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A zero-down FHA loan might sound too good to be true, but a new analysis from the nonprofit research group Urban Institute argues that allowing the Federal Housing Administration (FHA) to offer such loans would put roughly 6.5 million renters in a position to buy their first homes. And for newbie landlords, it would offer an on-ramp to investing without the biggest hurdle to starting their landlording journey: a down payment.
Why the Talk of Zero-Down Payment FHA Loans?
After the 2008 financial crash, zero-down payment loans almost became banished from the homebuyer’s lexicon of acceptable phrases. However, amid rising home prices, they have been creeping back to the periphery of home lending—with warning signs attached. However, they have largely been ignored by governmental bodies for fear of steering buyers toward risky loans.
Despite this, mainstream lenders have gradually warmed to the idea of very low down payment homebuying, though they require PMI (private mortgage insurance) and higher monthly payments. Smaller credit unions and community banks have flirted with 0% down payment loans, while Fannie Mae’s Conventional 97 and HomeReady loans and Freddie Mac’s Home Possible program offer loans with 3% down. The current down payment standard for an FHA loan is 3.5%.
The Urban Institute makes the case that Congress should allow zero-down FHA loans to not only make homebuying easier but also replace the “inconsistent patchwork of down payment assistance programs” and help buyers accrue home equity.
Urban Institute’s modeling suggests:
Zero-down FHA loans would add only a modest amount of extra default risk (HousingWire reports it’s about 12 basis points).
This risk could be offset by a small increase in FHA mortgage insurance premiums (such as a 25-to-35-basis-point upfront PMI adjustment) if policymakers demanded it.
Compared with large down payment grants, a permanent zero-down product could reach more borrowers and exert less upward pressure on home prices because income and savings are no longer factors in buying a home.
According to the study, in 2018, 17% of the nation’s 46 million renter households were financially “ready” to buy, and turning renters into homeowners will ease pressure in tight rental markets.
The Urban Institute recommends setting a credit score threshold of 700 to mitigate the risk of default. A 660 score could be accepted for borrowers with a two-year history of on-time rent payments or a minimum of six months of cash reserves.
The Advantages of an FHA Loan
An FHA loan is often favored by new investors, as it allows a low down payment and greater credit flexibility (typically 3.5% for borrowers with credit scores of 580 or higher). It allows buyers to purchase one- to four-unit homes, enabling owners to house-hack—renting out additional units to help pay the mortgage while they save for their next investment.
Although a borrower generally cannot have two FHA mortgages at the same time, by refinancing the first home into a conventional mortgage before buying a second home a year later, in which they again plan to house hack, investors can take advantage of an FHA loan multiple times to build their portfolio, as long as they can offer a legitimate reason for moving when applying for another FHA loan.
The advantage of using an FHA loan to house hack is that lenders will typically allow you to count 75% of the projected rental income from the nonoccupied units toward your qualifying income, thus allowing you to buy more home than just your salary would allow you to qualify for. However, a conventional 5% loan is possible for a second home without refinancing the first FHA loan.
How Realistic Is a Zero-Down FHA Loan?
Although the government has proposed several initiatives to increase homeownership, zero-down FHA loans appear, on the surface, the least likely to receive a green light due to the risks involved. Even with a higher credit score, such a low barrier to entry sets off alarm bells for government regulators who remember the easy-credit era leading up to the 2008 financial crisis.
“It’s not very popular to make things more stringent, but you want to make sure the borrower is able to make the payments,” Tobias Peter, senior fellow and co-director of the nonprofit American Enterprise Institute Housing Center, told Homes.com News about the FHA zero-down idea. “Yes, we can qualify more people, but there are not enough starter homes for these people to buy, so that will drive up home prices.”
Current Low- and No-Down Payment Options
Even if zero-down payment FHA loans do not become a reality, there are currently several low- or no-money-down structures that small investors can use under existing rules. According to CNBC, Guild’s Zero Down mortgage combines a 3.5% FHA loan with a forgivable second mortgage, effectively lowering your down payment to zero. And borrowers can be approved with credit scores as low as 600.
Guild also offers several low-down-payment options, including a 1% down loan. CNBC Select reports that the creative FHA structure Guild uses to minimize a borrower’s out-of-pocket expenses is increasingly being favored by lenders looking to serve borrowers with good credit scores who are low on cash.
Final Thoughts: There Are Lots of No Down Payment Options That Can Be Utilized by New Investors
Down payment assistance (DPA) programs can be accessed through state housing finance agencies, local governments, or nonprofits and layered on top of FHA loans to cover all or part of the 3.5% down payment requirement.
Rocket Mortgage explains that while FHA itself does not operate an official DPA program, many buyers combine an FHA first mortgage with grants, forgivable loans, or low-interest subordinate loans, structured to meet down payment and closing cost needs.
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This is amongst the safest of the no-money-down investment strategies when paired with house hacking a two-to-four-unit home because the interest rate is protected and the rental income is used to qualify buyers for the loan and offset mortgage payments, compared to many of the other techniques used by investors.
While zero-down loans get prospective homeowners into houses, they leave them with almost no equity cushion should they need to access funds in an emergency via a HELOC.
Even with stellar credit scores, owning rental property entails risk—from both tenants (such as nonpayment of rent) and essential repairs, which is why not having to put money down is not an excuse to have insufficient money sitting on the sidelines should things go awry. In fact, accruing a sizable nest egg of reserves makes sense for this very reason.
