I recently wrote about the Seller's Concessions Ruse, whereby buyers get assistance with their closing costs by inflating the sales price and moving the fees to the seller's side of the settlement statement.  It's basically a way for the buyer to finance his closing costs.  This is very similar to other programs that provide "down payment assistance" to homebuyers.  There are good reasons for requiring a buyer to make a down payment - finding creative ways around the requirement has consequences that HUD is finally realizing.  If buyers can't afford a reasonable down payment and closing costs, they should not be buying a home.

So what is wrong with 100% financing, or down payment assistance programs?  First, and most obvious, the down payment protects the lender from heavy losses in foreclosure.  If the home is worth more than the loan amount, the lender has a better chance to recover its losses at a sheriff's sale.  Second, a lesson I learned from my father, when people have something invested in their purchase they are more likely to take care of it.  Homeowners are more likely to make their payments if they have their own money invested in the property.  If a homeowner bought a home with no money down they have little to lose by simply walking away when the mortgage payment become an inconvenience.  They may have credit issues to deal with, but that is probably already a problem when a borrower reaches this point.  In some states, there is the possibility of a deficiency judgment if the sheriff's sale does not make the lender whole.  However, those are rarely pursued by the lender.

Down payments of 20% used to be the norm.  For borrowers who could not afford 20% down, on even a modest home, could turn to FHA; if they qualified, they could put down as little as 3%.  But, even 3% was meaningful enough for some borrowers to feel like they had a substantial investment in their home that they wouldn't just give up in foreclosure.  People worked hard to earn their down payment and they were proud to be homeowners.

Now, many homeowners have more of a "renter's mentality."  If they get down payment assistance, they can buy a home with no money down... after tax pro-rations, they could even get cash back at the closing.  In essence, they are getting a home without so much as even a security deposit that would have been required if they decided to rent.  If they would have rented and failed to make their rent payments, the landlord would have them evicted within a couple of months and the security deposit, or last month's rent, would have been forfeited.  But, when they buy and fail to make mortgage payments they can stay in the home until after the sheriff's sale, which could take a year or more!  For some, buying is like getting free rent for a full year - try getting that deal with a landlord.

So how does "down payment assistance" work?  Using programs like AmeriDream, a third party provides a "gift" to the buyer to use for their down payment.  That would be very generous... if AmeriDream weren't making money by providing the assistance.  They, of course, charge a fee paid by the seller which is greater than the assistance they provide.

The seller must participate in the AmeriDream program, but your loan officer can assist a seller in signing up for the program by showing where and how to apply. For your home buying needs, the loan officer will handle your application for AmeriDream down payment assistance, but may require additional information from you to help fill out the form. AmeriDream is just one of many organizations offering down payment assistance to those with FHA approved home loans. If you have been pre-approved for an FHA mortgage loan but don't meet the income requirements for the AmeriDream program, keep looking. There are several down payment assistance programs with no income requirements or restrictions.

Down payment assistance programs generally require the seller to pay a fee to participate. This fee is considered a payment for services rendered and not a tax-deductible charitable contribution.

See FHA.com.

And, that would be very generous of the seller, if the seller were to actually pay the fee out of his pocket.  But I doubt that is the case in most transactions.  Instead, the seller raises the sales price by enough to enable the buyer to borrower enough additional funds to cover the seller's fee.  So, basically, the seller is financing not only the amount of the down payment they need, but also the fee charged by AmeriDream.

Who cares?  What are the economic consequences of the transaction?  The seller doesn't care because they are still getting the same amount they would have gotten as the sales contract had been initially negotiated.  The Realtor will often base their commission on the originally negotiated sales price, so it doesn't cost the seller any more in commissions and the Realtor still gets their 6% of the "true" sales price. The mortgage broker still gets its fees - more than they would have gotten if the borrower failed to qualify because of a lack of down payment.  Sure the borrower owes more money, but they still got the home and when the additional amount is amortized over 30 years there is not much change to the payment.

FHA, however, is experiencing huge losses! 

In a speech to the National Press Club, HUD's Assistant Secretary for Housing-Federal Housing Commissioner Brian Montgomery warned that FHA must take action because these loans, which now make up one third of FHA's portfolio, are causing substantial losses. This year, as a result of its annual re-estimate, Montgomery said that FHA had to book an additional of $4.6 billion in unanticipated long-term losses, mostly due to the increased number of certain types of seller-funded loans in the FHA portfolio.

Raise your hand if you are surprised that billions of dollars in losses are attributed to borrowers who had nothing personally invested in their home purchase.  I would say that this is a type of fraud, but everybody knew what was going on... nobody cared.  I don't think that anyone would have a problem calling this a fraud if the seller simply agreed to raise the sales price and covertly slide a check across the table to the buyer without showing the transaction on the settlement statement.  So, what is the difference?  Either way, the buyer is not making the downpayment with his own funds.  The only difference, really, is that AmeriDream wouldn't get to charge a fee for passing the money around.

Ah... but what's the big deal... FHA can afford a few billion in losses, right?

Stressing that FHA is still solvent with reserves of about $21 billion, Montgomery also noted that no insurance company can sustain that amount of additional costs year after year and still survive. He said that unless the administration takes action to mitigate these losses, FHA will soon either have to shut down or rely on appropriations to operate.

To address the growing concern HUD has taken action... well, they have proposed to take action.  It has reopened the public comment period on a proposed rule. 

The primary focus of HUD's rule is to establish appropriate standards for down payment assistance that is categorized as a gift. Specifically, the rule would prohibit down payment assistance provided before, during, or after closing of the sale by the seller, any other person or entity that financially benefits from the transaction, or any third party or entity that is reimbursed directly or indirectly by any of the parties benefiting from the sale.

Montgomery said that the rule would clarify that down payment funds for FHA-insured mortgages cannot be derived from sellers, either directly or indirectly, or any other party that stands to benefit from the transaction financially.

Even with the new rule, HUD would still generously allow "true gifts" from a family member, a governmental or public agency, the borrower's employer or labor union and a charitable organization that qualifies as a tax-exempt charitable or educational organization. But Montgomery recognizes what I have been saying all along...

He pointed out that in these cases there is a clear quid pro quo between the homebuyer's purchase of the property and the seller's "contribution" or payment to the charitable organization. Often, these contributions function as an inducement to purchase the home. One of FHA's primary concerns with these transactions is that the sales price may be increased to ensure that the seller's net proceeds are not diminished, and such increase in sales price is often to the detriment of the borrower and FHA.

Common sense should prevail on this issue.  It is usually pretty clear when the borrower is actually making a meaningful down payment and when the down payment comes, indirectly, from the loan proceeds.  In my opinion, when a "down payment assistance" program is used, the buyer is NOT making a down payment at all.  Thus, the borrower has nothing vested in the home and the odds of default go up significantly.

Robert A. Franco
SOURCE OF TITLE