Monday, June 16, 2008

Commissioner Montgomery Takes on Seller Funded Down Payment Assistance Again

FHA Commissioner, Brian Montgomery, has resumed his battle against FHA program abuse via seller funded down payment grants which threaten significant losses to the FHA program. According to Brian Montgomery, this proposal is also to ward off an estimated 1.4 billion credit subsidy that is projected that the program will need at the beginning of fiscal year 2009.

HUD's proposed rule published in the June 16, 2008 Federal Registry titled Standards for Mortgagor’s Investment in Mortgaged Property: Additional Public Comment Period, is in response to the U.S. District Courts for the Eastern District of California and the District of Columbia injunctions in February 2008 and March 2008 which prevented FHA from implementing their final rule entitled “Standards for Mortgagor’s Investment in Mortgaged Property” published October 1, 2007 HUD in the Federal Registry On October 1, 2007 (72 FR 56002). Click here to view.

Like the 2007 proposed rule, today's proposed rule seeks to eliminate down payment assistance from all parties with a financial interest in the property as per the Code of Federal Regulations, Title 24, Part 203, Section 203.19 (C) 1-2 (April 2008 revision) which states:

(c) Restrictions on seller funding. Notwithstanding paragraphs (e) and (f) of this section, the funds required by paragraph (a) of this section shall not consist, in whole or in part, of funds provided by any of the following parties before, during, or after closing of the property sale:
(1) The seller or any other person or
entity that financially benefits from
the transaction; or
(2) Any third party or entity that is
reimbursed, directly or indirectly, by
any of the parties described in paragraph
(c)(1) of this section

The IRS ruled in May 2006 that non-profit organizations that funnel down payment assistance to buyers through "self-serving, circular financing arrangements" is inconsistent with with operation of as a section 501(c)(3) charitable organization. As such, organizations that provide seller funded down payment assistance no longer qualify as tax exempt entities.

Click here to view the ruling, and here to view the IRS press release.

FHA's delinquency rates have risen from 9.07% in 2000 to 16.571% during the first quarter of 2008 while borrower funded down payments have decreased from 75.75% in 2000 to only 46.05% in 2008. So-called "non profit" funded down payments have risen from 1.74% in 2000 to 37.30% in 2008 while increasing their early payment default rate from 7.98% in 2000 to 16.43% in 2005. In fact, loans involving "non-profit" down payment assistance have both the highest delinquency and default rate of any other down payment source, including family gift.

Unfortunately, seller funded down payment grants have a tendency to increase prices for everyone because of how they work. Typically, the seller agrees to increase the sales price to include the amount of the borrower's down payment grant which is pledged to be "donated" to the non profit company at closing. Prior to closing, the non profit company wires the borrower's down payment grant to escrow along with their fee demand. After closing, the amount of grant and the fee is deducted from the seller's proceeds and forwarded to the non profit company. The down payment contribution is typically in addition to contributions for closing cost and other concessions that further skew prices for everyone.

While FHA's proposed rule will eliminate seller funded down payment grants, it will not impact legitimate non profit, community, and government programs.

The proposed rule is not final, and the public and other interested parties are invited to make comment via by clicking here (Note: Document ID reference HUD_FRDOC_0001-1138).

Comments are due by August 15, 2008.

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