Losses on loans that utilized downpayment assistance prompted the prohibition of such assistance on mortgages insured by the Federal Housing Administration. But there are still situations where downpayment assistance is acceptable on FHA loans.
The National Housing Act limits the acceptable sources of the 3.5 percent minimum cash investment used on FHA-insured mortgages. In the FHA single-family mortgage credit handbook, HUD permits the minimum cash investment to come from family members, employers or labor unions, or close friends with a clearly defined and documented interest in the borrower.
Also acceptable are governmental entities and charitable organizations.
Prohibited from contributing to the minimum cash investment are property sellers and any other person or entity who financially benefits from the sale of the property. Contributions also cannot come from anyone who is reimbursed by an interested party.
A 2005 study from the Government Accountability Office found that downpayment assistance programs from non-profit organizations that were indirectly funded by property sellers led to a much higher default and claim rate than in transactions where the borrower funded his or her own downpayment.
In 2006, the Internal Revenue Service issued a ruling that determined charitable exemptions didn’t apply to organizations that provide downpayment assistance funded by sellers.
After issuing a final rule prohibiting seller-funded downpayment assistance on FHA loans in October 2007, a lawsuit was filed in U.S. District Court for the Eastern District of California challenging the final rule, and it was set aside in February 2008.
But the Housing and Economic Recovery Act of 2008, which was signed into law on July 30, 2008, amended the National Housing Act with language that prohibited seller-funded downpayment assistance.
An interpretation by the Department of Housing and Urban Development published in the Federal Register clarifies the acceptable use of federal, state and local government programs towards the required minimum cash investment.
These programs have a stated objective, for instance, of raising homeownership rates, revitalizing communities impacted by foreclosures and making homeownership affordable.
State and local governments also utilize housing finance agencies to provide downpayment funds.
“It is HUD’s interpretation that section 203(b)(9)(C) of the NHA does not prohibit FHA from insuring mortgages originated as part of the homeownership programs of federal, state, or local governments or their agencies or instrumentalities when such agencies or instrumentalities also directly provide funds toward the required minimum cash investment,” the notice states. “The addition of a statutory provision on prohibited sources of cash investment funds, as part of the amendments to section 203(b)(9) of the NHA enacted in HERA, was intended to preclude the abuse of the program where a seller (or other interested or related party) funded the homebuyer’s cash investment after the closing by reimbursing third-party entities and added the cost of this reimbursement to the sales price of the home, thus inflating the price of the home beyond its market value.”
The effective date of the interpretive rule was Nov. 29. While public comment is not required for HUD’s rule, it is considering public comments until Jan. 4, 2013.
