What was true a generation ago rings even truer today: saving money for a down payment and closing costs is a major barrier to homeownership (PDF) for first-time buyers.

According to the most recent Survey of Consumer Finances, nearly 90 percent of renters lacked the minimum 3.5 percent in liquid assets (or $13,000) needed to put down on the average-price home ($362,700) financed with a Federal Housing Administration (FHA) loan. This is true despite the existence of more than 2,000 bespoke state and local down payment assistance (DPA) programs nationwide.

None of these programs has achieved appreciable scale or funding to have meaningful impact, so it is understandable why calls for a standardized, national DPA program have become part of presidential electoral politics. Proponents say Vice President Harris’s proposal (PDF) to boost demand in a supply-constrained housing market through $25,000 grants to millions of first-time homebuyers will help level the playing field, while critics argue that it would drive prices higher.

We believe there is a more cost-effective approach to addressing the down payment savings deficit: a zero-down FHA mortgage option for first-time homebuyers.

Why a zero-down mortgage option specifically for FHA borrowers?

Although our proposal could be applied to the government-sponsored enterprises, private-label securitizations, and portfolio lenders, we focus on the FHA because of its unique focus on under-resourced consumers. For many years, four in five FHA borrowers have been first-time borrowers. 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 have little take-up if there were not a significant number of mortgage-ready borrowers. But Urban Institute research (PDF) shows 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. Using 2022 American Communities Survey data, we estimate that one-third of renter households (a little more than 15 million) have a sufficient income to afford the monthly costs of the average-price FHA-insured home ($362,700) at a 6 percent interest rate.

Evidence suggests a zero-down program would carry less inflationary risk than a national DPA program for first-time homebuyers because 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. In contrast, a zero-down mortgage relaxes a liquid asset constraint without changing effective borrower income. With little to no income effects, and holding FHA mortgage underwriting standards constant, a zero-down mortgage largely eliminates inflationary pressures. Moreover, it would be more efficient to implement because it uses the FHA’s established automated underwriting system (TOTAL Scorecard) and is available to all FHA-approved lenders.

A zero–down payment FHA mortgage program could build on a previous legislative proposal

Rather than designing a zero-down FHA program for first time homebuyers from scratch, the FHA and Congress can build and improve upon a 2004 bipartisan House measure (PDF), a Congressional Budget Office (PDF) report, and the US Department of Housing and Urban Development’s (HUD’s) fiscal year 2005 budget (PDF) proposal that would authorize the FHA to “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.” Just as today’s counterpart would do, that program was designed to target “credit-worthy but cash-poor working individuals and families who have been excluded from purchasing their first home because their limited incomes precluded them from being able to save for a downpayment.”

The following elements of the 2004 plan could work today.

• Add a surcharge to the mortgage insurance premium. To anticipate that zero-down mortgages would be marginally riskier than mainstream FHA purchase loans requiring (then) 3 percent down, HUD designed the program (PDF) to be revenue-neutral with respect to the Mutual Mortgage Insurance Fund.
• Cap the volume. HUD anticipated strong demand for the zero-down mortgage, estimating first-year loan volume of about 25 percent of 2004 endorsements (PDF). But to protect the FHA’s safety and soundness, the authorizing legislation would have capped volume at no more than 10 percent of the total volume of single-family loan endorsements during the preceding year, which would have limited first-year activity to about 100,000 zero-down mortgages.  Applying the 10 percent cap on the FHA’s 2023 loan volume ($209 billion) and the average FHA-financed home price means that today, the FHA could support about 58,000 borrowers with a zero-down loan in the program’s first year.
• Implement guardrails. The legislation required suspension of the program if the foreclosure rate among active zero-down loans exceeded 3.5 percent in any year. For context, the Congressional Budget Office (PDF) estimated that program defaults would average about 1 percent each year. Historically, the foreclosure rate for all pre-2009 FHA loans is 0.71 percent, while because of tighter credit requirement and more effective loss mitigation programs the current foreclosure rate for all active FHA purchase loans is currently 0.42 percent.
• Manage risk through housing counseling and standard underwriting. For the 2004 pilot, the FHA would have held 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.

What a zero–down payment FHA mortgage might look like today

HUD’s 2004 proposal and accompanying legislation is a good starting point for the new Congress and administration. For a zero-down mortgage program to work in today’s environment, the FHA would also need to take the following steps:

• Incorporate Great Recession and post-pandemic consumer protections and loss mitigation reforms that prevented more than half a million distressed borrowers from foreclosure. These homeownership preservation requirements that loan servicers must institute for distressed borrowers should reduce foreclosure risk relative to HUD’s 2004 proposal.
• Incorporate today’s tighter FHA underwriting, including credit standards and debt-to-income ratios.
• Consider requiring borrowers to demonstrate a strong commitment to their housing obligations. We recommend requiring them to have made 24 consecutive months of on-time rent payments as part of the mortgage application process, like Vice President Harris’s DPA proposal.
• Exclude settlement costs from the loan. The original HUD proposal included these costs, but excluding settlement costs would mean that the 101.75 percent effective loan-to-value (LTV) ratio for our zero-down FHA mortgage program would be significantly lower, putting borrowers less underwater as they start their homeownership journey.

Some may criticize this proposal for being too risky. But based on our calculations, well-underwritten zero–down payment loans would be minimally riskier than others. For one thing, we tend to overstate the initial equity that traditional FHA borrowers start out with because their 1.75 percent up-front mortgage insurance fee comes directly off the top of their 3.5 percent down payment, effectively reducing their initial equity by half. This increases the effective LTV ratio of standard FHA loans from 96.5 percent to 98.25 percent.

Regarding the risk of FHA borrowers who receive government-sourced DPA, the serious delinquency rate (i.e., all loans 90 or more days past due plus those in bankruptcy and foreclosure) is just 1.3 percentage points greater than for those who use their own funds for a 3.5 percent down payment (4.68 percent versus 3.36 percent [PDF]), while the foreclosure rate differential is even narrower (0.41 percent versus 0.35 percent).

HUD’s long-standing policy has been not to boost insurance fees on marginally riskier DPA-assisted mortgages, which composed 26 percent (PDF) of FHA purchase loans back in 2005, compared with 40 percent today. Our calculations suggest that well-underwritten, zero–down payment loans would be no riskier and therefore would not warrant higher insurance fees. The most recent capital reserves in the FHA’s Mutual Mortgage Insurance Fund (10.51 percent [PDF]) are more than five times greater than the 2 percent minimum required by law and are nearly twice the 2004 level when HUD proposed the original pilot, which gives us further confidence that a zero-down pilot with the guardrails we have suggested will not jeopardize the FHA’s safety and soundness.

Lastly, based on related FHA performance data, we estimate average losses from a portfolio of zero–down payment loans would be 0.44 percent (PDF) of their initial principal value, or less than $1,500 per loan, which is considerably less than the cost of a generous down payment grant. 

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. 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.