Inflated property values and high default rates on federally-insured loans were linked to seller-funded downpayment assistance programs in a study commissioned by the U.S. Department of Housing and Urban Development. But some groups believe an FHA zero downpayment program would alleviate such issues.
About 25% of FHA residential purchase loans included downpayment assistance funded by sellers, according to the study compiled by the Concentrance Consulting Group.
As these programs have flourished, however, the percentage of FHA-insured households with relatively high probabilities of default and foreclosure has increased and "has done so in such a way that even more credit risk is added because of the incentives of property sellers to recoup their cost via a higher house sales price," Concentrance concluded.
Nearly 90% of appraisers said the presence of seller-funded downpayment assistance in a transaction contributes to price inflation.
The study included 401 interviews in 10 cities with consumers, Realtors, appraisers, mortgage personnel, builders, and downpayment assistance providers.
"The report concludes that seller-funded downpayment assistance for mortgage downpayments has led to underwriting problems that require immediate attention," HUD said in a response to the study.
A common response was that these programs helped sell the home faster -- with sellers reporting they always received their targeted amount of net proceeds through the programs.
"There are natural tendencies in a production driven environment to place volume as a first priority ahead of loan quality," Concentrance recognized. "However, the seller-funded DAP exacerbates the subjective motivations of the participants who facilitate the negotiation, loan processing and risk management functions of the transaction, placing the FHA Insurance Funds at increased risk of mortgage defaults and foreclosures."
While appraisers said they feel more pressure from mortgage companies to make value in cases where downpayment programs were used, underwriters reported they too were feeling pressure from management to be more flexible.
Mortgage brokers and loan officers were reportedly described by many respondents as having the most power in the transaction -- yet the least amount of management control or oversight.
Additionally, the study gathered that seller-funded downpayment assistance organizations do not have the structure or capacity to offer risk-mitigating services such as face-to-face borrower counseling or education programs.
Many borrowers were more prone to spontaneously purchase a home due to the assistance and HUD pointed out that most borrowers do not understand where the funds come from, nor that they ultimately end up financing the downpayments.
It was also found that downpayment assistance recipients typically were low-to-moderate income, first-time homebuyers with a lack of savings, and disproportionately members of minority groups.
Mike Petrie, chairman of the Mortgage Bankers Association, recently cited the HUD report in testimony before Congress in which he encouraged the approval of a zero downpayment FHA pilot program. He noted prospective borrowers for the pilot would be the same as those currently insured under seller-funded downpayment assistance loans, but indicated the new FHA program would be more beneficial because it would provide borrowers with risk mitigation features and would make homebuying education a requirement.
Concentrance also supported the implementation of the proposed zero downpayment program because it would eliminate the illusion of equity created by downpayment programs.
In addition, the group suggested seller-funded downpayment loans be recognized as 100% financing or zero downpayment loans to have the same risk management controls apply. Seller-funded loans are being serviced similar to the way loans are serviced with an investment by the borrower. Without the prescribed risk management protections the FHA Insurance Funds are currently being placed at increased risk of potential losses.
Standards should be established for documenting and adjusting property values for homes purchased with seller assistance, Concentrance recommended, and uniform control requirements should be developed for mortgage lenders to follow for ordering and managing the appraisal process.
Amongst other recommendations, the study conductor suggested HUD add a loan officer registration. HUD currently tracks and uses several metrics to reward or punish mortgage lenders, appraisers and underwriters based on their performance. But the group said HUD has no controls or tracking mechanisms for loan officers originating unacceptably high risk FHA loans.