FHA’s ‘High 5’

QUESTION:

There is now talk of raising the required Federal Housing Administration down payment to 5 percent. How would such an increase impact the real estate market?

ANSWER:

As this is written in early summer, there’s a serious proposal on Capitol Hill to increase the FHA down payment from 3.5 percent to 5 percent. For someone borrowing $200,000 with an FHA-insured loan it means that an additional $3,000 in cash would be needed to close a transaction if the higher down payment were required.

There is, in fact, no reason to increase the FHA down payment.

First, despite a woeful real estate marketplace, the FHA is doing reasonable well. According to the Department of Housing and Urban Development, FHA reserves are expected to grow by $9.76 billion in fiscal 2011 and $5.01 billion in 2012.

Second, requiring a larger down payment may actually make FHA loans more risky.

How? Because borrowers will have fewer dollars in savings, and the FHA program itself will get little benefit. As Barry Rutenberg, 2011 first vice chairman of the National Association of Home Builders, points out: “Research has shown that requiring a higher down payment does little to reduce risk of default but causes home buyers to use more of their reserves for the down payment.”

Third, a steeper down-payment requirement will deter some would-be homebuyers, not a good idea at a time when the housing market is fragile.

The reality is that while big lenders originated millions of toxic loans during the past decade the FHA stuck by its standards. HUD has always required borrowers to verify income and employment for new FHA loans. One result is that FHA borrowers – often first-time buyers – have typical credit scores above 700.

The question that ought to be asked about a higher FHA down-payment requirement is whether it will make the FHA program materially stronger and lead to additional home sales. The answer on both counts is plainly no.