When all else fails, why not sue the federal government?
That’s the card Nehemiah Corp. and AmeriDream have played, perhaps to defend their very existence as two of the largest downpayment assistance organizations in the United States. Yet while these organizations and their 180-plus brethren have helped many people buy a home, their business model has been suspect since the start and today’s weakened housing markets would be better off without their inflationary intervention.
Downpayment assistance programs funnel "donations" from builders and home sellers to buyers, who use the "gifts" as all or part of their downpayment. The amount of money at stake isn’t nominal: AmeriDream alone has given more than $726 million, in chunks of $3,600 on average, to more than 200,000 home buyers since 1999, according to the lawsuit.
The issue is important because these programs have become a staple of home loans backed by the Federal Housing Administration. The percentage of FHA loans that involved such aid increased from just 1.7 percent in 2000 to more than 33 percent in early 2007.
The FHA has quantified a significantly higher risk of default on these loans. In 2001, nearly 16 percent of FHA loans that involved seller-funded downpayment assistance resulted in mortgage insurance claims. The claims rate for FHA loans without such assistance was just 7 percent. The FHA has estimated that in the future, 23 percent of the downpayment-assisted FHA loans eventually will result in claims compared with just 11 percent of FHA loans without such assistance.
The FHA proposed new restrictions on nonprofit downpayment assistance, but a federal judge blocked the proposal due to a rule-making technicality. The lawsuit claims that FHA’s effort to tighten up the rules would be unconstitutional because it would discriminate against minority, low-income and single-parent home buyers, who are the chief recipients of downpayment assistance.
Government agencies have repeatedly called attention to problems associated with these programs. A March 2005 report commissioned by HUD found these programs led to underwriting problems and increased the borrower’s effective cost of homeownership. A November 2005 report by the U.S. Government Accountability Office came to similar conclusions. A May 2006 IRS ruling clarified that many of the programs didn’t even qualify as tax-exempt organizations.
The stark disparities in FHA default rates suggest that while seller-funded downpayment assistance may help borrowers buy a home, such aid doesn’t support their ability to own that home. In effect, these "gifts" differ little from a teaser rate on an adjustable-rate mortgage. Misuse of downpayment assistance programs was even implicated in a foreclosure scandal that rocked a North Carolina community developed by Beazer Homes. This sort of dubious assistance doesn’t truly benefit disadvantaged people if they aren’t able to afford to own the home they’ve bought.
The problem is that downpayment assistance is a circular transaction even though the "gift" is processed by a third-party, which also collects a fee from the seller in addition to the "donation." Skeptics might question the appropriateness of using those fees to fund a lawsuit against appropriate and necessary government regulation of these schemes.
The ideal solution would be to ban these programs because the risks to lenders, mortgage insurers and borrowers outweigh the supposed benefits. Unfortunately, political realities, vested interests and the misguided lawsuit may make an outright ban difficult or impossible to achieve.
If a compromise proves the only palatable outcome of the rule-making dispute, these elements should be front and center:
? additional reporting requirements and intense regulatory scrutiny of downpayment assistance providers,
? an IRS form that would require sellers to acknowledge that a downpayment "donation" is not tax-deductible,
? IRS audit and enforcement of the non-deductibility of these "donations,"
? risk-based pricing on FHA loans that involve seller-funded downpayment assistance,
? full disclosure of the source and amount of such assistance to lenders and appraisers, and
? a ban on seller and buyer downpayment assistance participation through the same organization in the same transaction.
The last item would mean that a home seller who felt an urge or obligation to be charitable would still be able to make a "donation" to a downpayment assistance organization, and a home buyer who needed downpayment assistance would still be able to apply for a "gift" from such a group, but the seller and buyer wouldn’t be allowed to participate through the same organization or an "affiliated" program. If these organizations survived such an arm’s-length requirement, their claims would be much more believable.
Marcie Geffner is a freelance real estate reporter in Los Angeles.
Copyright 2008. Marcie Geffner. All rights reserved. No part of this article may be used or reproduced in any manner whatsoever without written permission of the author.
