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Feds cut down-payment assistance programs

For a decade, credit-challenged homebuyers have used a regulatory loophole that lets them get Federal Housing Administration mortgages without putting their own money down, while at the same time avoiding costly subprime loans. About 7,000 buyers per month were exploiting the loophole, and now the feds are squeezing it shut.

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The new policy means that prospective homebuyers with marginal credit will have to act quickly if they want to buy houses without putting any money down. Otherwise, they will have to save for down payments or wait for the FHA to roll out its own zero-down program.

At issue is a controversial method of scraping together the down payment for a house. Many subprime lenders require down payments of at least 5 percent. That's a high hurdle for people who already have credit problems; luckily for those borrowers, loans insured by the Federal Housing Administration require smaller down payments -- as little as 3 percent.

Lenders mandate down payments for several reasons, the main one being that borrowers are less likely to stop making monthly payments if their own money is at risk. To make sure that borrowers have something to lose, no lender allows sellers to make down payments on behalf of buyers. But for FHA-insured loans, there has been a way to get around that seller-funded prohibition.

The housing boom and the loophole
The FHA allows homebuyers to accept gifts of down-payment money from nonprofit organizations. There's your loophole: Since the 1990s, the FHA has grudgingly allowed home sellers to "contribute" money to nonprofits, and for the nonprofits to then "donate" the money to homebuyers. In effect, sellers could fund buyers' down payments, which was a no-no, but the enterprise was technically legal because the money was shuttled through nonprofits. The nonprofits collected service fees from sellers.

A lively down-payment assistance industry grew quickly behind the protection of this loophole in FHA regulations. In the 2000 fiscal year, 6 percent of FHA-insured purchase loans had down payments channeled through nonprofits; four years later, 33 percent did. When this funding method was most popular, in fiscal years 2003 through 2005, more than 10,000 people per month were taking advantage of it, boosting the housing boom. From 2000 through 2006, more than 650,000 buyers got their down payments through nonprofits.

The federal housing department and Congress have commissioned at least three studies since 1999 that concluded these loans were riskier than FHA loans that didn't involve down-payment gifts. Sellers inflated home prices to recoup their contributions to the nonprofits, researchers found.

The studies recommended that the nonprofit down-payment assistance loophole be closed. Mortgage lenders, home builders and down-payment assistance programs argued to keep the loophole open, on the grounds that boosting the homeownership rate was good for everyone. The feds didn't take action until now.

 
 
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