WSJ: IRS Revokes Non-Profit Status for Seller Funded Down Payment Assistance Providers

by Alex Stenback on May 5, 2006

Late yesterday, the IRS revoked the non-profit status of what are known as "Seller Funded" down payment assistance programs.  From today’s Wall Street Journal:

The Internal
Revenue Service dealt a serious blow to organizations that provide down-payment
assistance to home buyers in a ruling that could curtail the ability of
lower-income U.S. citizens to purchase homes…The programs have been contentious because, in an effort to increase sales in some cases, the money for the down-payment assistance came mainly from large home builders and individuals selling their homes. The IRS says "in a typical scheme, there is a direct correlation between the amount of 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 article also reveals that a stunning 31% of all FHA home loans in 2004 (about 170,000 loans) involved assistance from these organizations, which just blew us away.  Still more pressure on the fringe/non-prime segment of the market. 
ยท IRS Limits Home Down-Payment Gifts [wsj.com- sub req'd]

{ 6 comments… read them below or add one }

Paul May 5, 2006 at 5:03 pm

Alex, Do you think that this is a serious attempt to stop fraud? Or to just prevent the market from artificially inflating? Or more sinister yet, is it a way to keep people renting, thus furthering the financial gap?

Historically, haven’t these programs been THE WAY for under-served populations to get into their own homes? We now have the MHFA and other county programs – but I think we’ve all seen how long that money lasts.

Although the IRS hasn’t entirely taken this option away, it seems like a step in that direction. What are your thoughts?

Clark May 6, 2006 at 10:04 am

There are a number of really bad downpayment assistance charities that should have been shut down a long time ago. But, there are also some that are doing some very good work.

The really interesting thing about this situation is that the IRS and HUD have repeatedly approved this as a charitable model. Through these programs, hundreds of thousands of low income homebuyers have been able to purchase a home — without government assistance.

For the past three years HUD has been wanting to replace this program with one of their own — at taxpayer expense, of course. HUD has been unable to get congressional support.

Interesting isn’t it that these programs that have been approved by both these agencies for nearly 10 years are now being label “scams”. Watch for a push for a replacement government program that will cost the taxpayer and burden the low-income homebuyer with higher mortgage insurance premiums.

Editor May 6, 2006 at 12:05 pm

Both make interesting points. Essentially these programs have been a work around to allow a zero-down payment option for FHA quality borrowers, which often have a riskier, though not necesarily sub-prime, profile.

To now label these as scams I think goes way too far. From a philisophical standpoint, I might be able to understand this change – the original concept for this exemption was to allow community and neighborhood orgs to help homebuyers, and I am not sure anyone expected a cottage industry to spring up where non profits were created purely to channel money from seller to buyer. Though I think at this point we are arguing semantic details – it has long been possible in the conventional/fannie/freddie marketto purchase a house, with zero down payment and no cash out of pocket by having a seller pay closing costs.

It would be interesting to see whether or not the default rates on FHA loans with this type of assistance differ significantly from the standard FHA (2.25% down) loan. I’d bet the difference is not statistically significant.

Will post more as information becomes available on this.

Larry Cragun June 1, 2006 at 4:33 pm

This had to happen. I saw these programs as a great benefit for home buyers, as an originator I probably did 3 or 4 a month. However, as an owner of a mortgage company my perspective changed. I saw a lot of pressure on appraisers to push values higher to cover the gift. I began to believe the programs would have to change. It is this values problem that I see as the biggest, especially with all the appraisal fraud discussed these recent years.

Larry Cragun June 1, 2006 at 4:39 pm

By the way, my understanding from talking to some of my major correspondents, is the default rate is much higher on gift program loans. I was told by one bank, the L A area was extremely high.

wendy July 4, 2006 at 2:42 pm

This presents a real problem for sellers who would like to contribute some type of sales concession to sell their house; however, is it really right for these psuedo down payment assistance companies to be in the same category as those that are from a municipality? I think I see both sides. .

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