Federal agencies are putting under the microscope the burgeoning cottage industry of home financing assistance programs that set up as a tax-exempt charities and then use sellers' funds to finance buyers' down payments.
The Feds say not only is the tax-exempt scheme illegal, the operations artificially inflate the cost of housing, they undermine underwriting quality and they put home ownership at risk.
That's not all.
"So-called charities that manipulate the system do more than mislead honest home buyers 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 down payment assistance programs that provide cash assistance to home buyers who cannot afford to make the minimum down payment or pay the closing costs involved in obtaining a mortgage can qualify as tax-exempt organizations under Internal Revenue Code section 501(c)(3), provided they are properly structured and operated.
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 and advises home buyers to verify an organization's tax-exempt status before using their service.
The "Search for Charities" button on the agency's Charities and Non-Profits website page allows consumers to search through the agency's data base of bona fide 501(c)(3) organizations.
The agency has 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 (HUD) "An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations" found that 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 compounded risk associated with the lack of a direct investment by the borrower who purchased a home with no money down.
HUD found that 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.
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 "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 (GAO).
Like the HUD report, GAO found that 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 to 3 percent more than comparable homes without the assistance, giving home buyers an even smaller equity stake.
FHA requires lenders to inform appraisers of down payment assistant 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.
