Is It Time For Higher FHA Down Payments?
August 25th, 2010
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Writing in the Financial Times, economist Charles W. Calomiris suggests that we raise down payment standards by 1 percent per year until all loans require 20 percent down.
Calomiris, the Henry Kaufman Professor of Financial Institutions at Columbia Business School, says in time “FHA mortgage guarantees would end, Fannie and Freddie’s assets would be sold into the market, and Federal Home Loan Banks would also be phased out.”
If the goal is to have less risk then surely Dr. Calomiris is right. More down means less risk for lenders and a greater willingness by borrowers to assure that homes do not go to foreclosure.
That said, is 20 percent down the magic number?
Right now you can get a freshly-minted FHA loan with 3.5 percent down. That’s surely a lot less than 20 percent but the down payment is not the whole story. With the FHA program borrowers trade less down for payments into an insurance plan.
To date the FHA program has worked very well — the program was started in 1934 and has insured more than 37 million loans. But what about raising down payment levels? Should the FHA move in that direction?
More Money Up Front
It follows that with more money up front that the FHA system would have less risk, say 5 percent down rather than 3.5 percent. The catch is that risk is not the only issue.
Right now we have a marketplace which desperately needs buyers, especially first-time buyers. If you raise the required down payment then the plain result will be fewer purchasers, exactly the incentive we don’t want.
But going from 3.5 percent to, say, 5 percent doesn’t seem like a big jump. For a $200,000 that would mean a $10,000 down payment instead of a $7,000 cost up-front. Is $3,000 really a big deal?
Well, actually, yes.
As an example, the tax credit for first-time home buyers ended in April and we are now seeing the last of the settlements related to that program. And what are those results? In July, as the National Association of Realtors explains, “existing-home sales, which are completed transactions that include single-family, townhomes, condominiums and co-ops, dropped 27.2 percent to a seasonally adjusted annual rate of 3.83 million units in July from a downwardly revised 5.26 million in June, and are 25.5 percent below the 5.14 million-unit level in July 2009.
“Sales are at the lowest level since the total existing-home sales series launched in 1999, and single family sales — accounting for the bulk of transactions — are at the lowest level since May of 1995.”
So yes, higher down payments reduce lender risk and less lender risk is not an idea to be ignored. But there are other issues as well, and in today’s economic environment we ought to hope that the FHA loan requirements remain just as they are for a very long time.
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