In recent testimony before Congress, Federal Reserve Chairwoman Janet Yellen confirmed what many aspiring homebuyers have known for several years. "It has now become the case that any borrower without a pretty pristine credit rating finds it awfully hard to get a mortgage," she said.
Lenders aren't the only ones acting in a risk-averse manner. Well-intentioned but outdated federal policies are keeping America's housing sector from achieving a full recovery.
In recent years, the Federal Housing Administration, which has been charged with supporting first-time homebuyers since the Great Depression, has raised its fees to levels that are pricing many creditworthy Americans out of the market. That's bad for the American dream and for the economy. What our economy needs now are fewer barriers to first-time homeownership not more.
First-time home purchases are now at historic lows. They have accounted for only 28% of existing home sales year-to-date, according to the National Association of Realtors. That's 6 percentage points below the five-year average and well below the long-term benchmark of 40%. This dearth of first-time purchasers has materially contributed to the lowest level of homeownership in nearly 20 years.
A number of factors have contributed to the drop in first-time purchases. For one, the economic slowdown has been especially tough on 24- to 35-year-olds an age group that traditionally comprises a significant share of first-time buyers. Many of today's recent college graduates are facing crushing levels of student debt. The post-crisis trend toward stricter underwriting standards has also made mortgages harder to come by.
But perhaps the biggest and most surprising challenge faced by today's aspiring homeowners comes from the FHA, the very agency created to help them.
Among other things, the agency provides mortgage insurance to first-time buyers. Borrowers support the agency's insurance fund through up-front charges and monthly premiums. If a buyer defaults, the FHA repays the lender with money from the fund. This affordable mortgage insurance has helped more than 34 million Americans purchase homes since the 1930s.
But in recent years, the agency has been more of a barrier than facilitator for many of first-time buyers. The FHA raised its fees to cover a wave of defaults in the wake of the financial crisis. This was a necessary step. However, premiums are still at crisis levels years later. For many would-be homeowners, it's just too much.
As recently as 2010, monthly premiums for an FHA-insured mortgage totaled .55% of the loan amount. Today, it's 1.35%, a 145% increase that translates into an additional $120 on a monthly mortgage payment for a $180,000 loan. The up-front fee that borrowers pay to the FHA has also risen dramatically, from 1% of the loan amount to 1.75%.
These changes are pushing potential buyers at the margin out of the market. According to the National Association of Realtors, the FHA's higher mortgage premiums pushed 1.5 million renters over a sustainable debt-to-income level to qualify for a home loan in 2013.
This year, the FHA is on track to help around 450,000 first-time homebuyers, according to the agency's most recent report to Congress. History suggests that this number is a full 33% lower than it should be. In the five-year period between 2009 and 2013, for instance, the FHA helped about 690,000 first-time homebuyers annually.
A new approach to lending policy will be necessary if the U.S. economy is to benefit from a resurgence in first-time home purchases.
To start, the FHA must adjust its policies to reflect today's realities not the cash-strapped days of the financial crisis. Last year alone, the agency's mortgage insurance fund increased in value by $15 billion. The FHA can afford to reduce monthly premiums to pre-crisis levels.
One revenue-neutral solution would shift a portion of today's monthly insurance fee into the up-front premium. By enabling borrowers to finance their mortgage insurance over the life of a loan, the FHA could improve affordability for consumers without eliminating revenue. Federal officials could also eliminate the requirement that buyers pay for mortgage insurance for the entire life of their loan and drop it when the borrower reaches 20% equity just as it is done in the conforming market.
Moreover, the time is right for the FHA to return to providing insurance on mortgages for condominiums, a significant part of the market for young buyers. Fifteen years ago, the FHA supported the purchase of nearly 100,000 condos. In the past 12 months, the agency has supported just 17,000 condo purchases.
The FHA knows that first-time purchases are declining. In fact, the agency recently launched "Homeowners Armed with Knowledge," a pilot program for pre-purchase counseling that targets first-time buyers. While this is a good first step, it will take more than homeowner education to solve this problem.
The housing sector is on the mend, but outdated government policy along with a struggling economic recovery is keeping the aspiring first-time buyer on the sidelines. The opportunity is in plain sight, and the time for action is now.
Richard A. Smith is chairman, chief executive officer, and president of Realogy Holdings Corp. A member of the Business Roundtable, he serves on the housing commission of the Bipartisan Policy Center and the policy advisory board of the Harvard Joint Center for Housing Studies.