The FHA’s Risky Zero Down Payment Loan Program

Before I say anything on the topic of government and non-profit programs that provide potential home buyers with down payments, discuss the default rates and the potentially positive or negative impact on the current housing crisis, let’s first review some quotes and graphics.

First the quotes.

From the WSJ:

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 down payment and closing costs, which came to about $12,000, were paid by the family selling the home via AmeriDream Inc., a down-payment-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 down payment 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.

Now, the key graphics:

Percentage of consumers who received down payments from various sources, and the default rates of the people participating in the program:

Default rates for mortgages in general:

 

So based on the information we have, what conclusions can we draw?

1. Home owners receiving down payment assistance have a default rate that is higher than the default rate for subprime fixed rate mortgages, and only lags the default rate for subprime ARMs by a couple of percentage points. In fact subprime ARMs are the only types of mortgages that have a default rate that’s higher than that for FHA loans with down payment assistance.
2. I don’t know if the people highlighted in the article are typical or not but they’re not exactly good candidates for home ownership. People who are living paycheck to paycheck aren’t financially stable enough to buy a home, nor are individuals who are unable to come up with barely 1-3 expenses for most households. The FHA is basically sponsoring future foreclosures if these people suffer any economic shocks at worse and a household living paycheck to paycheck at worse, I don’t think its sound public policy for the government to be in the business of encouraging either situation.

The nation’s economy (if not the global one) is already suffering from people trying to enable home ownership at all costs; the last thing the government should be doing right now is perpetuating such nonsense. From a public policy perspective, our government needs to abandon the idea that homeownership is a god given right, and instead take a more sensible and measured approach that seeks to enable home ownership for those that can genuinely afford it. The down payment assistance programs in place now must be curtailed (if not abolished), lets they extend the housing crisis by creating a future rash of foreclosures.

To be clear, I’m not against the program, provided it’s putting people into a strong, stable financial situation, and if the default rates are only slightly higher than those for regular FHA loans. The key is to set higher standards and aim to help people get ahead financially, instead of having them fiscally limp into home ownership. For example: instead of providing down payment assistance for people who can barely afford to make ends meet, provide it for those who will have enough savings for 3-6 months expenses (after they buy the house) if they receive help with the down payment.

Supporting home ownership is a great idea from a public policy perspective, but there is a big difference between supporting financially stable home ownership and enabling home ownership at any cost. Our efforts in this arena should be directed towards helping those that can genuinely afford it, and helping the rest shore-up their finances so they can afford to buy a home in the future. The only way to create a stable nation of homeowners, in addition to facilitating stable housing markets, is to work to ensure that every home owner is being put into an affordable, sustainable housing situation.

Sources:

The Wall St. Journal: “U.S.-Backed Mortgage Program Fuels Risks” -- NICK TIMIRAOS, June 24, 2008.

Graphics courtesy of the Wall Street Journal

Disclosure: none

Comments

[Redfish Mark]

Markham, very nice article, particularly your closing paragraph. We agree, and find that restoration of affordability will likely be one of the most important aspects of restoring order in housing. In our research the correlates between affordability and overall single family market health are pretty astounding.

[tcornelison]

First you need to get the facts straight. FHA does not have a 100% financing program. FHA has always allowed for gifts to be used for downpayment, coming from family members and non-profits such as churches and civic organizations. In the eary 90's a group out of Atlanta created a 503c nonprofit organization which identified a loophole in the FHA guidelines which could allow funds to pass through the non-profit from the seller to the buyer and FHA could not legally stop this.

This practice expanded into hundreds of national non-profits today raking in tons of cash in fees for processing a two wire transfers on the day of closing. FHA has never condoned this practice but in repeated legal challenges has never been able to stop it. In 2007 they passed a rule banning the practice. The courts struck it down. The current FHA reform bills will change the code making the practice illegal, however Congress will not get their heads out of the sand and pass either version. A bill passed the house last year and the Senate this year which would codify the ban on DPA's like Ameridream.

Congress and the courts, not FHA are the reason this is still taking place today putting the FHA in a situation that could bring down the agency if not corrected. If someone can't save 3% of the purchase price which is all they legally have to pay with FHA they should rent.

[Jane]

Not only has FHA/HUD tried to ban the DPA practice but the IRS called it a scam, and though I don't remember who said it, it was called money laundering. Not all down payment non profits are a scam under IRS terms but some are. I also agree that if people have this much trouble coming up with a down payment, even the small percentage required by FHA, they should probably not buy. Getting into a house is one thing; keeping it is another. I can only imagine how much more traumatic it'd be to get one's house, finally, then lose it. This isn't doing anyone any favors, it's just helping to make sales and line the pockets of builders, sellers, and all those who stand to make a commission. For the buyer it can be financial ruin. Any time someone exploits a loophole to get around a law it should be suspect, and fixed if necessary, but it should NOT be thought of as some charitable act.

[Markham]

To be sure I wasn't implying that the FHA was providing 100% financing, but to say they shouldn't be approving loans for people who need outside assistance to afford down payments.