In addition to 401(k)s, home equity is often the primary way in which working Americans accumulate wealth. Lower income households have very few, if any, alternatives when it comes to wealth building.
Democrats in the Senate are hoping a more aggressive payment structure will help more families create the type of generational wealth afforded to more affluent homebuyers. Last month a group of senators introduced a bill that would create a new 20-year FHA loan aimed at homebuyers with median incomes of 120% or less than the median income of their area.
20-year mortgages create equity faster because more of the monthly payment is applied to principal. However, that comes with a higher payment. To combat the higher payment that comes with a shorter mortgage term, the proposed loan would feature a subsidized 1.5% interest rate and no annual or monthly FHA mortgage insurance premium (FHA MIP).
Instead, the new mortgage would finance a 4% upfront mortgage insurance premium (UFMIP). The example provided in the proposal would see $96,219 in equity after 10 years of payments compared to just $50,268 with a traditional FHA loan. The difference in monthly payment was only $34 more with the 20-year loan.*
* $210,000 purchase price, $10,000 down payment. Traditional FHA loan at 2.75% has a payment of $970. Proposed 20-year FHA loan payment is $1,004.
Senator Mark Warner (D-VA) states, “The No. 1 way that middle class Americans build wealth is through homeownership. An opportunity that due to racism and structural inequality has been denied to too many families of color. Today, black families in this country have an average net worth just one-tenth the size of their white counterparts.”
Economic inequalities and government interventions into the mortgage space are beyond the scope of analyzing the merits of a new mortgage product. If a proposed plan helps more homebuyers become homeowners, that’s great. If that product is affordable and allows homebuyers to build equity quicker, that’s great, too.
The question is why make this available to only first-time homebuyers who meet area income thresholds? Perhaps a similar loan could exist for those who don’t meet the requirements but without the interest rate subsidy? A 20-year loan aimed at increasing owner equity would benefit all homebuyers. Next week we’ll explore the idea of alternative financing options for all homebuyers.