U.S.-backed mortgage program fuels risks

WASHINGTON – June 25, 2008 – Mortgages that allow consumers to put little if any money down when buying a home have largely disappeared as a financing option available from private lenders. But they are still available – and growing more popular – through a government-backed program.

That’s raising concerns among critics who blame no-money-down mortgages for many of today’s housing market woes. And while federal housing officials are moving to end the practice, for now home builders are promoting the programs to move unsold inventory.

“I just smell a massive taxpayer burden coming,” says Sen. Christopher Bond (R., Mo.), who calls the programs “too good to be true.”

The offers – including “100 percent financing” – are made possible due to downpayment assistance programs run by nonprofit organizations. These programs are funded largely by home builders and also by private homeowners desperate to sell. The seller-funded groups provide enough downpayment money to buyers that they can qualify for a mortgage backed by the Federal Housing Administration, which requires at least a 3 percent downpayment.

Supporters of the downpayment programs say they help the FHA fulfill its goal of assisting first-time home buyers. But critics say the programs will burden the government agency, and taxpayers, with bad loans. The FHA, which essentially is filling the void left by the collapse of the subprime market, renewed a push to eliminate the programs this month, after warning that above-average default rates for seller-assisted downpayment programs will force the agency to request a government subsidy for the first time in its 74-year history. The agency says it will need $1.4 billion next year.

The FHA estimates that downpayments provided by nonprofit groups account for 34 percent of all 200,000 loans backed by the FHA so far this year, up from 18 percent in all of 2003 and less than 2 percent in 2000. And the agency says that borrowers are two to three times as likely to default on their payments when they receive a downpayment from a nonprofit.

D.R. Horton Inc., the nation’s largest home builder by volume, is touting “100 percent financing” for its two- and three-bedroom condominiums near the beach in Maui, Hawaii, which start at $498,000. In the Seattle area, local builder Quadrant Corp. is advertising townhouses that can be purchased with as little as $500 down. “Use your coffee budget to move into a new home,” says an online promotion. In the St. Louis area, Vantage Homes recently promoted its suburban developments with ads suggesting a new home should be on the list of things to buy for those “looking for something to spend your economic stimulus check on.”

A flier promoting D.R. Horton’s Maui development, for example, says that funds for the downpayment would be provided by Nehemiah Corp. of America, the largest private downpayment assistance provider. D.R. Horton, based in Fort Worth, Texas, didn’t return calls seeking comment. Scott Syphax, president and chief executive of Nehemiah, a nonprofit organization, said D.R. Horton is one of 95,000 companies and individual home sellers that have participated in the assistance program.

To critics, mortgages with downpayment assistance are similar to no-money-down subprime loans, which have triggered a wave of foreclosures. Most bankers believe defaults are so high because borrowers who encounter financial difficulties are more willing to walk away from a home when they didn’t put much of their own money into the purchase.

“The inescapable fact is that seller-funded downpayment assistance is particularly susceptible to losses,” says Howard Glaser, a mortgage-industry consultant and former official at the Department of Housing and Urban Development. “Too often today’s seller-funded loan is tomorrow’s foreclosure.”

Several years ago, during the height of the housing boom, some of the nation’s biggest builders curtailed use of seller-funded assistance programs because lenders offered 100 percent financing, often via their subprime divisions.

But home builders are again embracing the programs because home sales have stalled, the subprime market is largely shut and traditional lenders are requiring large downpayments. Under the downpayment assistance programs, a third-party nonprofit provides the money to the buyer and is then reimbursed by the seller. The seller’s contribution to the program isn’t tax deductible as a charitable contribution. FHA regulations prohibit sellers from providing direct cash gifts to buyers, due to concerns that the value will be added to the price of the home, inflating its value.

Home builders say touting no- or low-money-down financing helps bring in new customers, even if they ultimately choose more conventional financing. “The bottom line ... is these promotions work,” John F. Eilermann Jr., chief executive of McBride & Son Enterprises Inc., the parent company of Vantage Homes, said in an email. He said the current marketplace demands flexibility, and he credits “creative marketing,” such as promotion of its $500-moves-you-in program, with increasing new home sales in 2007 from the previous year.

Advocates of downpayment assistance say the programs are also good for the broader economy. Nehemiah’s Mr. Syphax calls the FHA program an “economic stimulus.” Home builders fear that eliminating the programs will cripple sales. “It would chill the market here,” says Jeff Johnson, sales manager for Maracay Homes in Phoenix.

Dick Whitmore, a 47-year-old construction superintendent in Phoenix, put up just $250 to move into a three-bedroom home that he purchased in March for $189,000. He says the downpayment and closing costs, which came to about $12,000, were paid by the family selling the home via AmeriDream Inc., a downpayment-assistance program based in Gaithersburg, Md. “My wife and I are hardworking people, but to come up with five or six grand, that’s next to impossible,” he said.

Gloria Harris, a 57-year-old human-resources consultant, says she couldn’t have bought her $216,000 two-bedroom condo in McLean, Va., in January without the $16,000 contributed by the seller to cover the downpayment and closing costs. “I was having a hard time just trying to save because I was spending from week to week trying to live,” she says.

To be sure, the overwhelming majority of subprime loans in default are adjustable-rate mortgages. FHA-backed loans, including those with downpayment assistance, are fixed-rate loans with income verification requirements, which have better track records.

Assistance providers say their products helped keep low-income families away from subprime loans that reset to higher rates. The FHA had as recently as 2005 warned that eliminating seller-funded downpayments would leave borrowers with “options that are more costly and riskier than FHA.”

They also reject criticism that they are responsible for the FHA’s recent shortfall. “We are a convenient scapegoat,” says Mr. Syphax.

Seller-funded groups and supporters in Congress say that such programs should be regulated but not shut down, a proposal that HUD hasn’t shown much interest in in recent years. “If there’s a problem, let’s fix it,” says Rep. Gary Miller (R., Calif.), a vocal defender of the program and a former home builder and developer.

In the past, nonprofit groups have consistently outmaneuvered Congress and the regulatory agencies that have tried repeatedly to shut them down, thanks in part to a well-coordinated lobbying effort by a coalition of the nonprofit companies, low-income housing and minority groups and home builders. “I have holes on my shoes from walking around Washington,” says Mr. Syphax.

The two sides have a long history of doing battle. Housing officials backed down from a fight in 1999, and earlier this year courts rejected a similar attempt to shut down the program.