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Report: Down payment gift mortgages too risky

Most lenders don't allow home sellers to give down payment money to buyers, even indirectly, because those mortgages are deemed risky. But there's an exception: The Federal Housing Administration, or FHA, will insure home loans in which the seller provides the down payment -- as long as the money passes through a nonprofit agency first.

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Now a federal inspector concludes that such loans indeed are riskier and shouldn't be allowed. But the FHA clings to a narrow legal interpretation that allows indirect down payments by the seller, even as it acknowledges that such loans carry more risk of default and foreclosure.

Nonprofit down payment assistance providers play the middleman in 30 percent of FHA-insured mortgage transactions. That means three in 10 FHA-insured mortgages are structured in a way that private insurers won't touch. The cost is borne by borrowers who pay FHA insurance premiums, but taxpayers ultimately bear the risk.

The FHA insures mortgages for people with flawed credit who don't have a lot of money for a down payment. The agency requires buyers to make down payments of at least 3 percent, but some or all of that money can come in the form of a gift from a relative, employer, government or nonprofit agency.

The down payment can't come directly from the seller. But the FHA will let a nonprofit agency give down payment money to a buyer, then immediately collect a "contribution" of the same amount -- plus a service fee -- from the seller. The Nehemiah Program was the first nonprofit to use this loophole and many competitors have sprung up, including Neighborhood Gold and AmeriDream.

New study's conclusions
Since 2000, three studies have looked at down payment assistance. This year's study was done by the Government Accountability Office at the request of U.S. Rep. Bob Ney, R-Ohio, chairman of the Subcommittee on Housing and Community Opportunity. The 99-page report concludes that:

  • When home sellers indirectly give down payment money to buyers, they jack up prices by about the same amount, causing buyers to overpay.
  • Such loans have higher default and foreclosure rates.

The GAO recommends that the FHA track these loans better, require lenders to inform appraisers when the seller is indirectly providing down payment money, and to close the loophole that allows the practice.

Brian Montgomery, the federal housing commissioner who supervises the FHA, acknowledges that seller-funded down payments make for riskier loans. But he says the FHA's goal is to encourage homeownership among "the population that FHA was established to serve, families who are otherwise underserved by the private sector."

Next: The FHA wants Congress to approve a zero-down-payment program.
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