Down-Payment Woes

August 1, 2007; As originally appeared Builder Magazine by Pat Curry

In yet another tightening of mortgage lending, HUD has proposed the elimination of seller-funded down-payment assistance programs for loans insured by the Federal Housing Administration (FHA).

HUD has always prohibited sellers, including builders, from giving money for down payments directly to FHA borrowers, who are required to put down at least 3 percent of the purchase price. However, under current regulations, gifts are allowed from friends and family, employers, labor unions, and government agencies, as well as charitable organizations, which has led to the establishment of dozens of groups such as the Sacramento, Calif.–based Nehemiah Corporation of America.

Many of these organizations work directly with sellers, including builders. Under the seller-funded down-payment assistance model, the charitable organization provides a gift to the buyer to use for his down payment; that gift is then reimbursed by the seller, which also pays the organization an administrative fee. In the last decade, such organizations have helped 600,000 families buy homes, says Scott Syphax, president and CEO of Nehemiah.

Under the new regulation, the donation to the charitable organization could not come from the seller, “any other person or entity that financially benefits from the transaction, or any third party or entity that is reimbursed directly or indirectly” by the seller, the proposed ruling states.

It's certainly not good news for home builders, especially those that cater to entry-level buyers. Steve Palmer, CFO of Atlanta-based Bowen Family Homes, says that without down-payment assistance or the availability of 100 percent financing, 40 percent to 50 percent of first-time home buyers wouldn't qualify.

“With the meltdown of the sub-prime and alt-A markets, the loss of these programs without a true 100 percent FHA financing product to replace them would be devastating to the starter home–buying market,” Palmer says.

This is the second time in eight years that HUD has tried to do away with seller-funded down-payment assistance on FHA loans. HUD officials declined to comment about the proposed regulation during the 60-day public comment period, but provided detailed background information on its reasoning.

In congressional testimony earlier this year, HUD's inspector general, Kenneth Donohue, cited a 2005 General Accounting Office report that said the probability of default on FHA loans with seller-funded down-payment assistance was 76 percent higher than comparable loans without it.

A HUD study of the programs also cites concerns about inflated appraisals and sales prices to cover the seller's down-payment contribution and a tendency for buyers to not receive counseling that would help them make the transition to homeownership.

Syphax says his organization has tried to get HUD to address those issues over the years, with no success. With the increased number of defaults on exotic loans normally marketed to subprime borrowers, this isn't the time to eliminate seller-funded down-payment assistance, he says.

“Part of the irony of trying to kill off Nehemiah-style down-payment assistance is that funding for working families is drying up,” Syphax says. “One of the last successful programs is becoming increasingly the only game in town, and that's when the federal government tries to close the last door to opportunity for folks who have no other options.”

Well, maybe not the last door. The proposed rule doesn't ban assistance from charities that receive their funding from parties with no financial interest in the transaction. The Housing Development Fund in Stamford, Conn., for example, gets its down-payment assistance money from state, federal, and philanthropic sources. The organization avoids seller-funded assistance because it doesn't benefit the buyer, says Joan Carty, president and CEO of the Housing Development Fund.

“There's a lot of pressure to bring in an appraisal to meet the assistance [when it is seller-funded],” she says. “It's a rush job. There are additional fees and transactional costs and not enough checks in place.”

Regardless of whether HUD adopts this regulation, seller-funded down-payment assistance more than likely will disappear. The Internal Revenue Service ruled in 2006 that seller-funded down-payment assistance programs aren't charities for tax purposes; the process of examining those groups' tax-exempt status is already underway.