2009-02-12ml-implode.com

By Aaron Krowne - ML-Implode

The LA Times has written a powerfully misleading, yet insidiously subtle piece posing as an "impartial" news article regarding FHA seller-funded downpayment assistance programs.

As we've covered extensively on this site (such as here, or here, and here, and here...), last year's housing bill outlawed seller-funded downpayment loans through the FHA. The loans work by channeling the downpayment funds from the seller to the buyer, typically along with marking up the home price by a similar amount. The program administrator (such as Nehemiah or Grant America) transmits and fronts the funds. The buyer presents them to the FHA as their 3.5% required downpayment.

Arguably, this process involves sales price fraud, a seller concession (in contrast to the claimed "charitable gift"), unlicensed lending, money laundering, and defrauding the Federal government (the FHA has no way of knowing which loans have "real" downpayments and which are being paid by the seller through markups). The FHA, IRS, FBI, GAO, and Congress itself have all ruled against or reported critically on this practice. It's enough to make you wonder if the Mob is involved.

In other words, there's a lot of reasons Congress outlawed the practice at the behest of the FHA, which only secondarily involve possibly higher default rates on these loans.

But you wouldn't know any of this after reading the article from our friends at the LA Times. The story paints the debate as one of whether prospective homeowners in an ailing market should receive private aid. The story starts right off with the SFDPA companies' talking points:

... supporters of the program, which over the last decade helped more than 1 million Americans buy a home [Ed. note: SFDPA proponents admit that at least 20% of these loans have since gone bad], say its demise has deepened and extended the economic crisis by preventing a significant pool of buyers from entering the home market.

The controversy goes to the heart of the debate over how to revive and stabilize the housing market -- whether the government should opt for financial security by eliminating as much of its own risk as possible or reach out to employed, lower-income Americans and help them buy homes at the most opportune moment in recent history.

"Tens of thousands of families are sitting on the sidelines, employed people who can't move into home ownership," said Scott Syphax, who pioneered the concept of the down-payment program. "They are trapped."

That's right, if the housing market is bad it is because because people cannot get houses with no-money-down! Nevermind what started this crisis in the first place: too-loose lending, with ever-vanishing downpayments and "teaser" financing arrangements. In other words, unsound and aggressive "affordability measures" are actually a bad thing in the long term. Can't we all agree on that by now?

Al Green (D-TX), the main sponsor of H.R. 600, the bill to renew seller-funded downpayment assistance, goes one better with an outright lie instead of just propaganda:

"We are not talking about a program that taxpayers have to subsidize," Green said. "We can handle any defaults within the program. These loans are pretty solid."

Oh really, Al? The FHA is now already running in the red, for the first time in its 75-year history. There is no way to know how much of this is due to seller-funded downpayment loans versus the economy or characteristics of the rest of FHA's portfolio, but this does mean that soon we will be at the point where every additional dollar of defaulted loans will have to be covered anew by the taxpayers. There is no free lunch. As a taxpayer, do you want to make the bet that you won't have to pony up any money to bail out no-money-down loans with jacked-up sale prices... in this housing market?

Throughout the story, plain old downpayment assistance loans are conflated with seller-funded downpayment loans -- but the two are very different. Only the latter was actually outlawed by the housing bill last year (probably having something to do with the overall fraudulent and deceptive nature of the seller-funded variety of transactions).

We are not opining on "real" downpayment assistance loans. "Real" downpayment assistance loans come from a charitable source that is not the seller. Presumably, legitimate programs performing this function have other means to make sure the borrower has "skin in the game" -- such as a sense of shared responsibility for the fate of the community. Seller funded loans, on the other hand, are by their nature abusable by home builders, banks, individual sellers, and real estate agents (and of course the SFDPA administrators) to offload inventory or make a quick buck by making sales and generating "churn".

So don't buy into the bait-and-switch that DPA = SFDPA -- an implicit assumption rife in nearly all of their rhetoric (much of which is deceptively astroturfed to make it appear that there is more "grassroots support" than there actually is for these programs).

In fact, the article does a piss-poor job of clearly explaining this basic difference, which you think they would get right if they were even trying:

Under the program, down-payment money did not come from the government, but a nonprofit middle man, such as Syphax's Sacramento-based Nehemiah Corp. of America, which grew to handle about 40% of the transactions.

The nonprofit would send money for the down payment to an escrow agent, who would get the money to the seller. After the deal closed, the seller would reimburse the nonprofit the amount of the down payment. Sellers could recoup that money by increasing their price, or simply take the loss in exchange for getting a buyer with a federally backed loan.

It's an uncritical aside that the seller "might" recoup the amount of the downpayment by increasing the sale price (artificially). Reading this, it is not particularly clear that this is actually how the process works:

  1. The seller finds a buyer and hawks the SFDPA program to them.
  2. The seller signs a "participation agreement" with the SFDPA administrator (that is, a legally-binding promise to reimburse the 3.5% downpayment funds)
  3. The seller typically marks up the home price by that same 3.5%
  4. The borrower qualifies for the FHA loan, with the grant letter as proof of downpayment (As far as the FHA is concerned, the grant is a charitable donation that comes from an independent nonprofit, not the seller. Suckers!)
  5. SFDPA administrator fronts the downpayment money to the closing agent.
  6. The sale transaction closes.
  7. The seller takes 3.5% of the sale proceeds, plus a service fee, and repays the SFDPA company.
  8. $$$ - profit!!! (SFDPA company, bank/seller, real estate agents, lender)

Of course the losers in this scheme are the FHA (the taxpayer -- who actually has to insure these loans), and ultimately the borrower -- who is probably already underwater and overextended.

Which brings us to a major point totally ignored by the article (which doesn't seem to bother discussing a single objective counter-argument to SFDPA): by the nature of these loans, the borrower starts out with zero or even NEGATIVE equity. Even if they can afford the monthly payments, negative equity is a very very bad thing, especially in a falling market. What happens if the borrower has a curtailment of income, or otherwise has to move? At the moment they have to sell, the borrower -- who demonstrably couldn't come up with a 3.5% downpayment in the first place -- has to put cash up to complete the transaction. This amount has to be equal to the amount the property has been overvalued. Otherwise, they will foreclose (or go to short sale).

This seems to us like a pretty horrible thing to do to someone, and a horrible situation to mislead first-time-buyers into these days. Remember, we now have a national FALLING housing market for the first time since the Great Depression, which means no equity will quickly tend to become negative equity. All the studies that look at past data -- including the Brill report (which still admits SFDPA loans default at least 50% more than non-seller-funded loans) were not looking at an environment of FALLING HOME PRICES. All of the past data is with rising prices -- and for the bubble years leading up to 2007, very strongly rising prices.

Those days are gone, so these loans are even MORE dangerous than before. To both borrowers and taxpayers.

Our final complaint with this article is the deceptive "case study" they include:

For example, Eric Jones, a letter carrier in Sacramento, had never quite been able to afford a down payment on a home.

Last summer, Jones, along with his wife and two sons, moved into an almost new, $208,000 home in Sacramento with help from the down-payment program. Jones has made his mortgage payments and even shifted to a biweekly payment schedule that will shorten his 30-year loan.

"There is no way I would want to lose my home and go back to renting," he said. "It gives me a sense of pride. It makes me feel more a part of American society."

Awww, it just gives me the warm fuzzies that Jones now feels like more a part of American society because he got a "free house" (by the way, a $60,000 Mercedes for no money down on a subsidized loan would make ME feel like a prouder member of American society -- any takers? No?)

But seriously, reading this, you might naively assume that Jones' home was being innocently marketed for $208,000, and he bought it with "charitable" downpayment assistance. But this isn't very likely. In fact, backing out 3.5% and a few hundred in fees, the more likely REAL PRICE of the Jones house was $199,000.

Indeed, we looked up county records and found that a model match for the Jones home sold in January for $190,000 -- which was also an REO (there are quite a few REOs on the Jones street, which, incidentally, suggests that home prices aren't exactly on an upward trajectory there). A larger home is even listed for $199,000. So the Jones home likely started out a bit expensive, then had the price inflated another 3.5% through the Nehemiah scheme. Because the seller could simply roll all immediate costs into a taxpayer-insured loan, they didn't have to adjust the sale price in accordance with the realities of the market. Is this fair?

It certainly isn't fair to Mr. Jones, who (regardless of what he might think right now), is in all likelihood about $20,000 underwater on his new home.

If Mr. Jones is not effectively underwater, then situation would still be still bad, as pressure has been created to channel others in the same neighborhood into taxpayer-insured, seller-funded loans too -- to help afford an excessive $200,000+ for these homes. This dynamic is why SFDPA is now a lose-lose proposition for the economy: either borrowers are immediately underwater, or the price fraud sticks and has a ripple effect through inflating neighboring home prices, causing further ruin for more people down the road.

And speaking of REOs, this case also illustrates something else insidious: since the Jones house was a bank-owned foreclosure, the bank clearly used the SFDPA laundering scheme to unload the troublesome property onto taxpayers at a marked-up price. So we have to wonder if banking interests in general, laden with vast inventories of foreclosed properties, are also behind the quiet push to re-legalize SFDPA. Hmm...

All in all, it is shameful that people want to continue these kind of deceptive practices. And shameful that the LA Times didn't do a better job of taking a critical look at them.



Comments:

thetruthfromNC at 17:54 2009-02-12 said:
This article and others like it also mislead the truth. Per HUD the defaults of DPA loans are double the norm. Since FHA averages 3-3.5%, the REAL number must be 6-7%, not 20%.

What FHA should do IS come out with a zero down payment program with higher upfront and monthly MIP to cover the additional loses.

Some will say that's what got us into the problem in the first place, but for those I have one question I have asked over and over again with no response.

If no money down doesn't work then why do we NEVER hear of problems with USDA loans that have always required no money down. Maybe some of the people at HUD need to talk to the USDA people and learn a thing or two.

Actually the credit requirement are higher at USDA, which makes my point, if you select the right borrowers you can allow them to buy with no money down. Permalink

Do_the_math at 20:31 2009-02-12 said:
This article and others like it also mislead the truth. Per HUD the defaults of DPA loans are double the norm. Since FHA averages 3-3.5%, the REAL number must be 6-7%, not 20%.
The combined delinquency and default rate for FHA loans is just over 20% according to HUD's NW site. While nobody really knows what the true delinquency, default, or claim rate is for FHA loans involving SFDPA, it is undisputed that the rate is at least 50% higher than loans not involving seller-funded assistance (per SFDPA provider commissioned reports). However, government reports and government sponsored reports indicate that the default rate is 2-3 times higher than loans involving SFDPA. No matter how you slice it, delinquency, default, and claim rates are substantially higher for loans involving SFDPA. So, when we are looking at an overall delinquency rate that is over 19%, the rate of delinquency/default on loans involving SFDPA has got to be scary.

This means that at least 1 in 5 SFDPA borrowers is currently delinquent or defaulted on their FHA loan. Hence, I call B.S. on the "94% success rate" that SFDPA spew constantly.

What FHA should do IS come out with a zero down payment program with higher upfront and monthly MIP to cover the additional loses.

Some will say that's what got us into the problem in the first place, but for those I have one question I have asked over and over again with no response.

If no money down doesn't work then why do we NEVER hear of problems with USDA loans that have always required no money down. Maybe some of the people at HUD need to talk to the USDA people and learn a thing or two.

Actually the credit requirement are higher at USDA, which makes my point, if you select the right borrowers you can allow them to buy with no money down.

Couldn't agree with you more on this and its exactly what we are asking the SFDPA supporters. I've even offered perimeters that are essential for low and no down programs.

Frankly, the SFDPA organizations aren't interested in 100% programs because 100% encroach on the SFDPA business. In fact, when Ameridream was given an opportunity to support H.R. 3043 (a FHA 100% pilot program) they recommended that the program be limited to borrowers with credit scores at or over 700 due to the risk. And mind you, H.R. 3043 was a well-thought piece of legislation that included mandatory buyer education and other protections that are not present in H.R. 600. Permalink

title_gal at 21:41 2009-02-12 said:
The fight against SFDPA must go on. Now is the time to get all the crooks that invaded this industry out. We must stand together and say "no more". We must make a stand.

This is a great piece and I am once again so proud to be a part of this place. Permalink

Winston Smith at 00:39 2009-02-13 said:
The very existence of these phony gift programs is an absolute disgrace to the industry and has been from the beginning. This industry has earned its ignominious reputation for having no moral or ethical compass.

Exploiting unsuspecting first time homebuyers with false promises of free money is disgusting. The skeletons will burst from the closet bearing shiny bracelets. Permalink

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