. This is problematic for several reasons.
The first of which is that lenders consider no-money down loans risky, no matter who the borrower is. Since the loans are considered risky, lenders charge interest rates well above market rates, and typically charge higher fees and greater mortgage points. If this is a conscious decision on the part of an investor, then fine. Presumably he or she has considered the greater up-front expense and weighed it against the potential profit and risk and made an informed business decision. If we’re talking about any other situation, then chances the borrower has just made a loan he or she can’t really afford anyway even more expensive.
This triggers the second problem: foreclosure. If the borrower can’t afford the mortgage payments, the lender will foreclose the property to recover the loan amount. If the borrower is an investor, he or she isn’t particularly concerned about high mortgage payments because he or she will probably not hold the property long enough to have to make too many payments. If the borrower is anybody else, he or she probably can’t afford the payments from the get-go. When you throw in that the borrower suddenly has to start paying property taxes and insurance, then you find a borrower who’s on the road to foreclosure.
There’s an extra nasty trick hidden in here. No-money down loans are almost exclusively made on investment property. That is, they are rarely made for people who want to buy primary personal residences. (Actually, these days, no-money down residential homes loans are quite common, but that’s a topic for another question about predatory lending practices. Someone ask me please!) In most states, when a person’s home is foreclosed, “homestead” laws protect the homeowner up to a certain dollar amount. As well, homestead laws usually prevent the foreclosing creditor from seeking money out of the debtor’s other assets in the event the foreclosure sale doesn’t cover the cost of the loan. As mentioned, these laws generally only apply to residential homes, so if your no-money down investment property is foreclosed, the creditor can seek your other assets like bank accounts, brokerage accounts, paychecks, and vehicles. Ouch!
So, while it is possible to purchase property with no money down, and in some cases it is even advisable, it’s generally best to stay away from no-money down deals.