Banking Law

Notwithstanding evidence that seller-funded downpayment assistance ("DAP" or SFDP") was demonstrably disastrous for the FHA (which is why Congress finally banned the practice), its proponents refuse to give up hope that the price-inflating, default-inducing DAP can rise from the grave. The latest redeemer wanna-be is Democratic Texas Representative Al Green (not the same Al Green who plagued the dreams of Ally McBeal). According to a recent story in BusinessWeek (hat tip to Housing Wire), Rep. Green is serious about pushing this bad idea forward.

A bill introduced by U.S. Representative Al Green, a Texas Democrat, and supported by the U.S. Conference of Mayors, would restart a program that allowed nonprofit groups to donate the 3 percent down payment low-income buyers needed to get FHA-insured mortgages. Sellers, often homebuilders, then contributed that amount, plus a fee, to the nonprofits.

The plan, which funded the purchase of more than 1 million homes over 10 years, was halted by lawmakers concerned about rising defaults and evidence that some buyers were overcharged. Those mortgages have soured at about three times the rate of other FHA-backed loans, according to agency data.

[...]

Green said he wants to revive the program with stricter screening and appraisals to reinvigorate the housing market. Doing so would put 300,000 families a year into homes, generating 235,000 jobs and more than $4 billion in tax revenue, according to AmeriDream Inc., a Gaithersburg, Maryland-based nonprofit that provided down-payment assistance in the past and supports Green?s plan.

?This is a program for decent, hardworking people,? said Green, a member of the House Financial Services Committee. ?Don?t make the zip code where you?re born the determinant of wealth. The real question is not ?Can the person make a down payment?? It?s ?Can they make the mortgage payment???

The bill has the support of 22 co-sponsors, including members of the Congressional Black Caucus and the Congressional Hispanic Caucus, both of which fought to keep the program.

In other words, major campaign contributors want Congress to resurrect a program that HUD estimates has cost it $14 billion in losses, losses that are backstopped by the American taxpayer. This will permit the FHA to once again insure loans to borrowers who have none of their own funds invested in the home they're purchasing, because builder-sellers have funneled the downpayment (incredibly small to begin with in the case of FHA loans) through non-profit community advocacy groups who are paid a "processing fee" by the sellers to "gift" to the borrower the downpayment advanced by the seller . HUD has convincingly shown that DAP FHA loans lead to higher prices and higher default rates.

The goal of putting more people in homes through hinky loans that a high number of borrowers will not repay makes perfect sense to...Al Green, sellers trying to sell homes, and non-profit groups that have sold themselves to builder-sellers who pay them fees to perpetrate this bad joke on the FHA. Of course "stricter screening and appraisal standards" will fix the basic problems of a concept is fundamentally flawed on its face. You believe that, right?

If you do, you'll be in the minority.

No amount of tinkering can save the program as long as sellers can contribute to the down payment and buyers have no capital invested, according to Lawrence Yun, chief economist at the National Association of Realtors in Washington.

?The whole structure is inherently fishy,? said Yun. ?This was not a real arms-length transaction. There?s too much temptation for the seller just to increase the price to cover the contribution. The builders pushed this to try and increase sales, but the lender is left holding bag.?

The evidence that DAP FHA loans have been a disaster is overwhelming.

While seller-financed mortgages make up only 10 percent of those insured by the FHA from the beginning of 2001 to October 2008, they account for 31 percent of the agency?s losses during that period, or $3.8 billion, according to FHA data. The FHA estimated in November that the mortgages will cost it an additional $10.4 billion, almost wiping out the 2 percent loss reserves the agency is mandated by Congress to maintain.

About 13 percent of down-payment-assisted mortgages originated in 2004 have defaulted compared with about 4 percent of other FHA mortgages, according to agency data. The figures exclude mortgage re-financings.

[...]

Mark Everson, then Internal Revenue Service Commissioner, called down-payment-assisted mortgages ?scams? in 2006 because of the way funds were passed from the sellers of homes to buyers through nonprofits.

?Organizations claiming to be charities are being used to funnel down-payment assistance from sellers to buyers through self-serving, circular-financing arrangements,? Everson said at the time. ?So-called charities that manipulate the system do more than mislead honest homebuyers and ultimately jack up the cost of the home. They also damage the image of honest, legitimate charities.?

Supporters of DAP have cited a 2004 study by the Milken Institute to support the benefits of DAP. Unfortunately, that study has a wee bit of a problem.

The study?s lead author, Milken researcher Perry Wong, said he has since reversed his opinion.

?We?ve learned that to assume that if you just give someone a place in a community all sorts of good things will happen is wrong,? Wong said. ?The model could work if you assist the buyer but not give the money away. The buyer has to have a stake.?

That's a problem that "tougher screening" and "stricter appraisal standards" can't address: skin in the game. If there's one thing that the problems we've seen with underwater residential mortgage loans over the last several years should have taught us is that when the buyer doesn't have it, he or she is more likely to walk away from the loan when times get tough.

Let's hope that this idea continues to slumber in the eternal rest that all bad ideas richly deserve and too seldom achieve.

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Two upcoming Bank Law Stuff webinars co-sponsored by Bank Business Advisors, LLC (in which this blog's author has a stake) may be of interest to readers. On January 27, 2010, Denver attorney (and Bank Business Advisors member) Tom Bieging and former banker and current banking consultant Larry Martin, principal of Bank Strategies, LLC, will present "Banks Under The Microscope: Today's 'Hot Buttons' For Bank Examiners." On February 3, 2010, Bank Business Advisors' John Walker will moderate a panel discussion with Larry Martin and Dan McDonald, Director of Loan Review Services at bank accounting firm Fortner, Bayens, Levkulich & Garrison, P.C., on the current and coming commercial real estate "freight train" and what its headlong rush down the tracks will mean for community banks.