What's wrong with down-payment "gift" programs, in which all or most of a homebuyer's equity stake comes from the seller, funneled through a third party? And why is the federal government determined to ban them as quickly as possible?
Here's how they work: Say you want to buy a house, but you don't have the required cash for a down payment. You sign up with a third-party intermediary - typically a tax-exempt charitable organization that advertises its specialty. The seller of the house sends a contribution to the organization roughly equal to the money you need. The intermediary then pockets a fee of $400 to $600, and passes along the balance for the down payment.
Though rare in the nongovernment loan market, such deals have been commonplace at the Federal Housing Administration, where they've accounted for more than one-third of total volume in recent years. Normally, FHA applicants are required to pay a minimum 3 percent down. Using a seller-funded gift program, that can be cut to zero.
But now FHA wants to pull the plug on these arrangements, citing excessive defaults, foreclosures and losses so severe they threaten the solvency of the agency's insurance funds. On top of that, in the last year the IRS has revoked the tax-exempt status of 31 nonprofit organizations that specialize in down-payment gift programs.
Despite such setbacks, down-payment-assistance purveyors are mounting a stiff political defense, rallying the Congressional Black Caucus and the Congressional Hispanic Caucus, among other influential supporters. In recent letters to committee leaders on Capitol Hill, the groups asked that they scrap pending legislative provisions that would eliminate seller-funded gifts with FHA-insured mortgages.
In a June 9 speech at the National Press Club, FHA Commissioner Brian D. Montgomery announced that, even without legislation, his agency plans to prohibit the gift programs by regulation later this year. Gifts by relatives, local government agencies, employers and charities that do not recycle funds from sellers to buyers would still be permitted under the rules.
FHA is part of the Department of Housing and Urban Development, and it functions as the government's primary source of support for low-down-payment, fixed-rate mortgages for first-time and moderate-income buyers, many of whom are minorities. In the past year, FHA applications have more than doubled, and the agency has become the country's most active refinancer of adjustable-rate subprime loans for owners facing unaffordable payment jumps.
But according to HUD, FHA loans using seller-funded gifts are ending up in foreclosure and causing losses at between "two and three times" the rate of loans in which borrowers made their own down payments. In a proposed rule banning seller-funded gifts, HUD cited a 2005 study by the Government Accountability Office that found gifts funneled from sellers to buyers sometimes "raised the sales price of the homes involved in order to recover the required payments" funneled to buyers as inducements.
Inflated prices, in turn, said HUD, contribute to excessive losses when buyers default, leaving FHA to pick up the bill. Buyers using gifts default at higher rates in part because "they have no skin in the game" - no real stake in the house - according to Montgomery. HUD's proposed regulation includes extensive statistical data comparing performances of seller-assisted buyers with other borrowers from 2000 through 2007.
Two of the highest-volume providers of seller-funded gifts, Nehemiah Corp. of America and AmeriDream Inc. - whose tax exemptions as charitable organizations have not been revoked by the IRS - are incensed at HUD's plans. Scott Syphax, president and CEO of Nehemiah, challenged the department's foreclosure and loss statistics, claiming that HUD's database is "corrupt" and "has been cited as unreliable and not a body of information upon which you can base any substantial conclusions." He said it's a case of "garbage in, garbage out," and that HUD knows its data are inaccurate. HUD declined comment on Syphax's charge.
Ann Ashburn, president of AmeriDream, said down-payment assistance groups have helped "more than 1 million working families buy their own homes over the past decade," the vast majority of whom have not defaulted or been through foreclosure.
HUD has tried banning seller-assisted gifts before without success. Federal courts blocked a regulatory proposal issued last October, primarily on procedural grounds rather than on HUD's legal right to restrict down-payment gifts.
Where is this all headed? Quite possibly to court again. And of course, never rule out Congress. With heavier Democratic majorities widely expected in the House and Senate next year, gift proponents and their allies on Capitol Hill may simply try to stall the regulation and run out the clock.