A new breed of charity gives money to home buyers for down payments. But the grants drive up house prices for the people they are designed to help, and the resulting mortgages could be riskier -- with taxpayers paying the bills if too many loans go bad.

Down-payment assistance charities enable people to buy houses without putting their own money down, even when down payments are required. The organizations owe their existence to a loophole in a federal housing regulation that prohibits a seller from directly giving a buyer the money to make a down payment.

So the seller gives the money indirectly -- through the nonprofit. The nonprofit takes a piece of the deal through a percentage of the transaction or a flat fee.

Here's how it works: A nonprofit gives money to a home buyer for a down payment. The money doesn't have to be repaid. At closing or soon after, the home's seller contributes an equal sum to the nonprofit, plus an administrative fee of usually around 1 percent of the house price.

The buyer gets a house, possibly at an inflated price, without incurring the cost of a down payment. The nonprofit, the lender, the real estate agents and the seller or developer get what they want: money. And taxpayers assume some risk that the buyer won't repay the loan, because more than 90 percent of these mortgages are insured by the Federal Housing Administration.

FHA loans have looser underwriting standards than conventional loans. They're often used by first-time home buyers. A typical FHA loan requires a down payment of 3 percent.

"The reason we have down payments is lenders have found that when a person doesn't have anything at stake, they're not going to be as committed to keeping the discipline of making mortgage payments," says Jack Harris, economist with Texas A&M Real Estate Center. "I guess FHA is on the hook, because they're insuring those loans."

Proposal to close loophole dies
The FHA proposed banning sellers from indirectly making buyers' down payments through nonprofits, but backed down last year after buyers, lenders and nonprofits bombarded HUD with letters. Since then, the nonprofits have doubled their grant activity and set up a lobbying arm in Washington. The most prominent of the nonprofits are the Nehemiah Program, The AmeriDream Charity and Partners In Charity.

Federal policy encourages homeownership, and these nonprofits help to accomplish that goal. They are proud of what they do.

"Collectively, the industry makes a significant contribution toward helping families across the United States who are otherwise qualified to achieve single-family homeownership," says Scott Syphax, president and CEO of Nehemiah.

One executive estimates that 8,000 buyers a month get down-payment gifts -- double the number a year ago -- and that the figure will reach 11,000 a month by year's end.

"Our buyer is the person who was going to buy, anyhow, in a couple of years and was saving for a down payment," says Charles Konkus, a director for Partners In Charity. "So they had homeownership on their minds, and we've just accelerated the process and made them very happy."

One happy family
That describes delighted renters-turned-owners such as Joan and Darren Neff of Orient, Ohio.

The Neffs moved into a brand-new house in July -- so recently that Joan Neff still describes her former circumstances in present tense: "I've lived in an apartment since we were married three years ago," she says.

The Neffs are in their mid-20s. They hunted for a house two years ago but didn't have enough money for a down payment and closing costs. Their son was born a year ago, and the Neffs' dream of owning a house grew more vivid. They had about $15,000 in a 401(k) account and wondered if they should tap it to get into a house.

In February, the Neffs talked to a representative from builder Dominion Homes who suggested that they apply for a grant from Nehemiah to pay their down payment. Such a grant would allow them to buy a house this year without withdrawing from a retirement account.

"After they told us about the program, we signed the same day," Joan Neff says. They financed through Dominion's financial services arm. A few months later construction was completed and they moved in. The four-bedroom house cost about $180,000, so a grant for a 3-percent down payment would have been about $5,400.

Joan Neff says that without Nehemiah, she and her husband would have bought a smaller house and would have dented their cash and retirement savings. The grant enabled them to "keep building family wealth, which is especially important when you have a 1-year-old and you're saving for education."

She describes Nehemiah as "a great program. It was very easy -- user-friendly. Dominion and Nehemiah walked us through everything. It was easy to understand. Quicker than filling out an application to take money out of my 401(k)."

Speed and ease of use are big selling points when down-payment assistance nonprofits market themselves to lenders, real estate agents and builders.

"An easily done real estate and loan transaction probably has big fans in the industry," says Janet Jordan, housing director for CCCS of Atlanta. Some buyers are eligible for government down-payment assistance programs "that they're not told about by their agent or lender because they require more paperwork and legwork."

Counseling no longer required
When Nehemiah pioneered down-payment assistance in 1997, the nonprofit required recipients to go through counseling to explain things like how a mortgage works, the importance of paying debts on time, and how one should budget for the inevitable repairs.

Along came competition from rivals that didn't require counseling. Now Nehemiah doesn't require, but strongly encourages, homeowner counseling for gift recipients. The nonprofit published a book and offers a homeowner course online.

As he surveys the industry that Nehemiah spawned, Syphax plainly feels like a longtime resident of a neighborhood that has declined. He would like Washington to step in with "sensible regulation" of the industry. He favors homeownership counseling. He was pleased this year when HUD declared that down-payment recipients could no longer use the money to pay off bad debts, judgments and liens. Some of Nehemiah's competitors had encouraged such a use of the money.

Taxpayers back riskier loans
"We were against that because ultimately the taxpayers fund the FHA insurance fund," Syphax says. "To the extent that you have borrowers who are more likely to default on their mortgage payments, that costs the taxpayers money."

Word of HUD's policy change apparently hasn't reached everyone. Paul Barnett, a mortgage loan officer in Arlington, Texas, says about 85 percent of his borrowers use Partners In Charity to help make down payments. A lot of people in society live beyond their means, Barnett says, and some use grant money from Partners In Charity to retire debt at closing. "It's a lot smarter way, in my opinion, of paying off debt," he says.

Barnett received a grant from Partners In Charity this summer when he bought his first house. He had the money for a down payment, "but by using Partners In Charity, it allowed me to be able to hang onto my money and buy all the necessities for buying a home. All of the money was diverted another way. Our refrigerator, we bought a brand new washer and dryer, couches, furniture, bedroom suite -- we were able to buy outright."

He has worked for clients who had the down-payment money, "but why spend it when you can use that tax-deductible interest and buy something else?"

Buyers overpay
HUD probably can't prevent people from buying furniture with the money freed up by down payment grants. The department worries that down-payment assistance programs artificially inflate home prices. When HUD's inspector general audited the industry in 2000, it "found evidence that some home sellers increased the sales price to cover the fee they paid to the nonprofits."

The nonprofits do little to dispel that concern.

"The key point is the seller does not have to negotiate down," says Darl Williams, AmeriDream's regional manager for Indiana and Michigan. "When the buyer doesn't have any down payment, they lack leverage, so the seller will get full asking price for their house. The seller is happy. The buyer -- their alternative is to continue to rent, so they're happy. That's the key to why this works so well."

The Housing Action Resource Trust says this to buyers on its Web site: "With the HART Down Payment Assistance Program, Builders and Sellers receive offers at full list price."

"If your home has been on the market for a while and you are considering reducing your price to generate some new interest in your house, you may want to use The Nehemiah Program instead," says that organization's Web site. "Do not reduce the price, implement the program and start advertising 'Zero total dollars moves you in.' This can be a very effective selling tool!"

Other nonprofits carry similar messages in their literature. They note that in a typical home sale the seller knocks about 5 or 6 percent off the asking price because of price concessions and repairs. That means that a typical $100,000 house would sell for about $95,000. Using a down payment assistance program, the nonprofits say, the seller can hold the price firm at $100,000. After giving the nonprofit $3,000 for the down payment gift and $1,000 in administrative fees, the seller comes out ahead.

What if the buyer pays $100,000 for a house that's really worth $95,000?

Higher prices, higher risk?
"Higher sales prices mean higher loan amounts and even less (possibly negative) equity for buyers, which further increases the likelihood of default and risk to the FHA insurance fund," the HUD audit concluded. The HUD auditors found office memos and articles in industry publications that recommended increasing prices to make up for contributions to down payment charities.

Stephen Thode, director of the Goodman Center for Real Estate Studies at Lehigh University, says: "Are home buyers who get DPAs (down-payment assistance) winners? If they end up paying more for a property than they would otherwise pay, and housing prices do not increase significantly from the time they purchase to the time they sell, they may not be winners."

That's less likely to happen, Thode says, "if appraisers stick to their guns."

They don't always stick to their guns. In its audit, HUD reviewed 82 appraisals and concluded that "appraisers did not make adjustments for sales under down-payment assistance programs. Also, appraisers used other properties sold under these programs as comparables during the appraisal process." That would tend to artificially inflate home values.

Appraisers work independently and HUD wasn't accusing anyone of wrongdoing.

"We at Nehemiah are dead set against appraisal inflation," Syphax says, adding that the nonprofit wants to work with HUD "on improving the standards of enforcement of FHA appraisals to be sure that appraisal inflation does not take place."

Even if down-payment assistance programs slightly distort home values, the resulting mortgages aren't necessarily a lot riskier, Thode says: "If mortgage lenders continue to do their jobs and underwrite mortgages using the same standards for those using down-payment assistance as for those who are not seeking down payment assistance, there should be no significant difference in default rates."

Default rates disputed
HUD and the nonprofits disagree whether there are differences in default rates. In its audit, HUD looked at 2,264 Nehemiah loans made between August 1997 to May 1999. The loans were in the four cities with the most Nehemiah loans -- Indianapolis, Las Vegas, and Sacramento and Stockton, Calif. HUD compared the default rate of those loans with the default rate of all FHA loans made in those cities during that period.

As of late October 1999, HUD found that the default rate on the Nehemiah loans was 4.64 percent, while the rate on non-Nehemiah loans was 2.11 percent.

Nehemiah hired credit bureau Equifax to perform a counter-review, which concluded that about 8.3 percent of FHA borrowers were at least 30 days past due on their mortgage payments, while only 4.1 percent of Nehemiah gift recipients were at least 30 days past due. HUD dismissed the Equifax study, saying that it didn't compare loans of similar ages and time periods. In addition, HUD found 85 Nehemiah loans in default just in Sacramento and Stockton, while Equifax found 23 defaulted Nehemiah loans in all of California. That Equifax missed so many deadbeats might astound the legions of people who have gone through the hassle of removing incorrect and damaging information from their credit reports.

No one knows whether the FHA collects enough insurance premiums from mortgage borrowers to reimburse lenders when some of the loans inevitably go bad. The agency's insurance fund holds billions of dollars, but could be wiped out in a severe recession. Ultimately, the risk is borne by taxpayers.

A HUD official says the department is reviewing down-payment assistance programs again to find out if they expose the FHA insurance fund to more risk. Even if the study concludes that down-payment programs are risky, HUD might again do nothing. Last time it was because HUD received 21 letters encouraging it to ban down-payment charities, and 1,850 letters imploring HUD to let the nonprofits survive.

That decision came in the last fortnight of the Clinton Administration. Priorities are different with the Bush Administration, which is seriously pursuing a goal of increasing homeownership among minorities by 5.5 million families by 2010.

"We're going to have to work hard to achieve the goal, all of us," President Bush said in a speech June 18. "And by all of us, I mean not only the federal government, but the private sector, as well." He added that "probably the single barrier to first-time homeownership is high down payments."