The Federal Housing Administration has insured more than 47.5 million properties since the program was created in 1934, making it the largest mortgage insurer in the world. With its 3.5 percent down payment and notoriously favorable lending standards, FHA mortgages have been the top choice for first-time homebuyers since the housing recovery began five years ago. However, times are changing.
Despite shrinking inventories of affordable homes for sale and soaring home prices, first-time buyers have become the most important demographic in real estate. More than 2 million first-time buyers became homeowners last year. That’s more than one-third of all homes sold in 2017. With more than 995,000 sales in the first half of 2018, the first-time buyer market is stronger than it has been since 2005.
For the first time in history, in the third quarter of 2018, more first-time buyers chose conventional mortgages over FHA according to the quarterly First Time Buyer report from Genworth Mortgage Insurance. By the first quarter of 2018, the most recent data available from the Department of Housing and Urban Development showed that FHA’s share of purchase mortgages (mortgage to buy a home rather than refinance one) had fallen to 14.2 percent of all purchase mortgages, down from a recent high of 18.4 percent in the fourth quarter of 2016.
“The FHA loan is not the default low-down payment mortgage choice for buyers of homes anymore. There are other, less-expensive options,” says Dan Green, a former loan officer and expert on mortgage finance.
At a time when the first-time buyer business is booming, why is FHA losing market share?
New Competition From Conventional Lenders
The primary cause of FHA’s decline are dozens of new conventional low-down-payment products designed for the first-time buyer market. The most popular are two different 3 percent down mortgages introduced by Fannie Mae and Freddie Mac. The two GSE’s also are the primary purchases of a wide variety of new products from large and small mortgage lenders.
Some conventional lenders have even created new “zero down” mortgages where lenders offer a 3 percent down the loan. They give the borrowers a “grant” for the down payment and sell the loan to Fannie or Freddie.
Grants or tax credits are also available in some low-down-payment programs offered by more than 2400 local and state housing finance agencies. Some of these are for first responders, teachers and municipal workers to help them buy a home close to their place of work.
Mortgage Insurance: PMI vs. MIP
Both low down conventional loans and FHA loans are required to have mortgage insurance. Conventional loans are insured by private mortgage insurers whose rates are competitive and reflect the risk posed by each loan. FHA has its own insurance program. Mortgage insurance protects lenders from mortgages that default. It increases the cost of the loan and is usually added to the homeowner’s monthly mortgage payment. It makes it possible for buyers to use low down payment loans.
Private mortgage insurance (PMI) expires when the borrower’s home has appreciated enough to reach 20 percent equity (or has a loan-to-value ratio of 80 percent). Mortgage insurers are required by law to notify their customers when their LTV reaches 78 percent. It takes most homeowners about five-and-a-half years to reach an 80 percent LTV.
FHA insurance (MPI) never expires. Homeowners are required to pay it for the life of the loan. FHA homeowners can free themselves from mortgage insurance only by selling or refinancing into a conventional loan. FHA loans are assumable, which means that an owner can sell his home with his FHA mortgage rate included, which could be an advantage as rates rise.
In addition to monthly premiums, FHA borrowers are required to pay an “upfront” premium. Currently, upfront premiums are 1.75 percent of the base loan amount and are automatically rolled into the borrower’s monthly mortgage payment.
The financial website ValuePenguin compared the cost of MIP and PMI mortgage insurance to find out which is more expensive. On a $200,000 house with a down payment of 10 percent ($20,000), homeowners would pay almost four times as much in mortgage insurance with an FHA loan than a typical PMI premium of 0.76 percent, according to ValuePengiuin. While all FHA borrowers must pay the 1.75 percent upfront premium, the FHA sets different rates for annual premiums depending on term length, loan amount and down payment.
During the housing boom, FHA insurance was priced too low to cover the growing risk it acquired, leading to billions of dollars in losses that pushed the MMIF’s Capital Reserve Ratio below the mandated two percent level. Eventually, Congress authorized the Treasury for an infusion of cash to shore up required reserves. As a result, the fund has been managed conservatively since.
In 2016, the Federal Housing and Urban Development Department sought to make FHA more competitive by cutting the up-front premium. In one of his first acts after taking office in January 2017, President Trump vetoed the request and FHA’s market share has continued to suffer.
Rates and Approval Standards
Mortgage rates for FHA loans and conventional loans vary by credit score, lender, location and other factors. FHA rates tend to be very competitive since FHA loans are backed by the federal government. Low down payment mortgages require higher credit scores than FHA. Conventional lenders use risk-based pricing which makes an FHA loan a more affordable option for borrowers with lower credit scores.
FHA loans are popular with borrowers who have marginal credit. The average FHA borrower has a FICO score of 677 compared to 751 for conventional borrowers and will accept a score as low as 580. FHA also is much kinder to debt-burdened applicants, averaging a 44 percent debt-to-income ratio compared 36 percent for conventional borrowers.
Times have changed in low down payment market. Borrowers have more choices and the FHA has more competition. The decline in FHA’s market share has at least one silver lining. More of the risk of low down payment mortgages is moving towards investors and away from taxpayers.
FHA vs Conventional Low Down Payment Loans
|Conventional mortgages with down payments||FHA loans (purchase)|
|Minimum FICO credit score||Typically no lower than 620||The average is 677; the lowest accepted score is 580|
|Down payment||From 10% and to as low as zero.||3.5%|
|Mortgage rate||Usually higher than FHA||Usually lower than conventional|
|Terminate mortgage insurance?||Yes after LTV reaches 80%
|Mortgage insurance cost||0.20% to 1.50% of the loan amount||0.85% to 1.05% of the loan amount plus the upfront premium of 1.75 percent of the amount of the loan.|
Though it has declined steadily during the housing recovery, the FHA share of the first-time buyer market is still larger than it was during the housing boom.