The End of Down Payment "Charities"

The End of Down Payment "Charities"

The nine lives of down-payment assistance groups - controversial players in the housing industry - appear to have run out.

Federal rules require that only a charity, family member or employer can gift a down payment to a buyer who uses mortgages insured by the Federal Housing Administration. That rule spawned a cottage industry of down payment "charities" that gave down payments to home buyers and were then reimbursed by the home seller, typically a home builder.

(Since 2002, The Wall Street Journal has published three Page One stories pointing out some of the risks of the down payment gifts. See U.S. Backed Mortgage Program Fuels Risks, Scrutiny of Down-Payment Gifts Threatens Charitable Movement, and Home Buyers' Down Payments Are Now Paid by Some Builders.)

In May 2006, the Internal Revenue Service ruled that these groups were essentially funneling down payments from the builder to the buyer, while also collecting sizable fees from the builders, and thus were not bona fide nonprofits. Despite the ruling, these groups kept giving out gifts, mostly to low-income buyers who would not be able to afford a house without them.

A year later, the Department of Housing and Urban Development proposed a rule that banned seller-funded down payment assistance. But a federal judge stayed the ban, and the charities lived on.

The final nail could be the mammoth housing bill that's expected to emerge from Congress in the coming days. It would end seller-funded down payment assistance starting in October.

HUD officials, who have been warning for years that such down payment gifts lead to higher default rates, are no doubt cheering. But it's very bad news for home builders, which have been relying more on the gifts to boost flagging home sales in the absence of subprime loans. Miami-based builder Lennar Corp., for example, said recently that 33% of the mortgages it originated used down payment assistance, according to a research note by J.P. Morgan analyst Michael Rehaut.

"We believe the legislation's elimination of seller-funded down payment assistance program.....represents a material negative for the housing market and hence the overall bill could result in more harm than good near term,'' Mr. Rehaut says.

Readers, do you agree that eliminating these programs would hurt the housing market or is this a bit of "near-term pain" for long-term gain in reducing the default risk to government-backed loans.