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June 9th, 2010

FHA: Is a 5% Downpayment Really That Big of a Deal?



Especially in today’s real estate market where many mortgage lenders are requiring borrowers to put 20% down, saving for an adequate downpayment may be unattainable for many. The findings from a recent National Foundation for Credit Counseling (NFCC) survey agrees:

The NFCC recently asked consumers about their ability to meet the down-payment requirements associated with buying a home in today’s market. Of the more than 2,000 respondents, almost half (49 percent) admitted that they’d never be able to save enough money for a down-payment on a home.  This is discouraging news for the housing market in general, lenders, potential buyers, as well as existing homeowners.

On the opposite side of the spectrum, the Federal Housing Administration (FHA) requires borrowers to only put a minimum of 3.5% down. Unable to meet the constraints of 20% down, wave upon wave of new borrowers have opted for FHA loans over mortgages guaranteed by Fannie Mae or Freddie Mac.

Given the FHA’s ballooning market share, and the fact that their risk has grown right along with their portfolio, many have called for the FHA to increase their minimum downpayment requirements. While the FHA made some changes earlier this year that were designed to hedge against some of the recent risk they have accumulated, some argued that the changes didn’t go far enough.

As the FHA is now insuring such a larger portion of mortgages than they have in the past, and since a significant portion of those loans would otherwise have likely been sold and guaranteed by Fannie Mae or Freddie Mac in the past, we wonder, “Is raising the FHA’s minimum downpayment requirement to 5% really that big of a deal?”

Let’s First Take a Look at the Numbers:

Using HSH.com’s Amortization Calculator, let’s examine the difference in the monthly payment if we put 5% down verses 3.5%.

We’re going to use a home price of $200,000 and a mortgage rate of 5.25% (that’s above current market levels for a 30-year Conforming rate, buy we’re allowing for some increase).

  • 3.5% Downpayment ($7,000): $1,065 (loan amount = $193,000)
  • 5% Downpayment ($10,000): $1,049 (loan amount $190,000)

As you can see, the $16 dollar difference in the monthly payment isn’t all that substantial, yet, the increase means the borrower needs to save an extra $3,000.

Remembering Who FHA Originally Served

Remembering the audience of borrowers who the FHA originally served can help us understand why lawmakers, so far, haven’t seriously considered raising the minimum downpayment to 5%.

In “normal” times, borrowers didn’t need to rely upon the FHA because lending restrictions were not nearly as strict as they are today. Getting a Fannie or Freddie-guaranteed loan with 5% or 10% down wasn’t as big of an issue as it is today.

During the height of the real estate boom, the FHA’s market share was about 2% since there were so many private offerings available (subprime, etc.). Today, recent estimates put the FHA’s market share at upwards of 35% of all new originations.

Will Requiring 5% Down Kill Housing’s Recovery?

Back in March, FHA Commissioner David Stevens said it very well could:

An increase in down payments to 5%, from the current minimum 3.5%, would limit new FHA-backed loans by 40%, equivalent to 300,000 fewer home sales, according to testimony that FHA Commissioner David Stevens is set to deliver on Thursday [03/11/10].

“We share the goal of increasing equity in home purchase transactions, but determined after extensive evaluation that such a proposal would adversely impact the housing market recovery,” Mr. Stevens says in his testimony.

Raising the Downpayment “As Needed”

According to National Mortgage News, lawmakers will likely again reject raising the minimum downpayment requirement, but they could include language into an amendment that would allow the FHA to change the requirement on an “as needed” basis. At this point, we don’t know if that means raising it for more or less-qualified borrowers:

The House is likely to reject an amendment that would raise the minimum downpayment on Federal Housing Administration loans to 5% from 3.5%, but legislators might accept language giving the government insurer the authority to raise the downpayment as needed.

The Rules Committee meets Tuesday evening [6/08/10] to decide which amendments can be offered to the FHA reform bill (H.R. 5072) that the House of Representatives will vote on during Wednesday’s session. If approved by the Rules Committee, Rep. Melissa Bean, D-Ill., will offer an amendment giving FHA the authority to raise its downpayment, or minimum cash investment, requirement. The Bean amendment also asks FHA to submit an annual report to Congress discussing proposed or actual increases in downpayment requirements.

Readers, how would you react if the FHA increased their minimum downpayment requirement?

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6 Responses to “FHA: Is a 5% Downpayment Really That Big of a Deal?”

  1. huh Says: June 9th, 2010 at 2:40 pm

    why is the monthly payment more with a lower loan amount at the same rate? i think you have this backwards?

  2. Steve Says: June 10th, 2010 at 7:48 am

    Absolutely raise the DP requirement to 5%!

    The median sales price in New Jersey in the 4th quarter 2009 was $296,700 (according to the National Association of Realtors). I daresay most FHA mortgagors would be buying homes on the lower end of the scale, but let’s use the median figure anyway. (and keep in mind that NJ home prices are significantly higher than the national average price)

    With a 3.5% DP requirement, the buyer needs to have $10,384.50 down. With a 5% DP requirement, the buyer needs to have $14,835 down, $4,450.50 more. Buying at the median price, in one of the most expensive markets in the country, the buyer would still need less than an additional $5,000 for a down payment.

    And Commissioner Stevens thinks such an onerous burden would threaten the recovery of the housing market? Seriously? Have we such short memories of how we got into this mess?

    As a taxpayer, I would vigorously urge the FHA to increase the DP requirement to 5%.

  3. Tim Manni Says: June 10th, 2010 at 8:14 am


    Good eye! That’s our mistake…all fixed.


  4. Tim Manni Says: June 10th, 2010 at 8:31 am

    Hey Steve,

    I agree, I think Stevens overestimated his projections.

    What about the possibility of the FHA increasing the min DP requirement on a “as needed” basis? That could turn into a big mess real quick. If that’s a serious portion of the conversation, then instead of “as needed,” it should be “as market conditions dictate.” But that still could get messy.

    I think based on your monetary example and mine, we’ve shown that the DP increase wouldn’t be all that much. I provided a reasonable figure ($200,000), and as you said, I would bet that a good portion of FHA loans are for less than $200,000, and you provided a figure for one of the most expensive markets in the country.

    “As a taxpayer, I would vigorously urge the FHA to increase the DP requirement to 5%”: Do you think the FHA’s market share, and the makeup of that ballooned market share (borrowers who in the past would have gone to Fannie or Freddie), will stay as is for some time? If so, I agree that it could be raised. If FHA “goes back to normal” in the near future, is that reason enough to let the minimum DP requirement stay as is?

    Great comment, thanks,

  5. Mitch Says: June 16th, 2010 at 11:28 pm

    I go the other direction, which would figure. There’s many communities with a glut of homes. I think the idea of forcing homeowners to pay 5% of the worth of the home before they purchase, especially in this day and age when lenders don’t want to give up any money to begin with, is going to suppress the market even more, and many of those homes will stay empty. It’s always easy for some people to say it’s not that much money when it’s not their money being spent.

  6. Tim Manni Says: June 17th, 2010 at 10:33 am

    Hey Mitch,

    I hear you, but the change to the FHA’s annual premium (recently approved by Congress) will cost FHA borrowers even more than if they increased the DP requirements. Certainly if they increased both that would really have some negative impacts, but the cheaper of the two would be increasing the DP (if the home is reasonably priced).

    Thanks for commenting,

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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