The Case for Seller Paid DPA

In a letter to the Department of Housing and Urban Development’s general counsel Tuesday, the Mortgage Bankers Association commented on seller assisted downpayments. The statements were made in response to HUD’s request for comments on the proposed rule, “Standards for Mortgagor’s Investment in Mortgaged Property.” The housing agency is looking to codify standards on FHA-insured loans.

Seller funded downpayment assistance, first conceived by a Sacramento, Calif., councilman in 1997, is used on more than 30 percent of FHA volume, MBA said. While abuses have occurred, 81 percent of the loans are still performing.

“The growth of seller funded downpayment assistance has been nothing short of remarkable,” according to the group.

A study by the Office of the Inspector General in 2000 found higher default rates for loans with downpayment assistance — and even worse performance for loans with seller funded downpayment assistance, the letter indicated. A subsequent analysis by FHA led the agency to determine that data about downpayments should be collected by lenders at origination. Once enough data had been collected, another FHA analysis was conducted in 2004 on eight metropolitan statistical areas.

“When funds were provided by a downpayment assistance provider through a quid pro quo donation by the seller, sales prices were often inflated to compensate for the seller’s gift and fees paid to the downpayment assistance provider,” FHA’s study concluded. “This study also found that downpayment assistance providers, lenders and FHA did not have sufficient risk-mitigating criteria in place to identify and protect against the highest risk loans.”

The FHA study reportedly recommended the implementation of several risk-mitigating techniques that address credit and valuation concerns.

Another study conducted by the General Accounting Office in 2005 “confirmed the circular nature of these transactions and found that homes tended to be appraised and sold for about two to three percent more than comparable properties,” MBA wrote. GAO’s report recommended more stringent FHA underwriting criteria — especially for loans where the seller assisted with the downpayment.

GAO, in addition to others in the industry, testified before the Subcommittee on Housing and Community Opportunity at a hearing on Homeowner Downpayment Assistance Programs and Related Issues in June. In response to recommendations made at the hearings, HUD issued several mortgagee letters establishing procedural methods to mitigate risk. But MBA is calling on HUD to go beyond the procedural moves and define and implement stronger underwriting controls.

HUD proposes to prohibit down payment assistance from charitable organizations that is reimbursed dollar-for-dollar by the seller because the practice frequently results in an inflated sales price, MBA reported.

Currently, seller fees are capped at 6 percent in addition to any downpayment assistance — potentially enabling up to 9 percent in contributions. The trade group recommended establishing a cap for seller contributions, including downpayment assistance, at the lower of 6 percent or the level customary for the area.

“This will significantly mitigate the risk that total seller contributions will not exceed market norms and result in an inducement to purchase that has the propensity to inflate value in order to cover the seller’s costs,” the letter said.

MBA also called for defined high-risk loan characteristics with more stringent eligibility requirements for debt ratios, reserves, credit and the layering of these risk factors. Improved appraisals reflecting all seller contributions — including downpayment assistance, as well as stepped up usage of automated valuations and desk reviews were also recommended.

Prior meetings between MBA and FHA representatives yielded a new requirement that lenders provide the tax identification number of any organization providing downpayment assistance in each loan closing. The move has enabled the analysis of loan performance is impacted by the practice.

The Washington, D.C.-based organization warned that low-income, first-time and minority consumers would be most hurt by FHA’s proposal as is. The group cautioned the rule as proposed could cut FHA volume by as much as half — and possibly more quickly deplete the Mutual Mortgage Insurance Fund. Such a reduction in volume would potentially create significant liquidity issues for securities issued by Ginnie Mae, which are backed by FHA-insured mortgages.