Are FHA’s Changes A Model For Canadian Insurers?

The U.S. Federal Housing Administration (FHA)—which calls itself the world’s largest mortgage insurer--is increasing down payment requirements for those with credit scores under 580. Affected home buyers will now need to pony up down payments of 10%, versus 3.5% previously.

To many, higher down payments for people with low Beacon scores intuitively makes sense.  In fact, Beacon-based down payment guidelines are already common for refinances and non-prime mortgages.  (Although 580 is too low a cut-off by Canadian prime lending standards.) 

In Canada, higher down payments have been all over the news ever since Jim Flaherty threatened tighter lending standards in December.

If our Finance Department does make changes to down payment requirements, the FHA’s model may be worth considering.  Beacon-based down payment guidelines on purchases would alleviate concerns about default risk and housing bubbles, while leaving current home ownership options available to strongly-qualified buyers.

In Canada, a person with a 610 credit score (for example) often gets to put down the same down payment as someone with an 810 credit score.  Does that make sense?  Some don’t think so.

Delinquency rates start rising noticeably as people’s scores get down to the low 600s, as is evident in this chart from Equifax.  As such, the government could easily use Beacon and/or debt ratio guidelines to gear down payments to risk levels.

What doesn’t make sense is to impose an across-the-board down payment rule.

People with 720 Beacons and 38% TDS ratios, for example, present very little default risk. Therefore, a 5% down payment may be very appropriate in such cases.

People with a 620 Beacon and a 42% TDS (for example) present higher default risk, so perhaps a 7.5% or 10% down payment makes sense.

This is an admittedly simplified view. There’s a lot more to the statistics behind default probabilities, and there are always exception cases.  Yet, the principle of Beacon-based down payments on purchases seems right, and the FHA, for one, agrees.