FHA Reform Will Not Include Higher Down Payments

by Gina Pogol
June 17th, 2010

Despite the efforts of several Congresspeople, FHA borrowers will not be required to put up more than 3.5% for a down payment as long as their credit scores are 580 or higher. Amendment after amendment that included higher down payments went down in flames. Is it due to the devilish work of the evil Empire itself, the National Association of Realtors? Is it because too many in office felt the need to suck up to FHA borrowers? Probably not.

The reasoning behind the proposed down payment increase is that borrowers with a greater investment in their homes are supposedly more likely to honor their commitments and less likely to default if the real estate market or the economy goes south. I can find a few holes in this argument.

1. First, one person’s “substantial investment” is someone else’s pocket change. For buyers at the lower end of the financial food chain, 3.5% may represent several years’ planning and saving for a home. For another family, 20% down could require little effort on the part of the buyers. My own home came that way — put zero down, got an 80/20 Alt-A mortgage, made $125k profit in five years, which was 20% down on the next home. Nothing out of pocket, no sweat. I doubt that my 20% makes me one bit more committed than I would be had I slaved to save $200 a month for years to buy a starter home or condo.

2. Prime borrowers walk away from homes too. In droves. In fact, a report from mortgage analysts at Morgan Stanley concluded that strategic default is highest among borrowers with higher credit scores, those with loans originated in 2006 or 2007, and those with prime-jumbo loans. Strategic defaults could account for as many as 40% of defaults from the 2006 and 2007 vintages of prime jumbo loans, analysts estimate.

3. Lender behavior doesn’t support this. Looking at FHA guidelines, you’d think that you could get a loan at 3.5% down if you have a credit score of 580, and one at 10% down with a score as low as 500. But just try and find a loan in real life with those scores – not gonna happen. Lenders, aware that a high default rate could get their FHA approval yanked, even if they abide by FHA guidelines, choose almost universally to impose higher credit score requirements on borrowers they approve. However, they aren’t requiring higher down payments. Probably because they know that an extra 1.5% down isn’t going to affect the default rate enough to be worth requiring.

Defaults that happen because of circumstances borrowers have no control over, like illness or job loss, will not be stemmed by making it harder for these people to get a mortgage. Assuming that Congress is then trying to stop defaults by those who can afford their homes, there are more effective ways to accomplsih this than by increasing the down payment by 1.5%.

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One Response to “FHA Reform Will Not Include Higher Down Payments”

  1. Carl Pruitt Says:

    You are right on the money with this one. I really don’t think the link between higher down payments and fewer defaults is as strong as most people think it is. In my own mortgage career, I saw too many people with easily obtained large down payments walk away, while people with no money fought tooth and nail to keep their homes even through job losses and serious illnesses.

    On the other hand, I originated plenty of FHA loans when the down payment was nearly 5% and I don’t think it killed the first time home buyer market. It’s a big circle. Easier qualifying helped lead to higher real estate prices, thus making it harder for people to come up with the higher percentage down payment.

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