For many first-time homebuyers, the biggest barrier to buying a home is accumulating the funds for a down payment. Rents now take more than 40 percent of many future homeowners’ gross pay, leaving limited funds after taxes, food, clothing, and other utilities to save for a down payment. Even with the Federal Housing Administration (FHA) requiring only a 3.5 percent down payment, building up enough capital can be an insurmountable challenge.

Down payment assistance (DPA) can help close this gap, but only government entities can offer it. Before the housing crisis, sellers would find ways around the FHA prohibition against providing DPA. In particular, sellers would offer DPA to buyers but would inflate the home’s sales price to reimburse themselves, which created exaggerated losses for the FHA. In response, Congress passed the 2008 FHA Modernization Act (PDF), which prohibits entities with a financial interest, including sellers and lenders, from providing DPA funds on an FHA-insured mortgage.

Now 15 years later, the housing environment has changed. Although realtors and sellers can still influence the sales price and stand to gain from doing so, lenders have far less control over a home’s sales price and no control over the appraiser. By lifting this restriction to allow lenders to provide DPA, either through self-funding or through a grant program, policymakers could help remove the down payment obstacle for many families.

Lenders could provide down payment assistance through two channels

The first channel for lenders to provide DPA would be through self-funding offered on an unlimited basis. The lender could charge the borrower a 1 percent higher interest rate to fund a 3.5 percent down payment, which would allow the lender to issue a Ginnie Mae–guaranteed mortgage-backed security (MBS) that would generate enough of a premium to fund the required down payment. Many public-sector housing finance authorities (PDF) use this funding technique. These loans still have access to all the features of the FHA streamline refinance program, which can allow borrowers to reduce their payments if they stay current on their new mortgage. Given the robustness of using premium-price Ginnie Mae MBS to fund the program, there wouldn’t be a need to limit its availability.

The second channel for a lender to give a borrower DPA funds would be through a grant provided by the lender’s corporate funds. Because these lender grants have limited funding, the programs could be restricted to specific income levels and priority markets.

With this second channel, borrowers would still have to pay mortgage insurance costs. Whereas lenders can offer DPA on GSE loans, they cannot do so on FHA loans. The borrower then is responsible for the difference between the private mortgage insurance that GSE loans require and the annual mortgage insurance premium that the FHA requires. Typically, the GSE requires that an FHA borrower pay between 0.99 percent and 1.86 percent annually, depending on the borrower’s credit score, for private mortgage insurance, and the current mortgage insurance premium is a 0.55 percent annual premium if the lender pays for the DPA using its own corporate resources. As a result, the borrower will be required to pay between a 0.44 and 1.32 percent higher annual insurance premium because the lender can use only GSE programs.

Policymakers can amend the DPA limitation to help borrowers

The FHA could work with Congress to amend the FHA Modernization Act so only entities that can affect the home’s sales price are banned from providing DPA. This amendment could be enacted as a stand-alone bill or attached to another piece of legislation, such as the 2024 budget. Allowing lenders to provide DPA as part of their special purpose credit programs will allow more underserved borrowers to become successful homeowners.

Another solution, which would effectively remove the challenge of accumulating a down payment, would be to make the FHA program a zero-down-payment program. If this change were made, the FHA program would join the other government-insured programs offered by the US Department of Veteran Affairs and the US Department of Agriculture that do not require a down payment. In 2004, the Bush administration proposed this change to the FHA program, so it’s not a new concept. 

In any case, expanding the availability of down payment funding is critical to help people with less wealth attain homeownership.