IRS ruling endangers down-payment charities
By Holden Lewis • Bankrate.com

The tax man wants to close a loophole that has allowed hundreds of thousands of families to buy homes without saving for down payments.

The Internal Revenue Service ruled this month that nonprofit down-payment-assistance programs don't qualify for tax exemptions if they transfer money from the seller to the buyer. In the last decade, these nonprofits have helped about 600,000 families buy homes without saving the 3 percent down payment that the Federal Housing Administration, or FHA, requires.

The ruling could lead to the destruction or disruption of the down-payment-assistance industry. IRS examiners will use the ruling to decide whether to strip organizations of their tax-exempt statuses. None have lost that status -- yet.

'... huge effect on consumers'
"I think it would have a huge effect on consumers, because this has been such a great tool for FHA home buyers," says David Ahrens, president of Buyers Fund, one of the three big nonprofit down-payment-assistance programs. (The others are AmeriDream and the Nehemiah Program, plus about 180 much smaller nonprofits.)

Ahrens adds: "The average first-time home buyer could be really hurt by this and could be pushed into loans, such as 80-20 products or interest-only loans, that would not be as advantageous."

Lenders require mortgage insurance on home loans in which the buyer makes a down payment of less than 20 percent. Some borrowers avoid mortgage insurance by getting two loans -- one for 80 percent of the purchase price, and a second mortgage for up to 20 percent of the price. This so-called "piggyback mortgage" is the 80-20 product that Ahrens speaks of.

The role of down-payment charities
Some companies will insure a mortgage for 100 percent of the home's value -- in other words, without a down payment. But the FHA requires a down payment of at least 3 percent. FHA borrowers tend to have flawed credit, and a lot of them have trouble saving the minimum down payment. That's where nonprofit down-payment-assistance programs come in.

Unlike private mortgage insurers, the FHA allows borrowers to receive some or all of their down-payment money in the form of gifts from family, government, employers or nonprofit organizations. The down payment can't come directly from the seller. On the other hand, until recently, nothing prevented a nonprofit from giving a down payment to the buyer, and then immediately collecting the money from the seller.

The down-payment-assistance industry was born in the 1990s to exploit the loophole. The buyer and seller would agree to use a down-payment program as a conduit for the money. Everyone benefited: The real estate agents got their commissions, the nonprofit got an administrative fee, the lender got a loan, the seller got the proceeds from the sale and the buyer got a house. In the last year, about 40 percent of FHA-insured loans included down-payment assistance.