Apples & Oranges, Part II

by Peter G. Miller
July 8th, 2008

Tom Lawler writes and says that down payment assistance programs should be banned under the FHA program. He makes these points:

“1. Why should the FHA “require” a 3% down payment, but then let the seller “pay” the down payment by hiking the home price by 3% — effectively meaning that it is a no down payment, 100% LTV loan. If you think the FHA should have a no down payment loan program, then let Congress create legislation to allow it, rather than having a “fake” 3% down payment program that is really a no down payment program. The DPA program is designed to circumvent a 3% down payment requirement in a “sham” transaction.

“2. In the case of the FHA DPA program, the FHA is taking on the credit risk of the loan. Yes, the FHA (and the lender) know about the DPA. And yes, the FHA has found that loans under the DPA program default at a massively higher rate than “regular” FHA loans. So yes, the “lender” and the “insurer” know about it, and the insurer wants to end the program because it is too risky. But for some reason it can’t? That makes absolutely no sense.

“Sure, if a lender who takes on the credit risk of the mortgage knows about the DPA and still makes the mortgage … well, that’s fine. But in this case, the entity taking on the credit risk (FHA, representing taxpayers) DOESN’T WANT TO INSURE SUCH MORTGAGES. And it shouldn’t.”

Allow me to offer a different view.

On the first point, hiking the sale price of a home by 3 percent to cover the cost of a down payment assistance program, I would say two things:

First, whatever happened to the appraisal? Lenders make loan on the basis of the fair market value or the appraised value, whichever is less. Thus it should not matter what the buyer and seller say, they cannot pump up the price without an appraisal and an appraisal should reflect the fair market value.

Second, why get upset with DPA programs when FHA rules plainly allow “seller contributions” of up to 6 percent of the sale price.

As the FHA explains, “contributions exceeding six percent of the sales price or exceeding the actual cost of prepaid expenses, discounts points, and other financing concessions as well as other inducements to purchase, result in a dollar-for-dollar reduction to the sales price before applying the appropriate LTV ratio. These inducements include decorating allowances, repair allowances, moving costs, and other costs as determined by the appropriate HOC.”

In other words, contributions up to 6 percent do NOT require a dollar-for-dollar reduction in the sale price under FHA rules. I would point out that 6 percent is bigger even than 3 percent. If the FHA is going to allow “seller contributions” why should it complain about down payment assistance?

Tom says that “the FHA has found that loans under the DPA program default at a massively higher rate than ‘regular’ FHA loans.” Given the gross manipulation of FHA numbers I am uncertain what HUD has found, if anything. When the DPA bans have been challenged in court, HUD has lost every time because it has not shown any damage from down payment assistance efforts.

However, only for the sake of argument, let us say that homes bought with down payment assistance do have a higher default rate then “regular” FHA loans. What is the default rate for homes with a 3 percent seller contribution? How about a 6 percent seller contribution? Let’s compare apples to apples.

One of my real gripes with the FHA effort to ban down payment assistance programs is this: If my parents are rich they can give me down payment assistance as a gift and no one gives a damn. But if my parents are not rich we have a strange requirement that I must save for a down payment. What is the default rate for FHA loans made with parental assistance? We don’t have the numbers so we don’t know the credit risk represented by such assistance.

The real issue with down payment assistance programs is this: HUD has previously approved DPAs. What it wants to do is keep them — but require risk-based insurance so it can maximize fee income.

For details, see the most recent court decision challenging the HUD ban on downpayment programs. As the Judge said, HUD has not been “honest with itself or the public.”

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This entry was posted on Tuesday, July 8th, 2008 at 2:51 am and is filed under . You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.

One Response to “Apples & Oranges, Part II”

  1. craig Says:

    These houses are selling so far below the appraisal values, that raising the price 3% can definetly fly under the radar. At the end of the day i belive that no borrower should be able to take out a zero-down loan. Its bad underwriting practice the main reason we are in this housing mess to begin with. Borrowers should be required to put 20 down. If you can’t afford that then you can’t afford to own a house! Just my thoughts…

  2. Nina Says:

    I would like to verify if seller could contribute the UFMIP that is added to my loan. I am about to close my FHA loan with the mortgage company and I thought I read it somewhere that seller could pay the MIP. Seller already has offered a big incentive during the sale of the hme 6 months ago and closing cost assistance at the same time, could seller still pay for the MIP?
    Thank you for your answer.

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