FHA down payment — how low is too low?
WASHINGTON — For the past several years, the Federal Housing Administration has been the go-to financing resource for cash-strapped home buyers who couldn't come up with a big down payment. It has zoomed from barely a 3 percent market share to nearly 30 percent of home purchase loans. Now, wildly popular FHA-insured mortgages could be on the verge of becoming more expensive — and tougher to obtain.
In the wake of an independent actuarial study that found the FHA's insurance fund reserves far below the congressionally mandated minimum, the agency says it is actively exploring ways to pump up its reserves — including raising insurance premiums and minimum down payments among other unspecified moves.
How might these changes affect home buyers? FHA officials won't discuss precisely what they're considering, but here are some of the possibilities.
Higher down payments: FHA's current minimum cash down payment is 3.5 percent. On a $200,000 house, a buyer can bring just $7,000 to the table, aside from closing costs. A purchase of a $500,000 house in a high-cost area requires only $17,500 in cash.
Critics say 3.5 percent does not force purchasers to have enough stake to discourage them from missing payments or risking foreclosure. Rep. Scott Garrett, R-N.J., introduced legislation last month requiring a minimum 5 percent down payment for all future FHA loans. Ed Pinto, who served as Fannie Mae's chief credit officer in the 1980s and is now a mortgage industry consultant, says FHA needs to move to a 10 percent minimum.
Many lenders and mortgage brokers argue that raising the limit could scuttle FHA's core purpose: serving consumers of modest means. Jeff Lipes, president of Family Choice Mortgage Corp. near Hartford, Conn., says a move to a 10 percent minimum "would effectively eliminate FHA as an option for first-time buyers." A 5 percent standard would reduce volume, he says, but not exclude such a wide swath of currently eligible borrowers.
Higher mortgage insurance premiums: Currently FHA charges an "upfront" mortgage insurance premium of 1.75 percent of the loan amount. Most borrowers roll that into their loan and finance it. FHA also charges an annual premium, paid in monthly installments, of either 0.5 percent or 0.55 percent, depending on the down payment. To rebuild reserves, FHA could tweak one or both premiums to yield higher revenues. It could, for example, raise the upfront premium to 2 percent or as high as the current statutory maximum of 2.25 percent. It could also raise the annual fee, but the total premium could not exceed 3 percent under current congressional limits.
Mortgage industry officials say raising premiums would be a logical move, with a gentler impact on borrowers. Lipes calculates that on a $200,000 loan, an increase in the upfront premium to 2 percent — and a move to 0.6 percent on the annual — would raise a borrower's monthly payment by just $10 at today's interest rates.
REDUCED seller "concessions": One of the big attractions of FHA financing has been the agency's liberal allowance for seller contributions to borrowers to offset settlement and loan-related fees. The current FHA limit is 6 percent of the house price, which critics say is excessive. They say the policy effectively allows financially marginal borrowers to buy houses they shouldn't, thereby raising FHA's exposure to losses. Pinto calls the 6 percent allowance "insane on a loan with a 3.5 percent down payment." He wants Congress to order FHA to reduce maximum concessions to 2 percent.
TougheR credit standards: In the mortgage market, FHA is by far the most lenient and flexible player when it comes to evaluating creditworthiness. It does not have a minimum credit score, though it permits lenders to impose FICO score minimums. FHA also traditionally has been more tolerant of credit history peccadilloes than Fannie Mae or Freddie Mac. When there are extenuating circumstances associated with credit problems — medical, marital or employment — FHA seeks to give applicants the benefit of the doubt.
But critics say underwriting generosity can lead to higher delinquencies, foreclosures and losses. They want FHA to toughen up. In fact, many mortgage market participants would prefer to see FHA move to the approach used by private insurers: risk-based pricing. Paul Skeens, president of Waldorf, Md.-based Colonial Mortgage Group, says FHA should calibrate premiums to a tiered system of credit scores and down payment amounts, charging more for borrowers with low down payments and low scores.
"If that's what it takes to make FHA solvent," Skeens says, "I'm all for it."
Ken Harney can be reached at email@example.com.