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Should We Bring Back FHA Seller-Financed Downpayments?

by Peter G. Miller
January 27th, 2010

It was just two years ago that Congress voted to dump downpayment assistance plans (DPAs) for FHA mortgages.

In basic terms, with a DPA a buyer seeks to purchase a home but lacks cash for a downpayment. The seller provides the money plus a smaller fee to a non-profit group and then group then turns around and gives the buyer enough money for the downpayment. Since the cash comes from a nonprofit group the grant was allowed under FHA rules.

The argument then was that DPAs had a disproportionate level of foreclosures and that they resulted in unjustified and higher home values, thus creating additional risk for the FHA.

Without these loans, said HUD Secretary Shaun Donovan, “the actuary reported that our secondary reserves would have remained above the two percent threshold.” Translation: A big reason for FHA mortgage losses is because of DPAs.

DPA Proponents

Support for DPAs — and there has been a lot of support in Washington — was based on the idea that at the time people were readily buying homes with no money down and that the FHA should be able to bring its loan products to that segment of the homebuying public.

In fact, the National Association of Realtors reports that in 2009 15 percent of all buyers and 20 percent of first-time purchase bought with nothing down.

Last year Rep. Al Green (D-TX) introduced HR 600, a bill that would bring back DPAs. Supported by 22 co-sponsors, the legislation would once again allow buyers to purchase with seller-provided downpayment assistance. Why bring back DPAs? Because they would stimulate more home sales and thus create more demand for housing and increase local job numbers.

The IRS

The catch is that since Congress shut down the DPA program, the IRS has also acted.

“Organizations that provide seller-funded down payment assistance to home buyers do not qualify as tax-exempt charities, according to recent IRS guidance. Revenue Ruling 2006-27 also addresses whether the assistance received for down payment is treated as a gift and included in a home buyer’s basis.

“Increasingly, the IRS has found that organizations claiming to be charities are being used to funnel down payment assistance from sellers to buyers through self-serving, circular-financing arrangements. In a typical scheme, there is a direct correlation between the amount of the down payment assistance provided to the buyer and the payment received from the seller. Moreover, the seller pays the organization only if the sale closes, and the organization usually charges an additional fee for its services. Such programs have non-charitable purposes of facilitating real estate sales for the benefit of sellers and related financing entities. Thus, the organizations do not meet the requirement of section 501(c)(3) that they be operated exclusively for charitable purposes.”

Given that the FHA has raised both downpayment and mortgage insurance premium standards, the likelihood of a DPA return is small. And if it does come back there is the matter of the IRS ruling, something that could take years to overturn unless reversed by Congress.

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This entry was posted on Wednesday, January 27th, 2010 at 7:05 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 “Should We Bring Back FHA Seller-Financed Downpayments?”

  1. s2kreno Says:

    Seller-paid DPAs should not back in my opinion. Homes purchased with seller-funded DPAs sold for 2-3% more than comparable houses, making them more likely to be underwater and more likely for borrowers to end up in default. Not everyone is suited for home ownership; if you don’t have the discipline or wherewithal to come up with two or three percent for a down payment, your situation is too precarious and taxpayer’s money should not be risked. A better solution is to require counseling, budgeting education, and set up accounts for disadvantaged people where they have to save their down payment plus two month’s reserves and every dollar they put in can be matched by a community organization. That way only those willing to work for it get help with home ownership, and they’d be better equipped to deal with the responsibility.

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