Reprinted with permission
There are good reasons for requiring a buyer to
make a down payment - finding creative ways around the
requirement has consequences that HUD is finally
realizing. If buyers can't afford a reasonable down
payment and closing costs, they should not be buying a
So what is wrong with 100% financing, or down
payment assistance programs? First, and most
obvious, the down payment protects the lender from
heavy losses in foreclosure. If the home is worth
more than the loan amount, the lender has a better
chance to recover its losses at a sheriff's sale.
Second, a lesson I learned from my father, when
people have something invested in their purchase they
are more likely to take care of it. Homeowners
are more likely to make their payments if they have
their own money invested in the property. If a
homeowner bought a home with no money down they have
little to lose by simply walking away when the
mortgage payment become an inconvenience. They may
have credit issues to deal with, but that is probably
already a problem when a borrower reaches this point.
In some states, there is the possibility of a
deficiency judgment if the sheriff's sale does not
make the lender whole. However, those are rarely
pursued by the lender.
Down payments of 20% used to be the norm. For
borrowers who could not afford 20% down, on even a
modest home, could turn to FHA; if they qualified,
they could put down as little as 3%. But, even 3% was
meaningful enough for some borrowers to feel like they
had a substantial investment in their home that they
wouldn't just give up in foreclosure. People worked
hard to earn their down payment and they were proud to
Now, many homeowners have more of a "renter's
mentality." If they get down payment assistance, they
can buy a home with no money down... after tax
pro-rations, they could even get cash back at the
closing. In essence, they are getting a home without
so much as even a security deposit that would have
been required if they decided to rent. If they would
have rented and failed to make their rent payments,
the landlord would have them evicted within a couple
of months and the security deposit, or last month's
rent, would have been forfeited. But, when they buy
and fail to make mortgage payments they can stay in
the home until after the sheriff's sale, which could
take a year or more! For some, buying is like
getting free rent for a full year - try getting that
deal with a landlord.
So how does "down payment assistance" work? Using
AmeriDream, a third party provides a "gift" to the
buyer to use for their down payment. That would be
very generous... if AmeriDream weren't making money by
providing the assistance. They, of course, charge a
fee paid by the seller which is greater than the
assistance they provide.
The seller must participate in the AmeriDream
program, but your loan officer can assist a
seller in signing up for the program by showing
where and how to apply. For your home buying
needs, the loan officer will handle your
application for AmeriDream down payment
assistance, but may require additional
information from you to help fill out the form.
AmeriDream is just one of many organizations
offering down payment assistance to those with
FHA approved home loans. If you have been
pre-approved for an FHA mortgage loan but don't
meet the income requirements for the AmeriDream
program, keep looking. There are several down
payment assistance programs with no income
requirements or restrictions.
Down payment assistance programs generally
require the seller to pay a fee to participate.
This fee is considered a payment for services
rendered and not a tax-deductible charitable
And, that would be very generous of the seller,
if the seller were to actually pay the fee out of his
pocket. But I doubt that is the case in most
transactions. Instead, the seller raises the sales
price by enough to enable the buyer to borrower enough
additional funds to cover the seller's fee. So,
basically, the seller is financing not only the amount
of the down payment they need, but also the fee
charged by AmeriDream.
Who cares? What are the economic consequences
of the transaction? The seller doesn't care
because they are still getting the same amount they
would have gotten as the sales contract had been
initially negotiated. The Realtor will often base
their commission on the originally negotiated sales
price, so it doesn't cost the seller any more in
commissions and the Realtor still gets their 6% of the
"true" sales price. The mortgage broker still gets its
fees - more than they would have gotten if the
borrower failed to qualify because of a lack of down
payment. Sure the borrower owes more money, but they
still got the home and when the additional amount is
amortized over 30 years there is not much change to
FHA, however, is experiencing huge losses!
In a speech to the National Press Club, HUD's
Assistant Secretary for Housing-Federal
Housing Commissioner Brian Montgomery warned
that FHA must take action because these
loans, which now make up one third of FHA's
portfolio, are causing substantial losses.
This year, as a result of its annual
re-estimate, Montgomery said that FHA had
to book an additional of $4.6 billion in
unanticipated long-term losses, mostly due to
the increased number of certain types of
seller-funded loans in the FHA portfolio.
Raise your hand if you are surprised that
billions of dollars in losses are attributed to
borrowers who had nothing personally invested in their
home purchase. I would say that this is a type of
fraud, but everybody knew what was going on... nobody
cared. I don't think that anyone would have a problem
calling this a fraud if the seller simply agreed to
raise the sales price and covertly slide a check
across the table to the buyer without showing the
transaction on the settlement statement. So, what is
the difference? Either way, the buyer is not making
the downpayment with his own funds. The only
difference, really, is that AmeriDream wouldn't get to
charge a fee for passing the money around.
Ah... but what's the big deal... FHA can afford
a few billion in losses, right?
Stressing that FHA is still solvent with
reserves of about $21 billion, Montgomery also
noted that no insurance company can sustain
that amount of additional costs year after year
and still survive. He said that unless
the administration takes action to mitigate
these losses, FHA will soon either have to shut
down or rely on appropriations to operate.
To address the growing concern HUD has taken
action... well, they have proposed to
take action. It has reopened the public comment
period on a proposed rule.
The primary focus of HUD's rule is to establish
appropriate standards for down payment
assistance that is categorized as a gift.
Specifically, the rule would prohibit down
payment assistance provided before, during, or
after closing of the sale by the seller, any
other person or entity that financially benefits
from the transaction, or any third party or
entity that is reimbursed directly or indirectly
by any of the parties benefiting from the sale.
Montgomery said that the rule would clarify
that down payment funds for FHA-insured
mortgages cannot be derived from sellers, either
directly or indirectly, or any other party that
stands to benefit from the transaction
Even with the new rule, HUD would still generously
allow "true gifts" from a family member, a
governmental or public agency, the borrower's employer
or labor union and a charitable organization that
qualifies as a tax-exempt charitable or educational
organization. But Montgomery recognizes what I have
been saying all along...
He pointed out that in these cases there is a
clear quid pro quo between the homebuyer's
purchase of the property and the seller's
"contribution" or payment to the charitable
organization. Often, these contributions
function as an inducement to purchase the home.
One of FHA's primary concerns with these
transactions is that the sales price may be
increased to ensure that the seller's net
proceeds are not diminished, and such increase
in sales price is often to the detriment of the
borrower and FHA.
Common sense should prevail on this issue. It is
usually pretty clear when the borrower is actually
making a meaningful down payment and when the down
payment comes, indirectly, from the loan proceeds. In
my opinion, when a "down payment assistance" program
is used, the buyer is NOT making a down payment at
all. Thus, the borrower has nothing vested in the
home and the odds of default go up significantly.