Sellers have probably abused their right to provide down-payment assistance through nonprofit groups, but regulators should establish caps and more stringent eligibility requirements on FHA loans rather than ban the practice outright, an industry group maintains.
In a letter to the Department of Housing and Urban Development, The Mortgage Bankers Association said seller-funded down-payment assistance on loans insured by the Federal Housing Administration has “provided an important tool for low-income, minority and first-time home buyers,” and should be reformed, rather than scrapped.
HUD has proposed tightening the rules governing down-payment assistance on FHA insured loans, in part because of concerns that allowing sellers and others who profit from a home’s sale to participate in circular financing arrangements artificially inflates home prices.
Of particular concern are charitable organizations that sellers often use to circumvent FHA restrictions on seller-funded down payments. Down-payment assistance from nonprofit groups has grown from 1.7 percent of FHA-insured single-family mortgages in 2000 to more than 30 percent this year.
In addition to inflating home prices, studies suggest loans that rely on seller-funded down-payment assistance don’t perform as well as other similar loans. A November 2005 study by the Government Accountability Office found that the default rate on such loans was 22 to 28 percent, compared with 11 to 16 percent for loans with other forms of down-payment assistance.
New rules now under consideration would prevent sellers from providing charitable donations or service fees from the proceeds of a home sale to charities that provide down-payment assistance.
The proposed 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 no longer considers charities that provide down-payment assistance tax exempt if they accept money from sellers.
Citing testimony from such groups, the MBA says seller-funded down-payment assistance has helped nearly 500,000 low- and moderate-income buyers purchase a home, with 81 percent of those loans still performing.
The proposed rule could reduce FHA loan volume by 30 to 50 percent — at the expense of low-income, first-time and minority home buyers, the group said.
“Considering that (FHA’s) market share is lower than at any time in recent history — less than 2 percent — the impact to FHA could be quite serious,” MBA Chairman John Robbins said in the Aug. 7 letter to HUD.
“While there appears to be much evidence that … seller-funded down-payment assistance has been abused, it is unnecessary to fully eliminate the program in order to address concerns of abuse,” the industry letter said.
Requiring more stringent controls could reduce the percentage of nonperforming loans and keep artificial price inflation in check while preserving the benefits of the program, the MBA said.
The MBA recommended that HUD:
- Cap seller-funded down-payment assistance at 6 percent or “what is customary for the area,” whichever is less.
- Establish more stringent loan eligibility requirements and screening for high-risk factors such as low or no reserves or poor credit history.
- Introduce better valuation controls to reduce the likelihood of inflated sales prices for homes with seller-funded down-payment assistance. In addition to standard appraisals, lenders could be required to use automated valuation tools “when available and appropriate” or perform desk reviews.
The National Association of Realtors advocates allowing the FHA to insure zero-down-payment loans for first-time home buyers, which the group claims would be “a major step” in eliminating the incentive for the “most abusive” seller-funded down-payment programs.
Legislation that would allow the FHA to use risk-based pricing and insure zero-down loans, the Expanding American Homeownership Act of 2007, has been introduced in the House of Representatives.