Thursday, June 26, 2008

Down Payment Assistance Programs

ranch houseThere has been a lot of talk recently about down payment assistance programs, and specifically whether or not they should be banned. Politicians and these down payment assistance companies have been fighting for some time on the subject, and so far the down payment assistance companies have won. Many believe that these programs are simply taking advantage of a loop hole in the FHA system and contributing to a huge number of foreclosures, while supporters proclaim that the companies are providing a vital service that is allowing low income and minorities the opportunity to enjoy homeownership for the first time. But what are we to believe? Are these programs really good or bad?

Ultimately, proclaiming whether these programs are good or bad is tough because in the end, it is subjective. On one hand, they are providing a way for people to own their own home; on the other, we have to ask ourselves, first off, whether or not owning a home is really the best thing for these people if they have no money? Are they, and are we as a country, better off with these individuals as homeowners? A tough question, but let’s take a stab at it.

The main objections to down payment assistance programs are that they have an unusually high default rate and put undue pressure on the homeowners and the FHA; they really aren’t non-profits; and they violate the intent of FHA regulations.

The unusually high default rate is most certainly a valid point. According to data on FHA loans, the down payment assistance loans result in around 3 times the normal level of default. In addition, I used a quote from FHA commissioner Brian Montgomery in a previous post in which he said, “…no insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, F.H.A. will soon either have to shut down or rely on appropriations to operate.” This quote was directly aimed at increased losses stemming from down payment assistance programs which now comprise around 35 percent of FHA loans. Supporters of the down payment assistance programs prefer to take the glass is half full approach and focus on the fact that 94 percent of these homeowners pay their mortgages with no problem, but it is hard to argue that the default is a serious problem when the FHA chief is on record saying that it could be the FHA’s downfall if they are not stopped.

The next complaint against these companies is that they aren’t really non-profits. In fact, the IRS has a big beef with the way many of these companies have been operating, and has revoked the charitable status of a number of these companies. That being said, as you can see the big players in the field have yet to be shut down and appear (at least in the IRS’s mind) to be operating within the guidelines set for charities.

The last point is the big one in my book: These companies are clearly violating the intent of the FHA’s guidelines. To qualify for an FHA loan, buyers have to be able to provide at least a 3 percent down payment--the catch is they do allow for gift funds to cover the 3 percent. However, it is expressly forbidden for those funds to come from the seller. In a typical down payment assistance arrangement, that is precisely what happens, only the down payment money is “cleaned” by passing through the non-profit (sounds kind of like money laundering, huh).

These deal work like this: The buyer and seller come to an agreement on price (typically bumped up enough to account for the following contribution), the seller donates 3 percent of the purchase price to XYZ non-profit and the non-profit issues a grant to the buyer for the 3 percent they need to buy the home--minus a handling fee, of course. Now how doesn’t that violate the intent of the FHA guidelines? The down payment assistance companies can spin this all sorts of ways, but at the end of the day they need to be able to answer this question: If the seller didn’t donate that 3 percent, would you still make that grant to the buyer? If they can truthfully answer that question, yes, then so be it; however, I’m pretty sure that is not usually the case. So it doesn't matter whether one seller’s funds are technically supporting some other buyer, and this buyer is being supported by some other seller. If the only way the deal is getting done is by the seller making the 3 percent donation, then it is a violation of the true intent of the guideline.

I’m not going to argue that these programs provide zero benefit, because I think in certain circumstances they can prove to be a valuable resource for people. But these programs are a blatant attempt to circumvent established FHA guidelines and should be put to an end. If we want to legitimize these programs then we need to change the guidelines to allow for them, and in my mind if we are going to do it, we need to create a box around it as well. I don’t think people should ever be buying a home if they have no money. What happens if the roof fails, or if they are out of work for a couple months? Everyone should have some savings, but homeowners need to have a substantial amount. Now if these people have some money, but want to keep it in reserve instead of putting it as a down payment on a house, then that is where I see down payment assistance programs as useful. Maybe the new guideline should be that buyers have at least 3 percent of the homes’ value in savings.


Anonymous said...

A few years ago I attended an affordable housing workshop where HUD officials were encouraging the use of these down payment assistance programs as a way to bring private capital in to help reach the president's goal of increasing home ownership by 5.5 million units. Now that a real estate recession is here, politicians are looking for scapegoats. In a down economy, low income people loose their jobs first, and then loose their homes. It has nothing to do with the source of the downpayment.

Anonymous said...

If downpayment assistance programs are so bad and this sole item resulted in one third of FHA's portfolio to go into default as Chairman Montgomery would like you to believe, what does that say about his stewardship at HUD. If you believe his numbers, a rational person would say, "this didn't happen overnight and since you are responsible, why did you wait until now to do something about it when you could have put in measures to regulate the process before now!" I've heard that there is a study out there in-progress that shows that FHA's defaults have been decreasing over the last six months - in this market. No one wants to talk about that... could it be that DPA is not the smoking gun that caused FHA to hit the skids? Could it be possible that the underwriting rules were not as good as they should have been? Are we going to disadvantage hundreds of thousands of families because our government can't do what they are supposed to do? Seems to me that Chairman Montgomery and quite of few of our Senators and Congressmen are using a little bit of sleight of hand.. blame the big bad DPAs for our failings while we create a bailout bill that spends huge amounts of taxpayer money and dwarfs the problem at the same time... Me thinks something is rotten...