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HUD Again Tries Stop Third-Party Down Payment Plans

by Peter G. Miller
June 9th, 2008

Having been rebuffed repeatedly in court, HUD is at it again attempting to end third-party down-payment assistance programs for FHA mortgages.

In a typical arrangement, a seller makes a contribution to a charitable organization of up to 6 percent of the sale price. The charity then provides a grant for the same amount to the buyer. The charity typically gets a processing fee for such work, say $500.

HUD’s strong distaste for third-party programs in strange in the sense that HUD wants FHA modernization, and some forms of FHA modernization would allow buyers to purchase with zero to 1.5 percent down.

Third parties would not be necessary if buyers could purchase with nothing down, but is that really such a good idea given the risk to HUD and the lack of buyer equity? If borrowers who get funding through third parties are a big risk, why are borrowers who get the same essential deal from HUD less risky?

The HUD release is below:

WASHINGTON – The Bush Administration today renewed its efforts to address risky government-backed seller-funded downpayment assistance loans that are significantly more likely to lead to foreclosure. HUD’s Federal Housing Administration (FHA) will reopen the public comment period on a proposed rule that would ban seller-funded downpayment assistance on mortgage transactions insured by the FHA. The proposed rule will be re-published in the Federal Register and comments will be accepted for 60 days following publication. The rule can also be viewed on FHA’s website.

In a speech to the National Press Club, HUD’s Assistant Secretary for Housing-Federal Housing Commissioner Brian D. Montgomery warned FHA must take action because these loans, which now make up one third of FHA’s portfolio, are causing substantial losses. This year, as a result of its annual re-estimate, FHA had to book an additional of $4.6 billion in unanticipated long-term losses, mostly due to the increased number of certain types of seller-funded loans in the FHA portfolio.

“Given these concerns, we cannot just stand by. No private mortgage insurance companies back these types of loans. We are concerned about this business because the substantial losses affect FHA’s bottom line and FHA’s ability to serve American citizens who need access to prime-rate home loans,” Montgomery stressed.

Stressing that FHA is still solvent with reserves of about $21 billion, Montgomery also noted: “However, no insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, FHA will soon either have to shut down or rely on appropriations to operate. That, I think, would have a far-reaching impact on the economy: it would severely reduce the number of new homeowners each year; and it would also sharply reduce the need for the services required to build and maintain homes. In other words, the negative impact goes far beyond the individuals who would not be able to purchase homes, and would likely be felt across the entire economy.”

The primary focus of HUD’s rule is to establish appropriate standards for downpayment assistance that is categorized as a gift. Specifically, it would prohibit downpayment assistance provided before, during, or after closing of the sale by 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 any of the parties benefiting from the sale.

The rule would clarify that downpayment funds for FHA-insured mortgages cannot be derived from sellers – directly or indirectly – or any other party that stands to benefit from the transaction financially. “The IRS, GAO and our own Inspector General have previously expressed concerns with these circular financing schemes. Data clearly demonstrates that FHA loans made to borrowers relying on seller-funded downpayment assistance go to foreclosure at three times the rate of loans made to borrowers who make their own downpayments,” noted Montgomery.

“In its entire 74-year history, FHA has been self-sustaining. That means that our income has exceeded our costs and we have not needed an appropriation of taxpayer dollars to cover FHA’s operations. That’s pretty unique for a federal program,” Montgomery said.

Permissible sources of gifts as a source of the homebuyer’s investment include a family member, a governmental or public agency, the borrower’s employer or labor union, and a charitable organization that qualifies as a tax-exempt charitable or educational organization.

In these cases, there is a clear quid pro quo between the homebuyer’s purchase of the property and the seller’s “contribution” or payment to the charitable organization. Often, these contributions function as an inducement to purchase the home. One of FHA’s primary concerns with these transactions is that the sales price may be increased to ensure that the seller’s net proceeds are not diminished, and such increase in sales price is often to the detriment of the borrower and FHA.

Discussing the Bush Administration’s effort to help families stay in their homes, Montgomery also called on Congress to pass legislation that modernizes FHA, which includes addressing the risks associated with seller-funded downpayment assistance. “Frankly, we need reasonable solutions to the housing crisis. And I think there is considerable common ground on confronting it. There is surely a consensus on a number of actions. But some in Congress are advancing legislation that, while well intentioned, could be problematic for the economy and the country. Some of the proposed Congressional actions could actually weaken FHA and endanger the housing market by turning FHA into a less stable, less solvent, more bureaucratic entity,” stressed Montgomery.

Clearly, this matter remains an area of significant concern for FHA, and HUD looks forward to receiving and reviewing public comments on the proposed rule. Commissioner Montgomery’s full remarks can be found on HUD’s website.

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