No 20 percent down requirement for FHA mortgages

by Peter G. Miller
July 29th, 2011

There’s been a lot of talk regarding a new federal standard for home loans and how it will impact the marketplace. In these discussions, Federal Housing Authority (FHA) mortgages are frequently mentioned as if they had some sort of disease which is tearing at the heart of the national economy.

The new rules under Wall Street reform create a standard for loans. If a loan fits, it is then a qualified residential mortgage (QRM). If it doesn’t fit, then the lender can still make the loan and a borrower can still be dumb enough to accept such financing.

Lenders, of course, are screaming about the new QRMs. They’re telling everyone who will listen that loans under the QRM will require 20 percent, so be very afraid of the new standard.

Why 20-percent down doesn’t apply

This is nonsense. The 20-percent standard does not apply to FHA loans. Or VA financing. Or loans bought by Fannie Mae and Freddie Mac. Or loans lenders hold in portfolio. In other words, the 20 percent requirement does not apply to any safe and sane mortgage. The big down payment requirement does not apply to nearly 80 percent of all loans made today.

As a side issue, lenders are distressed with the FHA.

“We support FHA’s role as a source of financing for first-time homebuyers and other underserved groups,” explains the chairman of the Mortgage Bankers Association, Michael D. Berman. “However, because of the wide disparity between FHA’s down payment requirement of 3.5 percent and the QRM’s requirement of 20 percent, MBA is concerned that the FHA programs will be over-utilized.

“While FHA should continue to play a critical role in our housing finance system, MBA firmly believes that it is not in the public interest for a government insurance program like FHA to dominate the market, especially if private capital is available to finance and insure mortgages that exhibit a low risk of borrower default.”

Since when did the “over-utilization” of a loan program become a problem? Imagine if Target started a campaign on Capitol Hill to limit the size of Walmart because the bigger retail chain was “over-utilized.”

Here’s an idea: If the lending industry wants to make fewer FHA loans, then compete.

Come up with something better. Come up with something cheaper.

Digging deeper

The real issue, the one hidden behind fake worries regarding 20 percent down, is that when lenders make terrible loans under the new system, they’ll be required to set aside 5 percent of the loan amount in a reserve fund.

And what happens if lenders must keep 5 percent in reserve? They have lower profits.

So, if we get rid of the 5 percent reserve requirement, then lenders can make more toxic loans. More option ARMs. More loans with no doc loan applications. More interest-only mortgages.

These are loans which should never have been allowed by federal regulators in the first place. Such mortgages are at the heart of the mortgage meltdown and failures on Wall Street. We don’t need these loans again. We do need the FHA.

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