Within the last ten years, credit-challenged homebuyers have used a regulatory technicality that lets them get FHA mortgages without putting their own money down, while at the same time avoiding subprime loans. Around 7,000 buyers per month were using this technicality, now the feds are shutting it down.
The new policy means that prospective homebuyers with less then perfect credit will have to act quickly if they want to buy houses without putting any money down. Otherwise, they will have to save for down payments or wait for the FHA to roll out its own zero-down program.
The issue being debated is a controversial method of putting together the down payment for a house. Most less then prime lenders require down payments of at least 5 percent which is difficult for those looking to buy a house with less them prime credit. The good news is that for those borrowers, loans insured by the FHA require smaller down payments, starting at only 3 percent.
Lenders require down payments for several reasons, the main one being that borrowers are less likely to stop making monthly payments if their own money is on the line. To make sure that borrowers have some personal collateral, not one lender allows sellers to make down payments on behalf of buyers. But for FHA-insured loans, there has been a way to get around that seller-funded prohibition.
The way around down payments
The FHA allows homebuyers to accept gifts of down-payment money from nonprofit organizations. There's is a trick: Since the 1990s, the FHA has allowed home sellers to donate money to nonprofits, and for the nonprofits to then "donate" the money to homebuyers. In effect, sellers could fund buyers' down payments, which was against the rules, but the enterprise was technically legal because the money was shuttled through nonprofits. The nonprofits collected service fees from sellers.
In the 2000 fiscal year, 6 percent of FHA-insured purchase loans had down payments channeled through nonprofits; four years later, 33 percent did. When this funding method was most popular, in fiscal years 2003 through 2005, more than 10,000 people per month were taking advantage of it, boosting the housing boom. From 2000 through 2006, more than 650,000 buyers got their down payments through nonprofits.
The federal housing department and Congress have commissioned at least three studies since 1999 that concluded these loans were riskier than FHA loans that didn't involve down-payment gifts. Sellers inflated home prices to recoup their contributions to the nonprofits, researchers found.
The studies recommended that the nonprofit down-payment assistance loophole be closed. Mortgage lenders, home builders and down-payment assistance programs argued to keep the loophole open, on the grounds that boosting the homeownership rate was good for everyone. The feds didn't take action until now.
Those who oppose the new rule change
This fall, the Department of Housing and Urban Development adopted a rule that prohibits the down payment money from coming, directly or indirectly, from the seller or "any other person or entity that financially benefits from the transaction." HUD administers the FHA. The rule takes effect Oct. 31.
The down-payment industry has been led primarily by two nonprofits: AmeriDream and Nehemiah Corp. of America. Both have asked federal courts to block HUD from enforcing the rule. The housing department won't comment, other than saying it will defend itself in court.
Should the new regulation goes into effect on Halloween, it would immediately end down-payment assistance grants from AmeriDream and all its competitors except Nehemiah. Scott Syphax, president of Nehemiah, says his nonprofit won a six-month exemption as a result of litigation against HUD 10 years ago, so Nehemiah will be able to serve as a conduit for down payments until March 31 -- six months after HUD published the rule in the Federal Register.
Right now, people who want FHA-insured mortgages will have to save up that 3 percent down payment, apply at Nehemiah before next March, or hope Nehemiah or AmeriDream win their court challenges.
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