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The FHA Wants to Make Zero-Down Loans. Is This a Good Idea?


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August 03, 2006

The FHA Wants to Make Zero-Down Loans. Is This a Good Idea?

Peter Coy

When the FHA was started in the Depression to insure mortgage loans and thus help people of modest means buy homes, it required a minimum downpayment of 20%. That hefty chunk of equity ensured that people wouldn't walk away from their homes if they ran into trouble. Plus, the ability to raise the downpayment was seen as evidence that the buyer was financially responsible and knew how to save money.

Over the years the downpayment requirement for FHA-insured loans shrank to 3%. It was a thin shell of equity surrounding a big ball of debt.

Now, the FHA has decided that even 3% is too steep a requirement for homebuyers. The FHA has been losing market share to others who require 2%, 1% or zero percent downpayments, including giant loan buyers Fannie Mae and Freddie Mac and many subprime lenders. So the federal agency has asked Congress to repeal the 3% minimum, and it appears that Congress is going along. On July 25, the House of Representatives voted 415-7 in favor of the "Expanding American Homeownership Act," which among other things would repeal the 3% rule. The Senate is expected to pass similar legislation, and the White House has expressed support.

Is this a good thing? Maybe, maybe not. I'm not so worried about lenders getting stiffed. I figure they can take care of themselves. I'm more worried about families that are lured by the no-money-down pitch into buying houses they can't afford. Some will end up killing themselves to keep up with payments. Some others will default and destroy their credit ratings.

I spoke today with Margaret Burns, director of FHA's Office of Single Family Program Development, and her deputy, James Beavers. They don't think default by zero-down borrowers is a big risk. They argue that credit-scoring software can tell them with great accuracy, based on bill-paying history, etc., which people can be trusted with loans.

Lenders who think downpayments aren't necessary regard them as relics of an era when lenders didn't know very much about their customers and couldn't trust them. The FHA's Burns says that today, most people who get zero-down loans from non-FHA lenders are financially responsible and do have cash on hand, but simply choose to use their cash for things other than a downpayment. She says the FHA is losing business to the competition by insisting on a downpayment that no longer serves an important economic function. And Beavers says the FHA's loans, even if they get rid of the 3% downpayment, are safe for borrowers because they don't have easily abused features like interest-only or negative amortization. "For us," says Burns, "the 3% is a big barrier to homeownership for people who should be able to benefit from FHA-insured loans."

Mortgage Bankers Assn. senior economist Mike Fratantoni had a similar opinion. Yes, he said, there's a danger to fragile neighborhoods if people default on zero-down loans. But that's more than offset in his opinion by the benefits to society from giving families a stake in society through homeownership.

Maybe the FHA and the MBA are correct and there's nothing to worry about here. To me, though, it seems like the FHA is simply joining a race to the bottom that was already in progress, with lending standards getting lower and lower in the name of competition. Sure, zero-down loans are fine for some buyers. And sure, homeownership can be a great thing. But not all families are financially suited for it. I worry about those who buy houses they shouldn't and then live to regret their choices.

05:37 PM

Mortgages

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Dear Mr. Peter Coy,

You are right in your thinking that the new FHA guidelines will be a race to the bottom. But of course,this all ties into the race to get undocumented immigrants into homes easiler then it will be getting them jobs. To complete a purchase, they don't need a Social Security number, their last two yearly tax returns, an offical ID, such as a consular registration card and a few credit references such as electricity and telephone bills are enough to appy for a mortgage and buy a home, per Frances Martinez Myers, President of National Association of Hispanic Real Estate Professionals.Mortgages are now beening processed with ITIN numbers, issued by the IRS, who has issued 9 million ITIN numbers since 1996. Also CitiMortgage, which has loaned 5.6 Billion in mortgages, since April 2005 in Texas, plans to loan 200 billion by the year 2010, just in Texas. This way Citibank does not have to loan the Mexico government money any longer, and then have to write it off. CitiBank will at least have some colateral left then the dust clears. This will also cement a population, that for the most part prefers to speak Spanish,( read no loyalty to U.S. values) not English, into being slaves to $150,000.00 home payments in Texas. If all this is to keep us in a population race with India and China, I do not want to be in Houston or any other big city in the U.S. in twenty years or even the next five years.

Posted by: Fran Walker at August 7, 2006 11:50 AM

You're both a little confused. If FHA can't back these loans, people will still be able to get them -- but only on outlandish terms from predatory, subprime lenders.

Posted by: thedude at August 8, 2006 03:02 PM

While I understand your concern, I don't agree that this is necessarily a bad thing. FHA guidelines currently do require a 3% down-payment. However, FHA has basically been offering a Zero-Down loan option for years. The borrower's 3% down-payment can come from any one of a number of allowable sources, including gifts from relatives, and more importantly grants from non-profit organizations. This has lead to a much larger problem that could be easily solved by allowing zero-down FHA loans. While there are many "true grant programs" available to first time homebuyers, such as the Department of Housing and Urban Development's very own American Dream Downpayment Initiative Program, (this program offers first time homebuyers a grant of up to $7,000 to use toward the 3% down-payment and even closing costs when purchasing a new home) there are other programs currently available that are more dangerous than a Zero-Down Loan could ever be.

The problem is that there apparently is a great deal of money to be made in creating a non-profit 501c corporation in this country (but thats another argument for another day) realizing the need for such a service, several non-profit companies such as The neighborhood gold buyers fund and Ameridream program were created to provide down-payment assistance to qualified home buyers. The idea behind these companies is fairly simple. Since they are technically non-profit and offering "grants," FHA considers the grant money an eligible source to be used toward their down-payment requirement. At closing the non-profit company gives the buyer the "grant" to use toward their down payment when buying the house. The buyer brings the money to closing and gives it to the seller as part of the purchase, finally the seller agrees to give the money back to the non-profit company, along with a small fee. (usually $300-$500) In theory this is a great program and everybody leaves happy. The seller is happy because they sell their house, the buyer is happy because he gets an FHA loan with no-money down and the non-profit is happy because they go on collecting fees and making lots of money (even though they are a "non-profit" company of course) Like most things, in practice these transactions leave much to be desired. The seller, who usually does not want to part with their house for less than the sales price, is convinced by their Realtor to raise the sales price of the home, in order to cover the amount of the down-payment-assistance they will need to give. The mortgage broker and appraiser make sure the house appraises for the increased amount (even if it isn't really worth the bumped up price) and then the buyer is blissfully ignorant that they have purchased a house with no money down for more than it is actually worth. If they later can't afford it or try to sell, they realize it is impossible, because 1.) they have no equity in the house, and 2.) they owe more money than the house is worse. Foreclosure is the only option for some and FHA is left holding the bill. This has become such a problem that the government is cracking down on many of these companies and programs. The IRS has recently announced in IR-2006-74, May 4, 2006 that it intends to target down-payment assistance scams; claiming that many seller-funded programs do not qualify as tax-exempt. Allowing FHA loans with zero-down payment will not only eliminate the need for these companies, but severely limit the problem of inflated appraisals and buyers getting stuck with loans for more than their house is worth. In the long run borrowers who can't afford the 3% down payment will be better off as well because they will obtain a solid, fixed rate loan insured by the federal government with a low competitive interest rate. Currently these same borrowers will typically end up with a sub-prime loan with a high interest adjustable rate mortgage that will more than likely increase, leaving them with a much higher mortgage payment after a 2 year introductory period and a pre-payment penalty that will cost them 1%-2% of their loan amount if they try to refinance out of their bad loan. I have to admit I'm in favor of a zero-down FHA loan.

Posted by: Josh Plummer at August 13, 2006 12:01 AM

Problem is that these 100% loans have not been tested in a down market. FHA is getting into this late in the game.

Posted by: Paul at September 3, 2006 07:00 PM

I have a question. It looks like the Senate will pass this bill and the President will sign it into law. My question is, WHEN will the consumer actually have the ability to take advantage of the new program? January 2007? If not, when?

Thanks!

Posted by: John at October 29, 2006 06:31 PM

The Fha just took its sweet old time. Should have done it sooner

Posted by: TJones at February 21, 2007 10:12 PM


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