The Trump administration may not be fond of FHA-insured mortgages — the president canceled a cut in fees for new loan applicants as one of his first official actions — but millennial homebuyers apparently are big fans.
A new analysis of loans closed during January found that 35 percent of millennials — those born between 1980 and 1999 — opted for Federal Housing Administration mortgages to finance their purchases, well above FHA’s overall market share of 21 percent.
The analysis was conducted by mortgage technology company Ellie Mae, tapping into its massive database of lenders’ transactions across the country. Meanwhile, FHA itself found that 82 percent of its home-purchase borrowers recently have been first-timers.
Why the strong attraction for FHA, especially at a time when competitors Fannie Mae and Freddie Mac have introduced new programs offering low down payments? Turns out it’s all about the total package of features for young buyers — not just the small cash outlays required up front.
Bradley Barron, 28, and Amy Gina Kim, who is 30, both work for tech-related companies in the Los Angeles area. They are new homebuyers and they’ve chosen FHA financing over conventional bank or Fannie-Freddie alternatives. Like many young couples, they’re carrying a lot of student debt — both have master’s degrees — and both now have well-paying jobs.
“We entered the working world with major student debt and no assets to our name,” Bradley told me last week. Their jobs are “great,” he said, but “we don’t have 10 percent to 20 percent” to put down. Both he and Amy are frustrated that they pay a substantial amount every month in rent that does not contribute toward building equity or an investment nest egg. So “the faster we get into a home, the less money we throw away on rent.”
They consulted with Steven R. Maizes, a vice president of mortgage lending for Guaranteed Rate, a large national retail mortgage banker, who walked them through the pros and cons of their alternatives. FHA turned out to be the answer.
“The vast majority of these [millennial] buyers, in the absence of getting a gift from a family member, simply don’t have” enough down payment cash, plus money to cover closing costs and post-closing money left over in the bank as reserves, said Maizes. FHA’s total package — which has some downsides as well as upsides — clinches the deal for many young first-timers.
So what’s FHA’s total package? Start with down payment. FHA’s minimum of 3.5 percent is low, but it’s not best in class. Fannie Mae and Freddie Mac have programs requiring just 3 percent down, but they come with a variety of eligibility requirements, such as income cut-offs in some cases. VA (Veterans) and USDA (rural loans from the U.S. Department of Agriculture) allow for zero down payments, but also have major restrictions — veterans status or geographic limitations.
What about credit? Here’s where the differences get really important for millennials, many of whom have middling scores compared with other generational groups. FHA accepts much lower scores than Fannie and Freddie — even below 600 FICOs. The average millennial first-time purchaser closing Fannie or Freddie loans in January had a FICO score of 748; the average for millennial purchasers using FHA was 690. Paul Skeens, president of Colonial Mortgage in Waldorf, Md., says that as a rule, whenever low down payment borrowers have FICO scores below 720, “FHA is going to give (them) the lowest payment.”
Debt-to-income ratios
Now for debt-to-income ratios, which are often a weak point with young, debt-burdened borrowers. Fannie and Freddie typically won’t go higher than a 45 percent DTI (monthly gross income compared with total recurring monthly debt), while FHA can stretch well over 50 percent — even to 56 percent, according to Skeens — provided there are “compensating” positive factors in the application, such as extra-strong income or multiple months of reserves. This flexibility on DTI to the high side is especially helpful for millennials with student-loan debts because FHA includes monthly payments on student loans as part of its debt calculation, even if payments are in deferred status.
One glaring drawback to FHA for some applicants: Unlike the private mortgage insurance that comes with low down payment Fannie and Freddie loans, FHA premiums are non-cancellable for the life of the loan. But most first-time buyers don’t remain in those starter houses for long periods of time, so it’s not likely to be a deal-killer.
Kenneth R. Harney of the Washington Post Writers Group is a past member of the Federal Reserve Board’s Consumer Advisory Council and is currently on the board of directors of the National Association of Real Estate Editors. Reach him at KenHarney@earthlink.net.
