The Federal Housing Administration would no longer allow down-payment assistance from charities or groups that accept payments from builders and sellers under a proposed rule change published in Friday’s Federal Register.

The Department of Housing and Urban Development says it plans to tighten rules governing down-payment assistance to stop sellers and others who profit from a home’s sale from participating in circular financing arrangements that inflate home prices.

The rule change would still allow down-payment assistance from family members, governmental and public agencies, employers and labor unions, and IRS approved tax-exempt charitable and educational groups.

The IRS last year said it would no longer consider groups that accept money from sellers to provide down-payment assistance tax-exempt.

The rule change is aimed at down-payment-assistance programs that accept money from home sellers or others who profit from the sale of a particular home. Under such circular arrangements, the down-payment-assistance payment is often added to the home’s sales price, HUD said in its Federal Register filing.

“Although FHA has attempted to preclude down-payment funding derived from contributions of the seller of the property, some charitable organizations have been able to circumvent these restrictions in various ways, including the establishment of a fund that provides the so-called ‘gift’ to the home buyer,” HUD said.

Situations that cause FHA concern are primarily those in which reimbursement is made after a loan closing by the seller, who provides a “charitable donation” and, in some cases, pays a “service fee” to the organization from the proceeds of the sale of the house.

“In these cases, there is a clear quid pro quo between the home buyer’s purchase of the property and the seller’s ‘contribution’ or payment to the charitable organization,” HUD said.

Unlike gifts from family members or government agencies, which reduce the amount of the purchase price financed by the homeowner, seller contributions increase the sales price of the home and result in higher mortgage payments, HUD said. Inflated sales prices result in inflated mortgage amounts, which increases the severity of individual claims on the FHA Insurance Fund and FHA losses on claims paid on such mortgages.

“Given that seller-funded gift programs thrive in stagnant or depreciating housing markets, the risk to FHA increases if FHA cannot recover the full amount owed when FHA acquires and resells a home that had been purchased by a participating borrower who had defaulted on the FHA-insured loan,” HUD warned.

The use of down-payment assistance from nonprofit groups was on the upswing during the housing boom, rising from 1.7 percent of FHA-insured single-family mortgage in 2000 to 33.2 percent so far this year. The percentage of FHA-insured loans with no gift has fallen from 75.8 percent to 49.1 percent during the same period, while down-payment assistance from family members has declined from 20.3 percent in 2000 to 12.1 percent in 2007.

HUD said the proposed rule is not intended to prevent builders and other sellers from offering cash incentives to home buyers, provided that any cash or cash equivalent results in a proportionate reduction to the mortgage. The rule would not bar “reasonable assistance” with closing costs unrelated to the minimum investment if permitted by local law.

Comments on the proposed rules are due July 10, and may be submitted through the Federal eRulemaking Portal at www.regulations.gov or by mail to the Regulations Division, Office of General Counsel, Department of Housing and Urban Development, 451 Seventh St., SW., Room 10276, Washington, DC 20410-0500. Comments should refer to Docket No. FR-5087-P-01, “Standards for Mortgagor’s Investment in Mortgaged Property.”

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