Will the FHA downpayments increase?

by Peter G. Miller
June 6th, 2011

There’s a lot of rumbling in Washington suggesting that an effort is now underway to raise the Federal Housing Authority (FHA) down payment requirement from 3.5 percent to 5 percent.

This is an inherently bad idea–and not unexpected.

Will your FHA mortgage cost you more?

“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,” said Barry Rutenberg, speaking for the National Association of Home Builders. “Sound underwriting is the key to minimizing foreclosures and defaults, not higher down payments. This is demonstrated by current FHA foreclosure reports on loans made to borrowers with sound credit profiles, which have significantly improved.”

Michael D. Berman, chairman of the Mortgage Bankers Association, says his organization also has “apprehension about legislation to raise FHA’s minimum down payment to 5 percent.

“We should not be placing such a high emphasis on just one factor in determining a loan product’s overall risk.” While down payment has an impact on default, other factors, including full documentation of income and borrower credit, can mitigate this risk. In fact, it’s FHA’s requirement of full documentation of all loans and its limited product options that helped insulate it from experiencing a more devastating default rate during the height of the housing crisis.

Why higher down payments don’t help

The fact is that there is no need for a higher FHA down payment.

First, the FHA’s annual mortgage insurance premium has already been raised by .25 percent. This might be necessary is the FHA was losing money but–guess what–according to past Commissioner David H. Stevens the “FHA is projected to generate approximately $9.8 billion in receipts for the U.S. Treasury in FY 2011, a significant increase compared to the $565 million of receipts generated in FY 2009.”

Second, the FHA

has massive reserves.

According to HUD, “due in large part to the performance of recently originated loans, FHA’s total capital resources increased by $1.5 billion since last year, to $33.3 billion, and are at their highest level ever – $5.5 billion greater than predicted last year. If the economy were to suffer a further significant downturn, recovery of the capital ratio could be delayed beyond the projected time frame.

“However, even in the actuaries’ worst-case stress test scenario, FHA’s capital resources remain sufficient to cover projected claim losses and FHA would not require a taxpayer subsidy, an improvement over last year’s assessment and due to new loans having higher credit quality than had been anticipated.”

At this moment a draft legislative proposal is being passed around on Capitol Hill to raise the FHA down payment to 5 percent as of Oct. 1. It’s not a good idea because the housing markets remain obviously weak–prices nationwide continue to fall and April existing home sales were 12.9 percent below a year ago, according to the National Association of Realtors.

So why make such a proposal? It’s all part of the effort to reduce the FHA insurance program by changing the rules rather than offering better financial products in the marketplace.

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