Down Payment on FHA Loans Could Increase to 5%

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The down payment for an FHA home loan could soon increase from 3.5% to 5%. This comes in direct response to the FHA’s dwindling funds.

The Federal Housing Administration needs money. The FHA insures mortgage loans made by direct lenders, such as Wells Fargo and Citi. But with the rash of defaults and foreclosures across the country, the FHA’s financial reserves have taken a serious hit. The House Financial Services Committee has raised the question of making these government-backed loans more expensive to obtain, and a new House bill could raise the down payment requirement from 3.5% (the current level) to 5%.

In addition to raising the minimum required down payment, the FHA Taxpayer Protection Act would also prevent the financing of closing costs. In other words, home buyers would no longer be allowed to roll their closing costs into the loan.

Incidentally, there is a strong correlation between the amount of money home buyers put down, and the likelihood that they will default on their mortgage in the future.

What This Means to Home Buyers

The FHA insures about 30% of all mortgage loans made within the United States. A government-backed loan is generally easier to qualify for, and more affordable on the front end. With a traditional home loan (one that is not insured by the FHA), you may have to put up to 20% down in order to be approved. But with an FHA loan, you can make a down payment as low as 3.5%. If the requirement gets raised from 3.5% to 5%, you’ll have to save more money to put toward your house.

Here’s an example of how this change could affect a first-time home buyer. Let’s say that I want to buy a house that costs $150,000, and I’m using an FHA home loan to pay for it. Here is the amount I would have to pay under the current guidelines, versus the proposed increase.

  • A down payment of 3.5% = $5,250
  • A down payment of 5% = $7,500

Bottom line: If you’re planning to use an FHA loan for your purchase, time may be of the essence. If the House bill is passed, it could go into effect next year, in 2010. This means you’ll have to come up with a larger down payment, when compared to the current guidelines.

2012 Update on This Story

There was continued discussion about this topic, throughout 2011. But as of January 2012, the Department of Housing and Urban Development still has no immediate plans to implement a 5% down-payment requirement on FHA loans. The current minimum is still set at 3.5% for qualified borrowers with credit scores above 580.

There has also been talk of implementing a mandatory 20% down payment for conventional mortgage loans. This discussion has followed along with the development of the so-called Qualified Residential Mortgage (QRM). We did a story on this subject in January 2012. As with the FHA changes, this is still theoretical at best. In 2012, well-qualified home buyers will be able to put as little 5% down when purchasing a home with a conventional loan.

Credit scores are equally important when applying for a mortgage, regardless of the financing program you use. Most lenders today are requiring FICO scores of 600 or higher when qualifying applicants. Of course, this can be offset by the size of a borrower’s down payment. A lender might relax this requirement for a borrower who can afford to put 20% down. This reduces the size of the bank’s investment (i.e., risk) in the deal, which typically makes them more flexible in other areas of qualification.

So, to recap. There has been a lot of talk about HUD raising the required down payment on FHA loans from 3.5% to 5%. But as of January 2012, it has not progressed beyond discussion. For now and the foreseeable future, the minimum remains at 3.5% of the borrowed amount.