Urban Institute: Zero-down FHA mortgages could expand first-time homeownership

Downpayment assistance programs are available to first-time homebuyers across the country in the form of more than 2,400 such offerings at the local and state levels, but they have not had an appreciable impact on the level of U.S. homeownership.

This is why a zero-down Federal Housing Administration (FHA) mortgage would be a more viable and cost-effective option, according to a recent issue brief published by the Urban Institute and co-authored by Michael Stegman, Ted Tozer and Richard Green.

“For many years, four in five FHA borrowers have been first-time borrowers,” they wrote. “The FHA has also provided access to families of color relatively more than other lending channels. It is also the only federally backed mortgage program that still requires a down payment.”

A zero-down option would not be useful if there were a lack of “mortgage-ready borrowers,” the group wrote. But prior Urban Institute research has indicated that “many potential millennial homebuyers are 40 or younger and do not have a mortgage but have the credit characteristics to qualify for a mortgage — suggesting a lack of a down payment is the only barrier to homeownership.”

The authors used data from the U.S. Census Bureau‘s 2022 American Community Survey to estimate that one-third of renter households, or roughly 15 million in total, “have a sufficient income to afford the monthly costs of the average-price FHA-insured home ($362,700) at a 6 percent interest rate.”

The writers also claim there is less inflationary risk on a zero-down FHA program when compared with a national downpayment assistance plan. The latter option was discussed by Vice President Kamala Harris multiple times on the campaign trail as a potential program she would’ve sought to implement had she been elected.

But the inflationary risk of such a program is clear, since “large down payment grants are essentially one-time income transfers that shift out the housing demand curve, which likely boosts housing prices to some degree,” the authors wrote. “In contrast, a zero-down mortgage relaxes a liquid asset constraint without changing effective borrower income.”

In terms of a potential legislative template, the group details a bipartisan proposal introduced by members of Congress during the George W. Bush administration that would “offer a new 100 percent financing mortgage product to help first-time homebuyers purchase a home by allowing zero downpayment loans and financing of the settlement costs.”

Several elements of this plan from 2004 could work in today’s mortgage market environment, they argue.

These include the addition of a surcharge to the mortgage insurance premium; a volume cap of about 10% percent of total single-family loan endorsement volume based on the preceding year’s totals; guardrails that would suspend the program if the foreclosure rate exceeded 3.5% in a given year; and holding borrowers “to the same underwriting standards that applied to the broader program and required one-on-one housing counseling from a HUD-approved counseling agency.”

Some changes would have to be made to the original proposal, they say, including post-financial crisis consumer protections and loss-mitigation options; incorporation of modern (and tighter) FHA underwriting standards; and the exclusion of settlement costs from the loan.

“The financial crisis, high rents, stagnant wage growth, and other factors have prevented many renters from building the savings required to afford a down payment. And for many, this is the only barrier to buying a home,” the authors stated. “A zero-down FHA mortgage option could help a new generation attain homeownership, while being cost-effective and presenting minimal risk to the federal government.”

The prospects of such a plan being discussed have changed significantly since the proposal was published on Oct. 29. While downpayment assistance and expanded incentives for homebuilders were discussed by Harris as a presidential candidate, the campaign of President-elect Donald Trump primarily focused on addressing housing costs by curbing immigration and by prioritizing the sale of federal lands to serve as bases for more new homes.

It remains to be seen what a second Trump administration will prioritize when it comes to housing affordability, an issue that does not appear to have played a major role in his election victory last week.