Another Blow to Downpayment Assistance

The U.S. Department of Housing and Urban Development has submitted for public comment a proposed rule regarding sources for the required 3 percent dowpayment minimum for Federal Housing Administration loans, according to a Federal Register notice Friday. The primary focus of the rule is to establish appropriate standards for downpayment assistance to a borrower that is categorized as a gift.

Comments are reportedly due July 10, 2007.

To date, HUD has limited permissible sources of downpayment gifts to family members, governmental agencies, the borrower’s employer and labor union, or charitable organizations, but statutes have been silent about permissible or impermissible sources of such funds.

“This proposed rule would codify standards regarding the use of gifts as a source of the mortgagor’s investment in the mortgaged property, and would also specify prohibited sources for a mortgagor’s investment,” the notice read.

“HUD is not narrowing the sources of gifts through this rulemaking but rather striving to ensure that gifts are gifts and that especially in the situation of gifts from charitable organizations, the gift is not a quid pro quo between the homebuyer’s purchase of the property and the seller’s ‘contribution’ or payment to the charitable organization,” HUD added.

HUD is particularly concerned of cases where the downpayment funds are replenished after loan closing by the seller who provides a “charitable donation” or pays a “service fee” to an organization from the proceeds of the sale of the house only if the borrower is using the charitable organization’s downpayment assistance program.

Another instance that demonstrates a clear quid pro quo between the borrower’s purchase and the seller’s contribution’ to the charitable organization, is when the funds come from an entity other than the seller but there is expectation of being reimbursed by the seller, according to the notice.

“FHA’s primary concern with these transactions is that the sales price is often 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,” HUD added.

The proposed rule would establish that a prohibited source of downpayment assistance before, during, or after the closing of the property sale is a payment that consists or contains funds provided by the seller, or any other party that financially benefits from the transaction; or any third party or entity referred to as a “donor” that is reimbursed directly or indirectly by the seller or any party that financially benefitts from the transaction.

The proposed rule intends to prevent the seller from providing the donor with funds through an individual or organization, such as a family member of the seller. The rule’s use of anyone who “financially benefits” intends to capture real estate agents or brokers, for example, who would benefit from the sale of the home to the mortgagor. Sales of existing homes by private sellers as well as sales by builders, developers, and others involved in new construction, or anyone that financially benefits from the purchase transaction are subject to the rule, according to the notice.

“While the proposed rule is intended to prevent sellers from funding downpayments in their own home sales transactions, the proposed rule is not intended to preclude sellers from contributing to charitable organizations, which are often sources of donor downpayment assistance, that provide downpayment assistance that is unrelated in any manner to any properties sold by the seller,” HUD specified.

“In addition, the rule is not intended to preclude reasonable assistance with closing costs not related to the minimum investment, which may be permitted under local practice.”

The proposed rule does not change HUD’s policy of allowing builders and other sellers to offer cash incentives to borrowers under the condition that any cash or cash equivalent given results in a proportionate reduction to the mortgage; an amount which the homebuyer then would have to provide as additional funds at closing, HUD wrote.

The proposed rule follows last May’s ruling by the Internal Revenue Service, determining that charities that relied on “on sellers and other real-estate related businesses that stand to benefit from the transaction” to finance downpayment assistance provided as part of the same transaction did not qualify for tax-exempt status. The IRS said inflated sales prices are often found on properties purchased with downpayment assitance from seller-funded nonprofit programs, which unlike true gifts that reduce the amount of the purchase loan, increase the sales price of a home and result in higher mortgage payments, HUD noted.

In 2005, research from the Government Accountability Office also reportedly showed that seller-related contributions to downpayment could contribute to inflated values on the price of the property.