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ML-Implode Statement On H.R. 6694 And FHA "Seller-Funded Downpayment Assistance" Loans

Dec. 16, 2008 - For immediate release.

Update, Feb. 12, 2009: H.R. 6694 has been replaced with H.R. 600, which is mostly the same. See this article for details.

With the housing market now in an advanced state of collapse, there has been ample time to analyze and discuss the proximate causes of the debacle.

A consensus has emerged that unsound loans caused the collapse; the only major contentious topic remaining is who was most responsible for them (i.e. greedy brokers? Wall Street? Borrowers themselves?). But it would seem that, at minumum, society has learned a few important lessons about home lending:

  • That people tend to think in the short term, embracing unsound loans to collect commissions, attain "homeowner" status, or please constituents and create the appearance of economic prosperity
  • That in the long term, unsound lending turns into foreclosures, financial ruin, physical blight, and social strife
  • That basic affordability metrics -- like a reasonable debt-to-income ratio, a meaningful downpayment, and fully amortizing payments -- do not lie.
  • That FICO scores take a distant back seat to basic affordability metrics, common-sense underwriting, and the basic fact of whether the borrower "has skin in the game"

At least, one would think society has learned those lessons. Unfortunately, the introduction of H.R. 6694 on the legislative docket challenges that assumption.

H.R. 6694, before Congress currently, would revive a recently-banned practice known as FHA "seller-funded downpayment assistance" (SFDPA) lending. In SFDPA, a third party arranges for the seller to make a "donation" to the buyer (through the third party) equal to the FHA mandatory 3.5% downpayment, which is then used for the purpose of the downpayment, in direct violation of HUD policy. This means that the buyer does not make a true downpayment born of personal sacrifice, undermining its purpose. In the end, this is the same sort of "100% financed" lending that was a major contributor to the collapse. In specific:

  • The home price is typically inflated (see our article for FHA and GAO studies), inflating valuations in general.
  • As a consequence, the borrower is likely to immedately start out with negative equity. Negative equity has been found to be the leading cause of foreclosure (See Fitch report)
  • The borrower made no personal sacrifice to take on the loan, and is likely to feel less of a committment to it, especially if their situation worsens.
  • Under H.R. 6694's risk-based premiums (RBP), those with traditionally lower scores (minorities and low-income households) would be disadvantaged and charged more, just like subprime.
  • Since FHA has now been expanded to cover loans in excess of $650,000 in "high cost areas" (the max becomes $625500 in January 2009), the loan principals can be quite high, sufficient to penetrate most of the market.
  • SFDPA is a breeding ground for "straw buyer" fraud, which is now known to have been rampant amongst failed loan categories (especially subprime). SFDPA "legitimizes" the markup-and-downpayment-launder process which is central to most straw buyer scams (ref. FBI report).

The FHA has found that SFDPA results in losses running at a rate of 2-3 times normal FHA loans (see FHA report).

Even worse, the analyses to-date done on SFDPA loans use past data, from the "up-side" of the bubble. During that time period, home values were rising, so there was no negative equity problem, and thus it was easy for borrowers to sell or refinance. Yet even in this favorable climate, SFDPA loans lost more than regular FHA loans. So in an environment of declining home prices, negative equity and an inability to sell are likely to dramatically worsen the default rates and losses on these loans. This means more foreclosures and more losses to the federal government (in other words, the taxpayer).

SFDPA funds are typically channeled through one or more intermediaries, in a manner arguably constituting "money laundering" (a Federal Judge recent issued a preliminary ruling that such a description could stand, see our press release). The IRS and FBI have called such "scams", "schemes" and similar (see Railey Declaration, item #11). The IRS considers the SFDPA payment a "seller concession" -- in other words, that 3.5% is not considered to be part of the home value for substantive purposes. The SFDPA administrator's fee is considered a sales expense. It is also, tellingly, NOT considered a "charitable contribution" (see IRS ruling).

The FHA does not "approve" SFDPA programs, contrary to some of the claims of companies that arrange these loans (see comment in our press release).

In 2007, the FHA began to swing to a loss, in large part because of SFDPA loans, and moved aggressively to stop the practice (though they had been trying since 1999; see our article). It tried unsuccesssfully to do so by changing the FHA rules, but was blocked by a SFDPA company lawsuit (they won on a procedural technicality). FHA then petitioned Congress to intervene and outlaw the practice entirely, which was finally done in the July 2008 housing bill. SFDPA was outlawed entirely by that bill, effective October 1, 2008 (specifically, downpayment grantors cannot now have a direct financial interest in the transaction).

However, defenders of the practice are back at it, and a new bill, H.R. 6694 was almost immediately introduced to revive SFDPA. In fact, the proposal was submitted within 24 hours of the final vote on the Housing Bill, on August 31st, 2008 as heralded by well-known SFDPA administrator Ameridream in a mass email campaign.

H.R. 6694 attempts to address some criticism of this type of lending by mandating risk-based pricing driven by FICO. However, as pointed out above, FICO is becoming less important than the equity position of the borrower for predicting defaults. Thus, such pricing would actually make the situation worse and more reminiscent of the reviled subprime lending, in that the borrower would once again be paying higher interest rates for a less-sound loan. In fact, H.R. 6694 co-sponsor Congresswoman Maxine Waters has even noted that risk-based insurance premiums based on FICO had a "disproportionate racial impact" against African-Americans and Hispanics as compared to Whites (see House hearing).

Proponents of the bill allude that SFDPA is necessary to allow families to help relatives buy their first home. However, this point is a red herring, as families can already gift the downpayment directly to the aspiring homeowner -- no new laws are needed opening up a risky category of lending to facilitate it. In addition, banning SFDPA does not prevent genuine assistance programs from making downpayment grants for charitable purposes, as these grants are not funded by the seller. But the truth is, SFDPA outfits glean most of their revenue from transactions that mostly benefit themselves and the seller and are not truly "charitable," which is why they oppose the current ban. Unfortunately, it appears many (including those in Congress) are still being fooled.

These companies also argue deceptively that the risk-based pricing will "make money" for FHA, and that the taxpayer will allegedly "save" $13 million a year due to the "risk-based pricing" provisions. However, this argument makes absolutely no sense, first, because the bill provides that the higher premiums be "refunded" after a record of on-time payment is established by the borrower. But if there are payment problems, there will be more loans in default, negating the benefit of the premiums. Even worse, the computation doesn't take into account the intrinsically higher default rates of these loans, and the likely worsening default rates as the housing market continues to decline. A handful of new defaulted SFDPA loans would wipe out the entire $13M "benefit" quickly.

In sum, SFDPA is a bad idea at an even worse time, and should continue to be categorically banned. SFDPA is a malicious distortion of the intent of downpayment assistance programs, turning them into a bonanza for parties that have a selfish financial interest in home transactions — with absolutely no consideration of whether the borrowers will end up in foreclosure. As such, SFDPA is an abuse of FHA and by extension, the taxpayer. H.R. 6694 would revive some of the worst aspects of subprime lending that caused the housing crash, and should be staunchly opposed by all who want to see a recovery for the housing market and the American economy.

—The Mortgage Lender Implode-O-Meter team

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Comments:

Crow at 15:19 2008-12-17 said:
Homebuilders are one of the most common industries to push for down payment assistance. They apparently can't sell their overpriced shoddy houses without it. The IRS has called these programs scams, and they've been compared to money laundering. Artificial price inflation is another result. With all that, and foreclosures too, there is no earthly reason to revive down payment assistance programs, and the industry is just looking to make more sales commissions. This attempt to bring them back has NOTHING to do with any altruistic desire to help Americans achieve the so-called dream of homeownership. True charities do not launder money for builders and sellers, and these programs were not charities, which was part of why the IRS called them scams. Permalink
BobbaLouie at 09:48 2008-12-18 said:
"H.R. 6694, before Congress currently, would revive a recently-banned practice known as FHA "seller-funded downpayment assistance" (SFDPA) lending."

This is the same scam practice of 100% financing that has the mortgage industry on it's heels. Will this industry ever learn?

Bobba www.scamandfraudblog.com Permalink

AMD at 14:59 2008-12-18 said:
This commentary includes too many inaccuracies to let stand, so I appreciate the opportunity to respond. Downpayment assistance funded in part by sellers, which does not cost the taxpayer a dime and helped create 1 million homeowners over the last decade, deserves a defense.

First, you incorrectly describe downpayment assistance, known as DPA, as a “violation of HUD policy.” HUD’s own office of general counsel reviewed DPA and found it in compliance. DPA funded in part by sellers operated within HUD guidelines for a decade and was designed specifically to serve the same population the FHA serves.

Second, you incorrectly describe DPA as a “loan.” DPA is not a loan. It is a gift that is not paid back.

Third, you advocate for DPA’s elimination on grounds that recipients make no “personal sacrifice” to save for a downpayment. This argument holds no credibility in light of the common and legal practice of wealthy individuals providing downpayment assistance to their relatives. Where is the personal sacrifice in that arrangement? Tragically, the law rewards individuals who are born into wealthy families, and punishes those who are not.

Fourth, HUD’s argument that recipients of DPA are 2-3 times more likely to go to foreclosure is statistical sleight of hand. The GAO has stated that 94% of DPA recipients pay their mortgage without difficulty when measured over a three-year period. A 94% success rate is solid no matter how you slice it.

Fifth, it is inaccurate to compare DPA to sub-prime loans. No subprime loans were backed by AmeriDream downpayment assistance gifts. AmeriDream’s DPA gifts were provided only to FHA qualified homebuyers with FHA loans. The average DPA gift was $3,600 and the average home price was $108,000, compared to an average $116,000 for other FHA-insured loans. This is the definition of modesty.

If one still believes HUD is an objective voice in this debate, please read the so-called “Brill Report” that finds HUD and other critics drastically exaggerated their claims against DPA. See report here: http://www.supporthomeownership.com/uploadedfiles/Alex-Brill-Report-Sept-2008.pdf

Finally, let’s take a broader look at the economy. There is near universal agreement that the housing market lies at the foundation of our economic crisis. As FDIC head Sheila Bair has stated, too much has been done to help Wall Street, and too little has been done help Main Street. The next generation of homeowners have no incentive to enter the market. DPA funded in part by sellers is a logical means for getting responsible, creditworthy homebuyers off the sidelines.

Thanks again for the opportunity to respond.

Ann Ashburn Permalink

Justin at 13:41 2008-12-19 said:
I won't hit all AMD's points, but there were a few I just can't let stand. Here we go:

Downpayment assistance funded in part by sellers, which does not cost the taxpayer a dime
This is a straw man response. Sure the DPA, itself, doesn't come from the taxpayer, but when SFDPA a) inflates house prices b) results in foreclosures that create losses for the Federal government, it negatively impacts the taxpayer.

Second, you incorrectly describe DPA as a “loan.” DPA is not a loan. It is a gift that is not paid back.
I believe you are misreading the article, which is using the phrase "SFDPA loan" to refer to FHA loans that are created with the help of seller-funded downpayment assistance.

Third, you advocate for DPA’s elimination on grounds that recipients make no “personal sacrifice” to save for a downpayment. This argument holds no credibility in light of the common and legal practice of wealthy individuals providing downpayment assistance to their relatives. Where is the personal sacrifice in that arrangement? Tragically, the law rewards individuals who are born into wealthy families, and punishes those who are not.
Here you're claiming the argument regarding "personal sacrifice" has no credibility while making a couple pretty blatant logical errors.

First, you're painting people as either haves or have-nots, which entirely ignores the fact that millions of people (most of whom aren't in the upper echelons of wealth) have been able to save enough money for a downpayment, and most of these savers would not be considered rich. Nor were most of these people born to wealthy families.

Further, even in those instances when family provides help with a downpayment, it's not as if they just fork over thousands of dollars only to forget about the money or their investment in their fellow family members. Families tend to become annoyingly intertwined with each other when money changes hands. This means that family will expect the buyer to pay a competitive price and have the means to afford the mortgage, even going so far as to help pay the mortgage down the road should it be needed.

Compare that sort of relationship to SFDPA. As you point out, SFDPA is a "gift" -- it's completely "no strings attached" to the buyer. This is a far cry from getting a gift from "mom and dad," which is anything but "no strings attached."

It's completely reasonable to expect a buyer of any asset to be able to save money. Having a stockpile of funds to buy a house is indicative of a person's ability to save first and spend later. It's also indicative of the sort of prudence that enables someone to weather unforeseen financial storms.

Fourth, HUD’s argument that recipients of DPA are 2-3 times more likely to go to foreclosure is statistical sleight of hand. The GAO has stated that 94% of DPA recipients pay their mortgage without difficulty when measured over a three-year period. A 94% success rate is solid no matter how you slice it.
I haven't looked into the stats, but just on the face of it, your counterclaim of "sleight of hand" strikes me as legerdemain, itself.

If 6% of DPA recipients fail to pay their mortgage over a three-year period as compared to only 2-3% of non-DPA recipients, then the stat is not only true (sleight of hand implying it is false), but its a meaningful difference -- one you are trying to write-off entirely. What more, we've yet to see how many SFDPA loans will default in a time where house prices are falling (such as right now, when we are experiencing likely biggest housing bust in U.S. history).

I'm gonna skip down and leave the rest for others to debate. You say:

Finally, let’s take a broader look at the economy. There is near universal agreement that the housing market lies at the foundation of our economic crisis. As FDIC head Sheila Bair has stated, too much has been done to help Wall Street, and too little has been done help Main Street. The next generation of homeowners have no incentive to enter the market. DPA funded in part by sellers is a logical means for getting responsible, creditworthy homebuyers off the sidelines.
So we had a monster house price bubble -- house prices reached untenable levels. Without going into the reasons for this, the bursting of the bubble means that house prices return to more historically reasonable levels. In other words, the cure for the disease is that house prices fall. The next generation of homebuyers is smart to wait for house prices to fall back to reasonable levels so they don't get stuck with more multi-decade debt than they need. SFDPA simply bails out existing homeowners to the detriment of would-be homeowners. So no, this "incentive" argument has no teeth -- the incentive would-be homebuyers need is for house prices to fall. SFDPA thwarts that process. Permalink
phillips65020 at 14:04 2008-12-19 said:
SFDPA is not evil. The people who manipulate it beyond it's intent are evil. If an appraisal report does not inflate value, the seller then will truly give up 3.5% of his/her profit and so long as credit & income criteria are met, this tool toward 100% financing is legitimate and worthwhile to reinstate. Permalink
Do_the_math at 14:39 2008-12-19 said:
This commentary includes too many inaccuracies to let stand, so I appreciate the opportunity to respond. Downpayment assistance funded in part by sellers, which does not cost the taxpayer a dime and helped create 1 million homeowners over the last decade, deserves a defense.

First, you incorrectly describe downpayment assistance, known as DPA, as a “violation of HUD policy.” HUD’s own office of general counsel reviewed DPA and found it in compliance. DPA funded in part by sellers operated within HUD guidelines for a decade and was designed specifically to serve the same population the FHA serves.

Second, you incorrectly describe DPA as a “loan.” DPA is not a loan. It is a gift that is not paid back.

Third, you advocate for DPA’s elimination on grounds that recipients make no “personal sacrifice” to save for a downpayment. This argument holds no credibility in light of the common and legal practice of wealthy individuals providing downpayment assistance to their relatives. Where is the personal sacrifice in that arrangement? Tragically, the law rewards individuals who are born into wealthy families, and punishes those who are not.

Fourth, HUD’s argument that recipients of DPA are 2-3 times more likely to go to foreclosure is statistical sleight of hand. The GAO has stated that 94% of DPA recipients pay their mortgage without difficulty when measured over a three-year period. A 94% success rate is solid no matter how you slice it.

Fifth, it is inaccurate to compare DPA to sub-prime loans. No subprime loans were backed by AmeriDream downpayment assistance gifts. AmeriDream’s DPA gifts were provided only to FHA qualified homebuyers with FHA loans. The average DPA gift was $3,600 and the average home price was $108,000, compared to an average $116,000 for other FHA-insured loans. This is the definition of modesty.

If one still believes HUD is an objective voice in this debate, please read the so-called “Brill Report” that finds HUD and other critics drastically exaggerated their claims against DPA. See report here: http://www.supporthomeownership.com/uploadedfiles/Alex-Brill-Report-Sept-2008.pdf

Finally, let’s take a broader look at the economy. There is near universal agreement that the housing market lies at the foundation of our economic crisis. As FDIC head Sheila Bair has stated, too much has been done to help Wall Street, and too little has been done help Main Street. The next generation of homeowners have no incentive to enter the market. DPA funded in part by sellers is a logical means for getting responsible, creditworthy homebuyers off the sidelines.

Thanks again for the opportunity to respond.

Ann Ashburn

I am not sure if this is really Ann Ashburn, but the arguments sound like those presented by Ameridream and other SFDPA providers. Before I respond to statements, I'd like to know if this is truly Ann Ashburn that made this comment. Permalink
Do_the_math at 14:52 2008-12-19 said:
SFDPA is not evil. The people who manipulate it beyond it's intent are evil. If an appraisal report does not inflate value, the seller then will truly give up 3.5% of his/her profit and so long as credit & income criteria are met, this tool toward 100% financing is legitimate and worthwhile to reinstate.
Nobody said that SFDPA was evil, just that the concept is a scam (according to the IRS).

If SFDPAs are prevalent in an area, the comps themselves are inflated as area prices are impacted.

Most MLS' do not require the agent to report when seller funded down payment assistance is used nor does public records. If several sales are inflated, then values become distorted. Over time, the effects of adding the down payment to the sales price results in higher prices.

The SFDPA providers advances the down payment which the seller pays back with a fee after closing. What part of that isn't a scheme to circumvent HUD policies that the down payment not be provided by the seller.

Using a laundering scheme to circumvent HUD guidelines to achieve 100% financing is not an ethical way of transacting business or promote responsible homeownership.

There are legitimate alternatives for buyers that need assistance. If the private sector wants to come up with a 100% program, there is nothing stopping them. Oh, but wait, the private sector did. As it turned out, 100% financing is very practical for markets, inflation, or the economy. Permalink

phillips65020 at 15:14 2008-12-19 said:
Property values are not inflated if the seller is truly giving up 3.5% of his/her profit.

If it's 100% financing you want to get rid of... ask for HUD to shut down RD. What's the difference? RD is a 100% financing program.

Fact of the matter is... you have too many brokers dictating content & value to appraisers. AMCs would be a step in the right direction to stop broker influence on appraisers & their reports.

Good underwriting and good appraisal reports make 100% loans to responsible borrowers worth our time & effort. Permalink

whippm at 18:45 2008-12-19 said:
HUD’s Faulty Reasoning

HUD has tried to link seller funded down payment assistance (SFDPA) with higher foreclosure rates by showing a correlation between the use of SFDPA and foreclosures. The problem is, they have not even attempted to establish causation using any number of proven techniques. A classic example of HUD’s specious reasoning in trying to link SFDPA with higher foreclosure rates by merely showing a strong correlation is the following: A Federal agency sets out to determine policy on the number of fire engines to send to fires. The agency does the following: (1) it gets data on all the fires in San Francisco for the last seven years; (2) it correlates the number of fire engines at each fire and the damages in dollars at each fire. The agency notes the significant relationship between number of fire engines and the amount of damage. The agency observes that:

The more firemen fighting a fire, the more damage there is going to be. Therefore, firemen cause damage.

The agency proposes a new rule to limit the damage caused in fires. It mandates that only one fire truck with a maximum of 5 firemen will be dispatched to any fire.

The flaw in the above reasoning is easy to observe. The strong correlation between the number of firemen sent to a fire and the damage that is caused does not mean that the firemen cause the damage. The larger the fire, the more firemen that are sent—so the truth is, large fires cause more damage. There are two variables that move in tandem, not because one is causing the other, but because a third variable causes an increase in both of the first two variables. Yes, foreclosures and the use of SFDPA move in tandem, but not because SFDPA causes foreclosures, but because other variables that cause people to need down payment assistance also put these people more at risk of foreclosure. FHA has failed to control for other factors that are indicators of a buyer’s probability of default such as co-borrower’s information, collections owed, amount of closing costs, employment, income, debt, monthly payment, bankruptcy, if the borrower is a first-time homebuyer, interest rate, FICO score (not just FICO category), etc. Permalink

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