FHA Zero-Down Plan Deserves Support
by Peter G. Miller

The first home I ever bought was financed with an FHA loan. At the time I had no idea how the down payment requirement was concocted or that the FHA did not actually provide the loan money I needed to finance the property. Ignorance was bliss and I was elated with my first house.

Like millions of other buyers before and since, the FHA program made sense to me because it required little down and had liberal qualification standards. It also provided a gateway to future benefits: That first home grew in value and became the basis for subsequent real estate purchases.

The FHA program is not a loan plan -- you don't get dollars from the government. Instead, it's insurance. The government says that in exchange for a premium paid by borrowers it will help lenders get their money back in the event a property must be foreclosed. Given the size of the government, it's a powerful co-signer and lenders gleefully accept its repayment promise. As a result, instead of requiring 20 percent down you can buy owner-occupied property with 3 percent down plus closing costs through the FHA plan.

You can use the FHA loan program to buy a first home, a property with as many as four units (as long as you live in one), a replacement (move-up) property or to purchase and fix-up a house. You can also use the FHA program to refinance. Such programs are enormously popular: According to the Mortgage Insurance Companies of America (MICA), 1.2 million FHA mortgages were created in 2002. That compares for the same year with 382,000 VA mortgages as well as 2.3 million loans backed by private mortgage insurance (MI).

One catch to FHA financing is that the amount you can insure is limited. How much you can get is determined by where you live. For details, see the FHA loan limit webpage.

HUD has now proposed FHA loans with nothing down, an approach which will particularly benefit first-time homebuyers.

In the usual case I'm not thrilled by loan programs with nothing down. I think it's important to have equity and that saving is a valuable financial exercise. At the same time I cannot ignore the VA mortgage program, a hugely-successful plan which for decades has provided loans with nothing down to those with qualifying federal service.

Critics of the FHA proposal note that the federal agency already has a significant foreclosure rate, one far higher than most private mortgage plans. Statistically they're right: According to the Mortgage Bankers Association -- a group which strongly supports the FHA zero-down plan -- during the third quarter of 2003FHA loans had a 2.80 percent foreclosure rate compared with 0.84 percent for conventional financing and 1.53 percent for VA loans.

But HUD is a government agency, not a private lender, so the measures of success and failure are different. Like the army, no one expects HUD to make a profit. Like the VA, HUD has a social responsibility and should take more chances than private loan guarantors. More risk equals more foreclosures -- and also more opportunities for those who might otherwise not find financing. If it's true that FHA has a 2.8 foreclosure rate, it's equally true that 97.2 percent of its loans are not being foreclosed. That's an "A" by most standards.

Congress should approve the HUD proposal because a zero-down FHA loan would help many people who have good incomes but little in savings. Some zero-down loans will fail, but that's why the FHA collects insurance premiums. As well, an FHA zero-down program would do something else: It would provide a zero-down benchmark consumers could compare with private programs, something good for the marketplace.

Published: February 17, 2004