An ultra-popular home loan option is currently allowing buyers to make a down payment of just 3.5%, even in a challenging housing market. Federal Housing Administration (FHA) loans have seen a notable increase in popularity, being the only type of mortgage loan that has seen a rise in the past two years.
According to recent data from consumer credit reporting agency TransUnion, FHA loans experienced a 9% year-over-year increase in the fourth quarter of 2023. These loans are designed to cater to first-time or low- to middle-income buyers, offering the advantage of lower down payments, with a minimum requirement of 3.5% for individuals with credit scores of 580 or higher. Even those with credit scores around 500 could qualify for a loan by putting down 10% of the home value.
However, it’s important to note that borrowers opting for lower down payments may be subject to mortgage insurance until they reach 20% equity, potentially resulting in a higher overall loan cost compared to making a 20% initial payment.
The increase in FHA loans comes at a time when overall mortgage origination has been on the decline. TransUnion’s analysis revealed that mortgage growth has been decreasing for the past nine quarters, with the total number of loans dropping to 900,000 in the last quarter of 2023, below the levels seen before the pandemic.
Despite the decline in mortgage originations, the smallest year-over-year drop in two years was recorded in the fourth quarter of 2023, at 11%. This trend indicates that consumers are still actively seeking mortgage options, particularly those who are first-time buyers or have budget constraints in a competitive housing market.
Satyan Merchant, senior vice president of automotive and mortgage at TransUnion, emphasized that FHA programs provide a valuable opportunity for individuals looking to purchase a home with a lower down payment. He noted that in markets where housing inventory is limited and prices are high, potential buyers often face the dilemma of whether to wait or proceed with a purchase.
While the data did not specifically address the generational demographics of FHA loan applicants, Merchant highlighted that typically, first-time buyers, particularly Millennials and Gen Zers, are actively engaging in the housing market to establish households and start families.
However, the prevalence of lower down payment options in the current market raises concerns reminiscent of the mortgage practices leading up to the 2008 Financial Crisis. A study conducted in 2021 highlighted the potential risks associated with lower initial down payments, indicating that such mortgages are more likely to experience delinquencies compared to loans with a 20% down payment requirement.
