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Faux down-payment charities raise prices, foreclosure risk
By Broderick Perkins
Federal agencies are putting under the microscope the burgeoning industry of home-financing assistance programs that set up as tax-exempt charities and then use sellers' funds to finance buyers' down payments.
The feds say not only is the tax-exempt scheme illegal, but the operations artificially inflate the cost of housing, undermine underwriting quality and put home ownership at risk.
That's not all.
"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," said IRS Commissioner Mark W. Everson.
The Internal Revenue Service's "Revenue Ruling 2006-27" explains programs that provide down payment or closing cost assistance for needy homebuyers can qualify as tax-exempt organizations under Internal Revenue Code Section 501(c)(3), provided they are properly structured and operated as a nonprofit.
Seller-funded programs don't qualify if they funnel down-payment assistance from sellers to buyers through "self-serving, circular-financing arrangements," the IRS said.
"In a typical scheme, there is a direct correlation between the amount of the down-payment assistance provided to the buyer and the payment received from the seller. Moreover, the seller pays the organization only if the sale closes, and the organization usually charges an additional fee for its services," the ruling states.
The IRS is examining 185 organizations operating down-payment assistance programs.
Homebuyers can easily verify an organization's Internal Revenue Code Section 501(c)(3) tax-exempt status before using its service by hitting the "Search for Charities" button on the website page at http://www.irs.gov.
The agency recently denied 501(c)(3) status to more than 20 organizations seeking tax exemption and is examining additional operations asking for the status.
A year ago, the U.S. Department of Housing and Urban Development's "An Examination of Downpayment Gift Programs Administered By Nonprofit Organizations" found seller-funded down-payment assistance has led to underwriting problems and an increase in the effective cost of home ownership on Federal Housing Authority loans.
Underwriters reported to HUD that credit profiles of down-payment assistance clients were inferior relative to other FHA borrowers.
"Risk-layering" practices of allowing maximum ratios, premium interest rates and temporary interest rate buy-downs all compounded the risk associated with the lack of a direct investment by the borrower who purchased a home with no money down.
HUD found the cost of home ownership and risk was increased by the processing fees charged by the seller-funded programs if the cost to the seller was passed through to borrowers in the form of inflated property prices. In some instances, the higher sales price also led to higher settlement fees.
"I think this is another example of something that appears too good to be true typically is just that--too good to be true," said Richard Calhoun, broker/owner of Creekside Realty in San Jose.
"I suspect that this issue is across all lenders with a concentration on lenders who work with first-time buyers or any buyer short on cash," he added.
The use of seller-funding down-payment assistance has increased substantially in recent years. Approximately 6 percent of FHA-insured loans originated in 2000 received down-payment assistance from seller-funded nonprofits, but by 2004 the assistance had grown to about 30 percent, according to another report, "Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance," produced in late 2005 by the U.S. Government Accounting Office.
Like the HUD report, GAO found seller-funded nonprofit assistance can dramatically alter the structure of the transaction.
GAO said homes purchased with seller-funded down-payment assistance were appraised and sold for 2 percent to 3 percent more than comparable homes without the assistance, giving homebuyers an even smaller equity stake.
FHA requires lenders to inform appraisers of down-payment assistance sources, but not that the seller financed the source. Without that information, appraisers can't fully consider how the assistance could impact the purchase price or the appraised price.
Again, like HUD, GAO found loans with down-payment assistance performed worse than loans without down payment assistance.
Further compounding the buyer's risk, "Our analysis showed that those states where the use of nonprofit down-payment assistance, primarily from seller-funded nonprofits, was higher than average, tended to have lower-than-average house price appreciation rates," GAO reported.
Real estate writer Broderick Perkins, executive editor of San Jose-based DeadlineNews.Com, writes regularly for this newspaper.
