The resurgence of the low down payment market

The dramatic rise in FHA insured loans in a time of historically low rates demonstrates two key aspects of the current American economy. The first point is that many US households have the inability to save for an adequate down payment on housing. Forget about the historical 20 percent down payment but many households cannot scrimp up even a modest 10 percent down payment. The second point is the American economy is still living on leverage. Debt is an elixir best served in moderation but as we are seeing with the low mortgage rates, the country is now setting a threshold where low rates are expected. As a case and point we now see FHA insured loans playing a major role in the housing market. Since Q2 of 2007 the number of FHA insured loans outstanding has more than doubled. This would not be such an issue if they weren’t defaulting in mass.

FHA the nostalgic bridge to easy money loans

There is little doubt that FHA insured loans are plugging the bottom end of the market. FHA loans were never intended to be a major player in the overall housing market. In a recent MBA survey that covers roughly 88 percent of all outstanding mortgages we find the following: FHA loans outstanding

Q2 2007: 3,030,214 Q2 2012: 6,827, 727

In this short period of time, FHA insured loans more than doubled. The benefit? FHA loans require a miniscule 3.5 percent down payment and this is what most typically jump into the market with. Nonsense chatter that people go in with more down payment funds is just not shown in the facts. Most people that use FHA loans use them for the following reasons:

-Lack of down payment funds
-Maximum leverage to squeeze in
-Little risk

FHA insured loans essentially function as a call option on a home. Think about the fact that selling a home will cost a home owner roughly 5 to 6 percent so right off the bat FHA buyers are already in a negative equity situation when selling costs are factored in. However, with such little skin in the game should home prices drop dramatically people have less of their money at risk. Why else would demand for these loans be so high? You can get a conventional mortgage with 20 percent down, fantastic rates, and no mortgage insurance. Mortgage insurance is now getting more expensive because of rising defaults. Don’t think this is true? Let us look at serious delinquency rates across mortgage products:

delinquent loans

While prime mortgages have a serious delinquency rate of 4.98 percent FHA loans are up to a stunning 9 percent. This is incredibly high given that this is a loan product that has been booming recently. Subprime loans are a dwindling segment of the mortgage market. In 2007 subprime loans made up 14 percent of all outstanding loans whereas today they are 9 percent and moving lower. However, FHA loans in 2007 made up 6 percent of all loans and are now up to 16 percent of all outstanding loans. We should be concerned about the delinquency rate because we will be on the hook for this. Of course it should come as no surprise that many that can barely save 3.5 percent to buy a home are more likely to encounter financial problems and increase a new category of distressed inventory. Home prices nationwide are being supported by low interest rates and low down payment products. For example, let us run the monthly payment for your typical nationwide home:

purchase home nationwide

Given the $50,000 typical household income an $180,000 home with a 3.5 percent FHA insured loan doesn’t look like it will stretch the budget too much. Run the figures for a $500,000 home in California:

purchase home socal

Notice how high that PMI is? This is how many in SoCal are squeezing into places and creating bidding wars with the low inventory that is being seen on the MLS. The low inventory is not a creation of a booming economy but by number games being pushed by the Federal government and Fed. The fact that over 9 percent of FHA outstanding loans are seriously delinquent (nearly 7,000,000 total FHA loans outstanding) should we simply continue giving out low down payment loans for the sake of getting people into homes? Clearly something is up here because prime conventional loans with higher down payments are performing much better. As we discussed in a previous article low interest rates are already hurting households in other less obvious ways. How long can this last? Hard to tell but the fact that mortgage insurance rates zoomed up this summer in a hot selling season should tell you that the underlying fundamentals of the economy are still shaky. Also, if FHA insured loans were such a good deal why don’t you see Wall Street banks jumping in to make 3.5 percent down payment loans with their own money to the American public? Currently the entire mortgage market is fueled by government backed products.

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