June 26, 2008
Down payment assistance charities, blamed for housing crisis, targeted for elimination in housing bill
The Senate version of the Foreclosure Prevention Act of 2008 (Section 113) contains the following language, designed to shut down seller-funded down payment assistance charities: [the quoted provision imposes a down-payment requirement on first time home buyers who seek FHA assistance, but, in effect, prohibits the use of funds from a seller-funded down payment assistance charity]
SEC. 113. CASH INVESTMENT REQUIREMENT AND PROHIBITION OF SELLER-FUNDED DOWNPAYMENT ASSISTANCE.
Paragraph 9 of section 203(b) of the National Housing Act (12 U.S.C. 1709(b)(9)) is amended to read as follows:
`(9) CASH INVESTMENT REQUIREMENT-
(A) IN GENERAL- A mortgage insured under this section shall be executed by a mortgagor who shall have paid, in cash, on account of the property an amount equal to not less than 3.5 percent of the appraised value of the property or such larger amount as the Secretary may determine.
(B) FAMILY MEMBERS- For purposes of this paragraph, the Secretary shall consider as cash or its equivalent any amounts borrowed from a family member (as such term is defined in section 201), subject only to the requirements that, in any case in which the repayment of such borrowed amounts is secured by a lien against the property, that--
(i) such lien shall be subordinate to the mortgage; and
(ii) the sum of the principal obligation of the mortgage and the obligation secured by such lien may not exceed 100 percent of the appraised value of the property.
(C) PROHIBITED SOURCES- In no case shall the funds required by subparagraph (A) consist, in whole or in part, of funds provided by any of the following parties before, during, or after closing of the property sale:
(i) The seller or any other person or entity that financially benefits from the transaction.
(ii) Any third party or entity that is reimbursed, directly or indirectly, by any of the parties described in clause (i).
The red-lettering in section (C) is my own gloss on the language in the statute. Even most real-estate lawyers would miss the significance of that section without a bit of important context. For years, the Service has been trying to shut down seller-funded down payment assistance charities. These are 501(c)(3) organizations that solicit funds from home builders and developers. The charities then make grant to lower and middle income families sufficient to make a down payment on a home, perhaps built by the same builder or developer who made the contribution. In essence, the charity convinces the home builder to provide a discount (equal to the down payment necessary to obtain third party financing) for first time home buyers. Oftentimes those homes are FHA backed, providing the creditor with even more protection. The Service mistakenly asserts that the seller-funding of the downpayment creates an improper private benefit, nevermind the public benefit gained from encouraging home ownership. Even if that were true, the answer, of course, would be to deny the seller a charitable contribution deduction not shut down the charity altogether!
The Foreclosure Prevention Act, a monstrous amalgamation of provisions that would make even a tax lawyer blush, does just that, shuts down the charities altogether. Proponents blame down payment assistance programs for the housing mess, never-mind the greed and graft of lenders, speculators, and adjustable rate mortgage brokers who really caused the mess. Talk about a regressive policy. From a Wall Street Journal Article last weekend:
The [no down-payment] offers -- including "100% financing" -- are made possible due to down-payment assistance programs run by nonprofit organizations. These programs are funded largely by home builders and also by private homeowners desperate to sell. The seller-funded groups provide enough down-payment money to buyers that they can qualify for a mortgage backed by the Federal Housing Administration, which requires at least a 3% down payment. Supporters of the down-payment programs say they help the FHA fulfill its goal of assisting first-time home buyers. But critics say the programs will burden the government agency, and taxpayers, with bad loans. The FHA, which essentially is filling the void left by the collapse of the subprime market, renewed a push to eliminate the programs this month, after warning that above-average default rates for seller-assisted down-payment programs will force the agency to request a government subsidy for the first time in its 74-year history. The agency says it will need $1.4 billion next year. The FHA estimates that down payments provided by nonprofit groups account for 34% of all 200,000 loans backed by the FHA so far this year, up from 18% in all of 2003 and less than 2% in 2000. And the agency says that borrowers are two to three times as likely to default on their payments when they receive a down payment from a nonprofit.
This all seems ridiculous to me. Blaming the charity and their beneficiaries for the housing mess is like blaming a lowly gas station attendant for price of gasoline. Everybody knows that the housing market crash is more a result of "irrational exuberance" of better off investors than the poor first time home buyers. Indeed, most down-payment assistance charities engage in extensive screening and require beneficiaries to attend long hours of budgeting classes before they are granted down payment assistance. Moreover, most of the homes in default these days were financed through adjustable rate mortgages, which FHA and most down-payment assistance charities do not support! No wonder both the Congressional Black and Hispanic Caucuses smell a rat:
The nonprofit groups have the backing of several influential members of Congress, including Reps. Maxine Waters (D., Calif.) and Barney Frank (D., Mass.). The Congressional Black Caucus and the Congressional Hispanic Caucus sent letters this month to House and Senate leaders urging that the programs stay intact, citing their role in improving minority home-ownership rates.
Fortunately, the House version of the bill does not contain a prohibition against seller-funded downpayment assistance. Still, the IRS is nevertheless pursuing its policy of denying or revoking tax exempt status to charities that receive funding from sellers or developers. For more discussion on the FHA efforts against downpayment assistance charities see this entry in the WSJ's Development Blog.
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The important issue for these money laundering "non-profits" is not that the DAP assisted loans are doing badly now that property prices are tanking. FHA has been trying to eliminate these things for years, and the reason is that they have performed so badly even when property prices are rising. See, for example, the GAO report that FHA is using as support for its regulation to ban them,
Figure 7 shows that in the first 5 years after origination almost 20% of these loans have been foreclosed on, in MSAs where prices were RISING about 4% per year. FHA predicts truly horrendous foreclosure rates, over 30%, now that prices are falling, but it's the high foreclosure rate in times of rising prices that triggered the efforts to ban them.
Posted by: mort_fin | Jun 26, 2008 8:01:27 PM
I am also curious as to just what evidence you have for the following statement that you made: "Indeed, most down-payment assistance charities engage in extensive screening and require beneficiaries to attend long hours of budgeting classes before they are granted down payment assistance."
I have never heard of these outfits engaging in "extensive screening" and the only "classes" I've ever heard of them requiring consist of reading through and clicking on a handful of web pages. Looking at the webpage for Nehemiah, the largest of these outfits, you can find the statement:
* No income or asset limits
* No geographical restrictions
If you are a qualified homebuyer using an eligible loan program, such as an FHA loan, The Nehemiah Program can help you become a homeowner!
This is at http://www.getdownpayment.com/buyers/index.asp
If they aren't screening on income or assets or geography, and let anyone qualified for FHA use the program, then upon what criteria do you claim they are "carefully screening?" Have you actually read the IRS decision on 501(c)3 status for these outfits, where it says that a primary reason for yanking their status is that they DON'T limit the program to groups that typically get charity, but instead let in all comers?
And what evidence do you have for this statement: "In essence, the charity convinces the home builder to provide a discount (equal to the down payment necessary to obtain third party financing) for first time home buyers." Again, did you actually read the IRS decision, where they noted that the seller provides a "gift" and then immediately JACKS UP THE PRICE to cover the gift. In what sense is this a DISCOUNT? Have you looked at Nehemiah's web page, where they advise sellers:
Does it cost a seller more money to use The Nehemiah Program?
No. When you review transactions that use The Nehemiah Program you will usually find that sellers’ net proceeds are equal to or greater than proceeds from traditionally negotiated offers. If a seller’s net proceeds are not satisfactory, they will usually not sign the purchase agreement.
Did you read the GAO statistical analysis that showed that homes sold with this assistance tend to cost about 3% more than comparable homes sold without this assistance? The average "gift" size, by the way, is about 3%. Again, how exactly is this a discount? "We'll give you 3% if you give us 3%." Some bargain.
Posted by: mort_fin | Jun 28, 2008 9:17:23 AM
I assume, from your email address, that you belong to some group with no interest at all in the mortgage industry. You are just an innocent bystander protecting us poor minorities and low income taxpayers by cutting off those dangerous grants. You deserve a pat on the back for your fierce advocacy on behalf of minorities and low income taxpayers.
Still, you (FHA and the IRS) are blaming charitable organizations and their beneficiaries for the sins of the mortgage industry -- of which you are not a part (right?) is so besides the point. The point of my blog is that punishing charities for making downpayment gifts to low and middle income homebuyers because (if your statistics are to be believed) the lenders, sellers and their aunts and uncles cheat and lie makes no sense. Why not just punish those in your industry who doing all the bad things to which your statistics relate.
Posted by: Darryll Jones | Jun 28, 2008 9:53:36 AM
Who said that lenders and sellers cheat and lie, to say nothing of their aunts and uncles? FHA rules ALLOW the use of these programs. The whole issue is about changing that circumstance. So long as the rules allow the use of the program, how would you punish lenders for using the program? So long as rules allow the use of the program, how would you punish sellers for using the program? And so far as I know, the aunts and the uncles aren't even parties to the transaction. You can't start punishing people for using the programs until the programs are banned.
And you don't have to take my word on the statistics. I gave you the link - you can click on it and check them yourself.
Posted by: mort_fin | Jun 28, 2008 3:01:42 PM
You said so -- you said that sellers jack up the price by 3% after making donations for low and middle income homebuyers. I posted on this topic at least three or four months ago (I don't have time to find the post, but will do so if you would like to continue this mutual education). In response, I received emails from both individual nonprofits and associations of nonprofits representing downpayment assistance programs. They informed me of the facts which form the basis of my assumptions. Whether you believe them or not is your decison.
The basic point is that your statistics show no connection between down paymenet assistance programs and default rates. There are many factors which might contribute to a 20% default rate. By the way, a 20% default rate translates into an 80% success rate. Should the entire program be scrapped because 20% of the low and middle income grant recepients default in the first year. Is the default rate due to other factors such as their inability to pay health costs, struggles to pay tuition or any other whole host of reasons that you, the IRS and apparently the FHA foist upon low income beneficiaries. You can throw all sorts of statistics at the problem, but it proves not the connection you assume. And what is the default rate for people who scrape together downpayments from family members, etc? You've stated a statistic, but no control group or comparison.
In any event, my initial post and my further reaction is based more on a tax standpoint. There is nothng wrong with a seller making a donation to a charity from which the seller subsequently recieves a private benefit. Donors make contributions to college football teams and get skybox seating, donors make contributions to museums and operas and get special seating.
That said, you still have not proven a connection between down payment assistance programs and the housing mess, at least not sufficient to single out low and middle income taxpayers for special approbation.
Answer me that.
Posted by: Darryll | Jun 30, 2008 8:16:01 AM
And one more thing, if it is true that the downpayment assistance programs are engaging in "money laundering" (a phrase I take as meaningless hyperbole), there are sufficient criminal and IRS laws to deal with them. What is YOUR evidence for the wholesale use of that term? And even if your statistics (lies, damned lies, and statistics) are true, the cost of homeownership for 80% who do not default is worth the 20% default rate (if that is even true) if one factors in the collateral consequences of homeownership such as stable families, stable communities, lower crime rates, upward mobility and a host of other postive consequences that would not occur at even an 80% rate without downpayment assistance programs.
Posted by: Darryll Jones | Jun 30, 2008 8:29:42 AM
So much and so little time. You state that I don't show a connection between down payment assistance and default rates. But I pointed you to the GAO report that shows that holding constant all commonly used underwriting criteria, down payment assisted loans go to foreclosure at almost double the rate of loans with assistance from other sources, and about 2.5 times the rate of loans that had no assistance, in MSAs with house prices rising at about 4% a year (Figure 8 in the report). That ISN'T a connection???? Then just what WOULD be a connection?????
You state that a 20% default rate translates to an 80% success rate. Please prove this. What is your definition of "success?"
You state that I offer a 20% foreclosure rate for down payment assisted loans, but don't offer any comparison statistics. AGAIN, the comparison statistics are IN THAT REPORT. About 10% for loans with assistance from other sources, and 6% for loans with no assistance. Before you go any further, could you maybe actually READ the report?
To the best of my knowledge, no one has objected to seller's using the "donation" to reduce their tax basis. The IRS has objected to calling it a "charitable donation" or deducting it from income, because the "donation" is not limited to helping any disadvantaged group and the primary purpose of the "donation" seems to be as a sales aid. Just TRY looking at the Seller tab on any of these web pages and come back and tell me that they are marketing this to "donors" as a way to help the underprivileged. Every Seller tab on every "charity" website touts this as a marketing program. You can take a donation if you receive something of value incidental to the donation, but not if the receipt of something of value is the primary purpose for the "donation." And the whole issue of whether the seller can take a "deduction" as opposed to a reduction in cost basis, is secondary. IRS has gone after only one of these outfits for touting that. The thrust of the IRS decision is that most of their revenue is received for selling a marketing service, and little if any is received for fostering a charitable purpose. Again I'll ask - have you actually READ the IRS decision?
You state that I have not proven a connection between down payment assistance and the housing mess. But I've shown that these things have really high foreclosure rates. Foreclosure ISNT'T a key part of the "housing mess"????
You state that my use of the phrase "money laundering" is "meaningless hyperbole." But I believe almost anyone reading this blog (is anyone reading this blog?) would understand money laundering to mean taking money from an illegitimate source and making it appear to be from a legitimate source. FHA rules specifically prohibit sellers from paying the 3% cash that is required from borrowers. In effect, the seller is an illegitimate source of the cash. But these non-profits exist for the primary (in many cases, sole) purpose of taking money from sellers and giving it to buyers, so that the source appears to be a non-profit, and not the seller. How is that not money laundering, in any commonly accepted sense of the term? But so long as FHA regulations permit this, exactly what criminal and IRS laws (sic) would you use to stop it? Please be specific, and cite the relevant statute or (I presume) regulation.
You state that a 20% default rate is worth it for an 80% success rate. Accepting for the sake of argument your unproven assertion that there is an 80% success rate, how did you go about making this calculation? What did you assume about the magnitude of the costs of default to borrowers who have defaulted, the benefits of success to those who have succeeded, the costs to local jurisdictions of unpaid property taxes from foreclosed homes, the costs to local jurisdictions from the increased costs associated with foreclosed homes, and the costs to others in the neighborhood of living near empty, boarded up, weed strewn, foreclosed homes? Please be specific. And what costs have you assumed for the taxpayers who have to pay the extra FHA mortgage insurance claims? And how did you go about adding up these costs and benefits to reach your conclusion?
You talk about stable communities, lower crime rates, etc. Would you consider this a stable community? http://enterprise.star-telegram.com/ARCIms/Maps/clt/sc_2.asp
It's a map generated by the Charlotte Observer last year showing foreclosures and bankruptcies in a community where most of the loans were done with seller funded down payment assistance. If this is your definition of stable, what would you regard as "unstable?"
Posted by: mort_fin | Jul 1, 2008 8:25:33 PM
I'm also extremely puzzled by this statement of yours: "Is the default rate due to other factors such as their inability to pay health costs, struggles to pay tuition or any other whole host of reasons that you, the IRS and apparently the FHA foist upon low income beneficiaries?" Is it your contention that FHA foists health costs on people???? Or that I force people to struggle to pay tuition???? How on earth did you reach those conclusions?
While it's quite difficult to figure out just what your point is from all of this text, are you trying to imply that the default rate on these seller funded down payment loans is high because of health costs or tuition costs? But don't people who make down payments ALSO have health costs and tuition costs? How could this be the explanation for the difference in their performance?
Posted by: mort_fin | Jul 1, 2008 8:51:42 PM
You waste a lot of time arguing against the charitable contribution deduction for the seller. In the post above, or in a previous post, I stated rather clearly that the donor who makes a donation intending to receive a benefit from that donation ought not get a donation, notwithstanding the law with respect to donors to college sports programs, operas or the like. Perhaps you might take your own advice and READ what I've said before you go about splitting hairs. I'm all for the position the IRS takes with regard to the seller's claim to a charitable deduction.
I, of course, appreciate that at least you (and my mother) read this blog -- is anybody reading your blog? -- but you insist on precision with respect to the language I use but then grant yourself the luxury of an extremely loose definition of "money laundering." Indeed, what is your source, what is your authority for the definition you use? You know who I am and my affilitation but I know nothing about you. What is your real interest in shutting down downpayment assistance programs?
I just don't have the time to go tit for tat with you but another example of your imprecision (whilst insisting that I be precise) is the claim that a seller's downpayment assistance is "illegitimate" -- how so? That a charitable contribution deduction is not warranted, a fact I stated before you chimed in so constructively -- does not make the assistance illegitimate. In fact, there are many forms of assistance made available to buyers of all income levels but I suspect you don't use the same meaningless hyperbole in response to those programs.
My point still stands. Whether the GAO report controls for underwriting criteria or not does not address your inability to show a causative connection between a gift (even one by an interested party who stands to profit from the gift) and the foreclosure rate. You seem to have plenty of answers, smart guy, but none include preserving the downpayment assistance low and middle income buyers need (we both agree) and then addressing the subsequent circumstances leading to the situation that causes you so much grief (or does it really?)
Posted by: Darryll | Jul 2, 2008 12:14:49 PM
I couldn't agree more with mort_fin. Seller funded DPAs are nothing more than a money laundering scheme that violates FHA regulations. I applaud Commissioner Montgomery for standing up the likes of Nehemiah and other "non-profits" that generate hundreds of millions of dollars from their down payment scheme.
There is a clear correlation with the FHA's rising delinquency rate and the increase in so called "non-profit" down payment assistance.
The fact that the seller contribution isn't tax deductible as a charitable contribution but is deductible as a sale expense should be anyone's first clue.
These non-profits do not help borrowers achieve successful homeownership- there isn't meaningful counseling, education, or even a screening process. There are no income or geographical restrictions, and the only criteria for participation is the sellers willingness to contribute a matching "donation".
Anybody who argues that seller funded DPA's are legitimate are either ignorant as to how these grants work, are deluding themselves, or have an economic interest in upholding the scam.
Posted by: Krista Railey | Jul 12, 2008 1:49:44 PM
As far as the comment above about sellers "jacking up" the price of the house to take care of this 3%, I just sold a house in Georga in 2008. Because of the loss of value of houses in our area, the requirement actually was that in order to sell my house, it had to be at or under appraisal value, then pay the 3% +/-. You guessed it. The house appraised for several thousand dollars less than it had a year before, I still had to pay the 3%, the real estate commission, closing costs, etc. All because I could not afford to make two house payments, and I had to sell it for whatever offer I cold get, because it had been on the market for a long time. Yes, my feeling is that this is a total rip-off to the seller and to the buyer. It is a lose/lose situation. At least we should be able to take the 3% off our income tax just like we do for attorney's fees, real estate commissions, etc. I understand these kinds of programs were slated to be stopped, but alas, they are still there, and every one involved is still taking tremendous losses. Let's get behind this and, rather than keep making mistakes that contributed to the mess we are in, let's get these kinds of practices obliterated from our laws. I learned many years ago that if I can't afford a house, don't let some smooth-talking realtor, banker, etc. talk me into buying one. Wait until you can actually take on the responsibility for a house - that way you won't end up losing it and creating headaches for everyone.
Posted by: Lyn Flowers | Feb 20, 2009 7:36:16 AM