Why Are Fewer First-Time Home Buyers Using FHA Loans Recently

In 2018, 31% of first-time buyers got an FHA loan; in 2020, it was 29%; In Jan., it was 24%. Newer 3%-down conventional loans may be part of the reason.

CHICAGO – Federal Housing Administration (FHA)-insured financing used to be a big first-time homebuyer draw because it required smaller down payments. But lately, more first-time buyers are opting for conventional mortgages instead, according to the National Association of Realtors® (NAR) Economists’ Outlook blog.

In January, 59% of first-time buyers obtained conventional conforming loans, while 24% obtained FHA-insured mortgages, according to the Realtors Confidence Index Survey. In 2018, 31% of first-time buyers secured an FHA loan; in 2019, it was 30%; in 2020, it was 29%.

One possible reason for the change: In 2014, Fannie Mae and Freddie Mac began offering finances for mortgages with a 3% down payment, similar to FHA loans. That opened the door to more first-time buyers.

But there may be other financial reasons more first-time buyers consider conventional financing. FHA mortgage insurance – a monthly add-on to all FHA loans – can be more expensive than private mortgage insurance, a similar add-on for conventional loans for buyers who put less than 20% down. For mortgages that meet Fannie Mae and Freddie Mac’s guidelines with conventional financing, “the borrower does not have to pay private mortgage insurance when the equity reaches 80%,” says Gay Cororaton, senior economist for NAR.

However, “in the case of an FHA-insured mortgage, a borrower obtaining a 30-year fixed-rate mortgage with 96.5% loan-to-value ratio will continue paying a monthly mortgage insurance premium for the life of the loan,” he adds. “In addition, the borrower pays an upfront mortgage insurance premium (UPMIP) at the time the mortgage is obtained, although the UPMIP can be rolled into the loan.”

Cororaton offers an example using a $300,000 home financed with a 2.7%, 30-year fixed-rate mortgage with a PMI of 1.5%. A borrower with an FHA-insured mortgage pays $43,797 over the life of the loan in mortgage insurance compared to $31,908 for a loan backed by Fannie Mae and Freddie Mac (also where the borrower stops paying the monthly private mortgage insurance in the ninth year when equity reaches 20%). A borrower with an FHA-insured mortgage pays interest of $3,380 if they roll the upfront mortgage insurance payment of $5,356, Cororaton says.

Source: “More First-Time Buyers Are Obtaining Conventional Instead of FHA Financing,” National Association of REALTORS® Economists’ Outlook blog (Feb. 22, 2021)