The Trump administration may not be fond of FHA-insured mortgages — in one of his first official actions, the president canceled a cut in fees for new loan applicants — but millennial home buyers apparently are big fans.
An analysis of loans closed in 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 recent home-purchase borrowers have been first-timers.
Why the strong attraction for FHA, especially at a time when competitors Fannie Mae and Freddie Mac have introduced 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 upfront.
Bradley Barron, 28, and Amy Gina Kim, 30, work for tech-related companies in the Los Angeles area. They are new home buyers who have 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 have well-paying jobs.
“We entered the working world with major student debt and no assets to our name,” Barron told me last week. Their jobs are “great,” he said, but “we don’t have 10 percent to 20 percent” to put down. He and Kim 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, Maizes said. 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 cutoffs in some cases. VA (Veterans Affairs) and USDA (rural loans from the U.S. Department of Agriculture) allow for zero down payments but have major restrictions, such as 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 — FICOs of even less than 600. 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.”
Now for debt-to-income ratios, or DTIs, 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 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 noncancelable for the life of the loan. But most first-time buyers don’t remain in those starter houses for long periods, so that’s not likely to be a deal-killer.
Ken Harney’s email address is firstname.lastname@example.org.