Before the housing bubble, in 1993, half the homes sold in California went to first time buyers. Today, according to the California Association of Realtors, fewer than one in three homes are sold to first timers. That’s the smallest percentage in a generation.
Last week, the Obama administration dropped the fees on FHA loans, the mortgages taken out by most first time buyers. Housing and Urban Development Secretary Julían Castro says bringing premiums down, will “open new doors of opportunity,” creating a quarter of a million new homeowners nationwide over the next three years. The move is touted as a way to entice millennials into the housing market and spur new home construction.
FHA loans are popular with first time buyers because they only require a down payment of 3.5% with a credit score of 580. The down payment doesn’t even have to be your own money: you can use a gift from your parents. And you can get home sellers, builders, or even lenders to pick up the tab for closing costs and other fees. Paul Habibi, a professor of real estate at UCLA’s Anderson School of Management, calls FHA loans “the best deal in town if you can qualify for it.”
But the fee cut may not make much of a difference in California, which isn’t a big market for FHA loans. Even as the housing market started showing signs of recovery, the number of FHA loans in California last year dropped by 25% over the year before.
There are a number of reasons:
The purchase price of California real estate generally exceeds FHA lending limits. While loan amounts are adjusted for the Golden State's high-priced real estate, the maximum FHA loan amount in Los Angeles and Orange Counties is $625,000. It’s lower in Riverside and San Bernardino Counties: $355,000.
Since the housing collapse, UCLA's Habibi says qualifying for a home loan is practically a “financial colonoscopy, what the lenders put you through.” But it’s particularly true for FHA loans.
Christine Alvarez, an accountant in North Hills, says many of her clients are first time homebuyers who’ve tried to get FHA loans. She says lenders are asking for what she describes as “crazy comfort letters” to satisfy their requirements. She says buyers can help themselves by having up-to-date tax returns, W-2’s, 1099’s and the last three months of bank statements.
It's not just the paperwork, it's also your FICO score.
While FHA loans officially require a credit score of 580, most lenders won’t consider buyers with credit scores under 640. That point spread might not sound like much, but Equifax and Moody’s Analytics estimates there are 13 million borrowers with credit scores stuck between those two numbers.
The extra scrutiny is tied to the extra risk of FHA loans. Since buyers can put down as little as 3% for the down payment, homeowners have less skin in the game. Habibi says that’s particularly dangerous if there’s another steep decline in home prices. “The minute people start losing their equity,” he says, “the more likely they are to bail.”
Roger Borland, an independent loan file manager in the Inland Empire says at this point, he’s on the side of the banks. “Banks want to make loans,” he says, “but only good loans.”
Cautious banks....and borrowers
There’s only so much that the federal government can do to loosen up the lending market. HUD Secretary Castro says FHA only insures home loans, it doesn’t make them. He says the agency can enforce guidelines, “but obviously we can’t force any private institution to make a loan that they don’t want to make.”
Banks aren't the only ones more cautious, says Chris George, head of the California Mortgage Brokers Association. George says there’s an “overwhelming wave of sensibility coming from the borrower side” from those who aren’t ready to take on the financial responsibility of owning a home.
Job instability, the change in perception that a home is not an automatic jackpot of an investment, plus the millennial generation’s penchant for mobility, he says, give would-be buyers “more cause for a pause to decide when they want to buy.”
Conventional Loans Still the Better Deal
FHA loans are more expensive than most conventional loans.
FHA took a big hit during the housing meltdown and required a $1.7 billion bailout in 2013. Those losses led to an increase in the fees charged for FHA loans.
But even with the new reduced FHA fees, Taz George, a researcher at the nonprofit Urban Institute says for borrowers with a higher FICO score, it’s more economical for them to get a conventional loan and pay the PMI, or private mortgage insurance.
PMI rates are based on how much of a down payment you can afford. If you put 10% down, you pay about 75% of the fee charged by FHA. If you can find a lender who'll fund a loan with just 5% down, you'll pay more than the FHA fee.
But Roger Borland says in addition to FHA's monthly fees, there's an upfront charge of 1.75% of the loan amount. So if you took out a $100,000 FHA loan, the loan amount you'd pay back would be $101,750.
One more advantage for conventional loans: once a homebuyer has accumulated enough equity to equal 20% of the home’s value, she can request that the mortgage insurance be cancelled. On FHA loans, that federal version of PMI remains in place for the life of the loan.
Lenders do require a higher credit score for conventional loans - a FICO score over 700 with 10% down.
Not the Only Game in Town
First time homebuyers have other options for loans, like the Neighborhood Housing Services of Los Angeles County. The non-profit has been partnering with banks since 1984 to help would-be homeowners with low to moderate incomes. Their loans require only a 3% down payment and a minimum credit score of 640. They even offer help with the down payment, offering a second loan that doesn’t kick in until the first 30 year loan is paid off. Last year, the group originated nearly 700 loans.
This is just the latest move by federal housing agencies to boost home ownership for first time buyers. In December, Fannie Mae and Freddie Mac, the federal agencies that buy mortgages from lenders and sell them on the secondary market, also decreased the down payment required for some home loans to 3%. But because - again - it’s the banks that actually make the loans, it remains to be seen how many lenders will participate. Bank of America initially said at least 10% down would be required, but says it’s evaluating the new guidelines.
The FHA move was applauded by the California Association of Realtors. CAR President Chris Kutzkey says, “anything that goes toward assisting buyers getting loans is something that we embrace wholeheartedly.”
Correction: an earlier version of this story identified Christine Alvarez as Christina.