In answer to a recent comment on my post “H. R. 6694 Passes Out Of Committee” I made the statement that:

“I’m absolutely not opposed to people putting money down. For most of my career in the mortgage business, buyers had to put down essentially 5%.

FHA is a self supporting program where the borrowers as a general rule carry their own weight by paying mortgage insurance premiums. They have to prove their ability to make the payments along with whatever payment they may be making on that SUV and those TVs. In addition, every lender and broker who offers FHA loans is held accountable for their default rates. FHA programs aren’t the problem bringing down the credit industry.

With seller assisted DAPs, the borrowers lose some of their ability to negotiate with the seller and end up in the long run funding their own down payment. Unlike the government programs which are being forced as replacements, this down payment assistance doesn’t come directly out of the taxpayers’ pockets.”

Krista Railey, an analyst for ml-implode.com, subsequently posted the following comment in response. You can find the context of her response here, but I will quote it to save you the time:

“I agree with you Carl. These programs create housing inflation and lead to higher default rates. Every single SFDPA program that I look at is ran as a for profit venture without regard for borrowers. I invite you to take a close look at the programs and the individuals behind the programs, and you will likely find a convoluted mess of multiple entities brokering programs. As to providers that do not obfuscate their identity and file IRS 990 returns, the flow of cash from the non profits to for profit entities involving the Officers says it all.

Currently Christopher Russell, Ryan Hill and the Penobscot Indian Nation is suing the ML Implode and myself to remove my documented article regarding their program from my blog and stifle free speech. Needless to say, its a sad day when bloggers get sued to silence criticism- especially on such a controversial issue as seller-funded down payment grants.

DownpaymentOutfitSuesMLImplodeInEffortToSilenceCr.html

If H.R. 6694 passes, it will be a travesty against FHA and the Taxpayers and will create higher home prices, higher defaults, and higher mortgage insurance costs for borrowers that save their down payment.

In fact, some buyers who save their down payment and are ready for homeownership will be displaced entirely just so some buyers can purchase before they are ready.

Representatives Maxine Waters (D-CA), Al Green (D-TX), and Gary Miller (R-CA) are selling out to trade groups and special interest while ignoring the fact that housing inflation and inflation overall is a greater threat to the housing market than whether buyers without down payments can purchase homes.”

Krista has misunderstood my original post which was actually made in support of bringing back seller assisted down payment programs, however her own post she links to makes some excellent important points and brings many issues to the table that I would like to comment on. Some issues that have been bothering me for quite some time.

I have covered in great detail elsewhere on this site the reasons why I feel that seller assisted down payment assistance is NOT, inherently, the significant source of FHA defaults that its critics think.

Here is a short list of just some of those reasons.

• The raw numbers used by HUD to document this increased default rate are significantly inaccurate.
• The study used by HUD to document the higher default rate of DAPs does not adjust for the higher levels of fraud which exist in the areas included in the study. Fraud which was most likely intricately but not inherently associated with transactions involving down payment assistance.
• Defaults are much more closely associated with areas experiencing rapidly decreasing values caused by foreclosures unrelated to FHA loans than they are to lack of down payment.
• Lender analysis has shown that when seller assisted DAPs are not combined with high debt ratios or unjustified bad credit or lack of previous housing payment history then default levels are comparable to loans without down payment assistance.

In other words, in my opinion the difference between a borrower making no down payment or a 3.5% percent down payment is not a significant factor in the desire of that borrower to fight and scrape to prevent default and keep their home when the going gets tough. Now a 20% or even a 10% down payment might be a greater incentive for that struggling borrower, but it is naive to think that 5% or less down payment makes a significant difference as long as the borrower had the real capacity to repay the loan in the first place. I believe that mortgage fraud is the most significant factor in the difference between default rates on loans with seller assisted down payment programs and loans with other types of down payment assistance.

Krista points out in her article that there is a definite “correlation” between increased use of seller assisted down payment programs and increased FHA default rates. I am far from an expert on the subject, but one of the first things learned when studying statistical analysis is that correlation is not the same thing as causation. The increase in defaults is also associated with higher rates of job loss and dislocation, higher gas prices, and of course, falling real estate values. As far as I can tell, increases in FHA default rates follow the same pattern in the same areas as all other types of loan defaults.

I agree with Krista that these programs are a cause of some inflation in real estate values. However, by that reasoning FHA should do away with seller assistance for closing costs as well, or taken to its logical conclusion we should get rid of FHA altogether. Any program which makes it easier for people to buy homes is going to contribute to price inflation.

Aside from HUD’s very successful loss mitigation program, one of the greatest advantages in terms of default rates that FHA loans possess is that the underwriter theoretically analyzes the reasons why bad credit occurred and why that situation is unlikely to happen again. In other words, the underwriter determines that the borrower has corrected whatever personal situation contributed to their past credit problems.

Subprime loans, on the other hand, have never required such analysis. Subprime lenders ended up giving loans for 100% of the value of the home as long as you had a paltry 580 credit score (sometimes even lower) and a certain number of credit lines showing on the credit report - regardless of the reason for the bad credit or whether the problem still existed. These loans vastly outnumbered FHA loans during the real estate boom and, I believe, far outdistanced seller assisted down payment programs in causing higher real estate prices.

Now, after all that seemingly enthusiastic defense of seller assisted down payment programs, I must say that some of Krista’s comments and concerns combined with information I have gleaned elsewhere have convinced me that there is a better way to achieve the FHA goal of helping those unable to meet conventional lending guidelines. Those who just don’t have the capacity in today’s economy to save up a significant down payment.

One of the reasons I have now changed my opinion is pointed out in Krista’s article. Non-profits have a surprising tendency to be associated with abuse from within the ranks. I won’t go into details here but hers is not the only report I have seen of abuses and strange flows of cash from the participants. Even from the top most well respected participating non-profits. And definitely from the swarm of non-profits that aren’t in the limelight, but are owned or controlled by home builders or mortgage lenders. All this aside from the fact that the first gut  reaction any mortgage originator or real estate agent with long experience has to these programs is to wonder why an action that would be regarded as mortgage fraud if the seller did it directly suddenly becomes “clean” when laundered through a non-profit agency. I believe this creates an aura around the transaction which contributes to a lack of respect for the rules.

Sure, I could tell you that the answer to this is simply to have the non-profits monitored more closely, but why bring in more inefficient regulators if there is another solution to the problem of getting buyers into homes. And I think there is.

There is also the problem of the increased mortgage fraud which tends to be associated with these programs. I believe this is primarily caused by the ease iwith which the seller and buyer can access the down payment money involved. Without these programs house flippers and other fraudulent sellers would either have to actually give straw buyers their down payment money two months in advance of closing the transaction, or would have to fraudently support the existence of the money with faked bank account statements. Why take those risks when it can all be done at the closing table with a paltry $500 or less in extra costs?

After a great deal of thought and analysis, I have come to the conclusion that the answer to these problems lies in one of the original FHA Modernization proposals. That answer is to lower the buyer contribution to 1.5% of the sales price. This amount is enough to show that buyer has at least a small amount of flexibility in their budget and ability to save, while not punishing those the FHA program exists to help in the first place. I also don’t believe that there would be any significant increase in defaults between a 1.5% down payment and a 3.5% down payment as long as other underwriting standards were maintained and layered risk was considered by the underwriter. This would also substantially increase the risk of discovery for those fraudulent house flippers who were endangering the FHA program through the use of seller assisted down payment programs in combination with mortgage fraud and thus make a significant dent in another problem weighing down the FHA program.

So, the answer to the question I asked in the title to this article is “Yes”, but not for any of the reasons HUD used as justification for banning the programs. I look forward to hearing other opinions on this and would like to thank Krista Railey for inspiring me to re-examine this issue.