A countdown clock on a Web site operated by Nehemiah Corp. of America is ticking off the days, hours, minutes and seconds until a new government ban will terminate virtually all seller-funded down payment assistance programs in the United States. But the clock may be stopped, now that a bill has been introduced in Congress that would reverse the ban.

The clock will tick off its last second Oct. 1, the last day when homebuyers will be able to use seller-funded down payment assistance with any mortgage backed by the Federal Housing Administration (FHA), a division of the U.S. Department of Housing and Urban Development (HUD).

The ban is part of the Housing and Economic Recovery Act of 2008, which President Bush signed into law July 30. The act states that a borrower’s down payment for any loan backed by the FHA can’t be provided before, during or after the sale by:

  • The seller.
  • Any other person or entity that financially benefits from the transaction.
  • Or any third party or entity that is reimbursed, directly or indirectly, by the seller or any other person or entity that financially benefits from the transaction.

An “entity that is reimbursed…by the seller” clearly refers to seller-funded down payment assistance programs, which collect “donations” from home sellers and then “gift” those donations to buyers, who use the funds to purchase the seller’s home. The seller also pays a fee, typically of several hundred dollars, to the organization.

More than 1 million buyers and sellers have utilized these programs, according to industry figures. The two largest organizations, Nehemiah in Sacramento, Calif., and AmeriDream in Gaithersburg, Md., have processed more than 300,000 and 250,000 transactions, respectively, according to company statements. Since 1999, AmeriDream alone has processed more than $26 million worth of “gifts” in chunks of approximately $3,600 on average. Numerous smaller down payment assistance organizations also operate throughout the United States. Both Nehemiah and AmeriDream also sponsor homebuyer counseling programs.

Nehemiah is still taking applications from buyers and accepting donations from sellers, according to CEO Scott Syphax. The housing recovery act specifies that seller-financed down payments can still be utilized as long as the borrower receives credit approval from the lender prior to Oct. 1.

Act now to tap seller-funded down payment

Homebuyers will have very few, if any, opportunities to buy a home without a down payment after the ban on seller-financed down payments becomes effective.

Conventional loan programs that allow seller-funded down payment assistance are “few and far between” and have accounted for less than 3 percent of Nehemiah’s transaction volume, Syphax says.

An FHA-backed loan with a seller-funded down payment was “the last of the 100 percent loans available,” says Peter Thompson, a senior loan officer with Professional Mortgage Partners in Downers Grove, Ill. “The conventional homebuyer programs have pretty much all done away with doing this. This is something that has been specific to FHA loans for quite some time.”

Indeed, seller-funded down payments have become so closely associated with FHA-backed mortgages that more than 33 percent of loans backed by the agency last year included such assistance, according to FHA data. “The new housing law says that the lender must have provided final credit approval on the loan before Oct. 1 in order to use seller-funded down payment assistance for the down payment. As of October 1, it is prohibited,” says HUD spokesman Lemar Wooley.

Buyers who want to use a seller-funded down payment may decide to “move up their time frame to (buy a home) a little quicker,” so they can take advantage of such assistance, Thompson says.

Controversy swirls around seller-funded down payments

The FHA has tried for some time to ban seller-funded down payments in connection with FHA-backed loans. The agency argues that sellers’ “donations” result in artificially inflated house prices and that homebuyers who use such assistance are more likely to default on their loan. Two federal government reports in 2005 concluded that these programs made homeownership more expensive for homebuyers who used them. The IRS has revoked some of the providers’ status as tax-exempt non-profit organizations.

Proponents say these programs create opportunities for minority and low-income families to become homeowners.

Thompson believes the ban will push some well-qualified buyers who only lack a down payment out of the housing market, though he also thinks it would make sense to take a closer look at these programs to make sure people aren’t abusing them.

Seller-funded down payment assistance “is one of the things that is getting more people into the housing market when this is what we really need to get the economy going,” he says. “It doesn’t seem like the timing (of the ban) makes sense.”

FHA may raise cost of mortgage insurance

The housing recovery act also makes two other important changes to FHA loan programs. As of Oct. 1, the same day when seller-funded down payment assistance will be ended:

  • The minimum down payment required for an FHA-guaranteed loan will be increased from 3 percent to 3.5 percent.
  • A brand-new risk-based pricing structure for FHA mortgage insurance will be discontinued.

The FHA had pushed hard for its plan to charge riskier borrowers higher mortgage insurance premiums. HUD Secretary Steve Preston said in a statement that without such flexibility, the FHA will have to increases prices for all borrowers or eliminate its refinancing program for subprime borrowers.

Program providers plan to fight back

Homebuyers may want to monitor H.R. 6694, a bill introduced by Rep. Al Green (D-Texas) that would require the FHA to accept seller-financed down payments and authorize the agency to apply a risk-based pricing structure for FHA mortgage insurance on loans that utilized such down payments. The pricing would be adjusted on the basis of the borrower’s FICO credit score. The bill has two co-sponsors, Reps. Gary Miller (R-Calif.) and Maxine Waters (D-Calif.), and has been referred to the House Financial Services committee.

“The recent housing bill may have slammed the door on working families, but we are heartened that Congress has begun to take steps to re-open it,” AmeriDream president Ann Ashburn said in a statement in support of the bill.

Nor has Nehemiah given up on reinstatement of the seller-funded down payment assistance model, Syphax says. Yet even he hints that perhaps these programs shouldn’t be brought back in exactly the same format as they previously existed. He says the programs were “tremendously effective,” but “could and needed to be improved.”

“We will be fighting to bring back the program as we always thought it should have been and that we have been asking HUD for over a decade to help us create, which is a program with higher standards, more services provided to homebuyers and one where there is effective data capture, so we can continue to learn how to improve the program even further,” he says. “That’s what we’re fighting for.”