Can Downpayment Assistance Work?

The HUD Inspector General issued a report on FHA-Insured Loan with Borrower-Financed Downpayment Assistance. Downpayment assistance has a long history of failure, a history that has led to big losses for the FHA and foreclosures for borrowers. The IG audited HUD’s oversight of FHA-insured loans that were originated with downpayment assistance. The Inspector General had already determined that “lenders allowed FHA borrowers to finance their own downpayments through an increase in their mortgage interest rate as part of programs administered through housing finance agencies.” (1)

The IG found that HUD

failed to adequately oversee more than $16.1 billion in FHA loans that may have been originated with borrower-financed downpayment assistance to ensure compliance with HUD requirements, putting the FHA Mortgage Insurance Fund at unnecessary risk. Between October 1, 2015 and September 30, 2016, HUD guaranteed nearly $12.9 billion in FHA loans that may contain questioned assistance. While governmental entities are not prohibited sources of downpayment assistance, the assistance provided through these programs did not comply with HUD requirements. FHA borrowers were required to obtain a premium interest rate and, therefore, repaid the assistance through higher mortgage payments and fees. Despite the prohibition against similar seller-funded programs, HUD’s requirements appeared to have enabled the growth of these questioned programs. In addition, HUD did not adequately track these loans and review the funding structure of these programs. Despite concerns raised by OIG, HUD failed to protect FHA borrowers against the higher mortgage payments and higher fees imposed on them, which increased the risks to the FHA Insurance Fund in the event of default. (1)

The Urban Institute’s Housing Finance Policy Center has criticized the IG’s report on methodological grounds. I will defer to the Urban Institute’s critique because they have done a lot of work in this area.

But I do think that the IG is right to pay careful attention to downpayment assistance programs. Historically, they have proven too good to be true. One of the FHA’s biggest failures resulted from the downpayment assistance program that was set forth in the American Dream Downpayment Assistance Act of 2003.

The IG recommends that HUD

(1) reconsider its position on questioned borrower-financed downpayment assistance programs,

(2) develop and implement policies and procedures to review loans with downpayment assistance,

(3) develop requirements for lenders to review downpayment assistance programs,

(4) require lenders to obtain a borrower certification that details borrower participation,

(5) ensure that lenders enter all downpayment assistance data into FHA Connection, and

(6) implement data fields where lenders would be required to enter specific downpayment assistance information. (1)

The IG’s procedural recommendations all seem reasonable enough, whether you agree or disagree with the folks at the Urban Institute.


P2P, Mortgage Market Messiah?

Monty Python's Life of Brian

As this is my last post of 2015, let me make a prediction about the 2016 mortgage market. Money’s Edge quoted me in Can P2P Lending Revive the Home Mortgage Market? It opens,

You just got turned down for a home mortgage – join the club. At one point the Mortgage Bankers Association estimated that about half of all applications were given the thumbs down. That was in the darkest housing days of 2008 but many still whisper that rejections remain plentiful as tougher qualifying rules – requiring more proof of income – stymie a lot of would be buyers.

And then there are the many millions who may not apply at all, out of fear of rejection.

Here’s the money question: is new-style P2P lending the solution for these would-be homeowners?

The question is easy, the answers are harder.

CPA Ravi Ramnarain pinpoints what’s going on: “Although it is well documented that banks and traditional mortgage lenders are extremely risk-averse in offering the average consumer an opportunity for a home loan, one must also consider that the recent Great Recession is still very fresh in the minds of a lot of people. Thus the fact that banks and traditional lenders are requiring regular customers to provide impeccable credit scores, low debt-to-income (DTI) ratios, and, in many cases, 20 percent down payments is not surprising. Person-to-person lending does indeed provide these potential customers with an alternate avenue to realize the ultimate dream of owning a home.”

Read that again: the CPA is saying that for some on whom traditional mortgage doors slammed shut there may be hope in the P2P, non-traditional route.

Meantime, David Reiss, a professor at Brooklyn Law, sounded a downer note: “I am pretty skeptical of the ability of P2P lending to bring lots of new capital to residential real estate market in the short term. As opposed to sharing economy leaders Uber and Airbnb which ignore and fight local and state regulation of their businesses, residential lending is heavily regulated by the federal government. It is hard to imagine that an innovative and large stream of capital can just flow into this market without complying with the many, many federal regulations that govern residential mortgage lending. These regulations will increase costs and slow the rate of growth of such a new stream of capital. That being said, as the P2P industry matures, it may figure out a cost-effective way down the line to compete with traditional lenders.”

From the Consumer Financial Protection Bureau (CFPB) to Fannie and Freddie, even the U.S. Treasury and the FDIC, a lot of federal fingers wrap around traditional mortgages. Much of it is well intended – the aims are heightened consumer protections while also controlling losses from defaults and foreclosures – but an upshot is a marketplace that is slow to embrace change.

The Road to Rent-To-Own

Rent To Own Sign quoted me in Rent-to-Own Homes Can Be a Risky Option for Buyers. It opens,

Instead of shelling out thousands of dollars to rent a home each month, some landlords give their tenants the option to buy the home while they are leasing it — using the rent they’ve paid as a credit toward their mortgage downpayment.

But while rent-to-own options appear like a winning proposition for potential homeowners who have not been able to save up enough money for a down payment or lack a good credit score, these deals can be fraught with many setbacks.

Each state is governed by different laws, and some of them protect homeowners in case they fall behind on payments, said David Reiss, a law professor at Brooklyn Law School. This is a crucial point that needs to be addressed with a lawyer before the contract is signed, because a consumer could end up “losing everything” that he had paid toward the house if he loses his job, Reiss added.

“Rent-to-own transactions can be very complicated and there are fewer consumer protections available, so interested buyers should beware,” he said. “There are a lot of shady operators out there.”

Reiss on the FHA and Low Downpayment Mortgages

I will be speaking at the Cleveland Fed’s 2013 Policy Summit on Housing, Human Capital, and Inequality on Thursday, September 19 from 2:40PM-4:10PM.  My panel is on

Affordable Housing, Mortgage Underwriting, and Default: The Case of the FHA

In the past few years FHA’s market share has increased substantially, as have its default and foreclosure rates. Recently, the White House announced that the FHA may have to make a capital call to Treasury for the first time in its history, prompting much debate over the future of the organization. In this session, a panel of experts will discuss the FHA’s financial situation, its role in providing affordable housing, and explore potential policy responses.


Emre Ergungor, Senior Research Economist, Federal Reserve Bank of Cleveland


Edward J. Pinto, Resident Fellow, American Enterprise Institute, How the FHA Hurts Working-Class Families

David Reiss, Professor, Brooklyn Law School, How Low is Too Low? The Federal Housing Administration and the Low Downpayment Loan

Joseph Tracy, Executive Vice President and Senior Advisor to the President, Federal Reserve Bank of New York
Interpreting the Recent Developments in Housing Markets

My summary and implications are below and those for the other speakers can be found at the link above.

Summary and Findings
The Federal Housing Administration (FHA) has been a flexible tool of government since it was created during the Great Depression. It succeeded wonderfully, with rapid growth during the late 1930s. The federal government repositioned it a number of times over the following decades to achieve a variety additional social goals. It achieved success with some of its goals and had a terrible record with others. Today’s FHA is suffering from many of the same unrealistic underwriting assumptions that have done in so many subprime lenders as well as Fannie and Freddie. The FHA has come under attack for its poor execution of some of its additional mandates and leading commentators have called for the federal government to stop undertaking them. This article takes the long view and demonstrates that the FHA also has a history of successfully undertaking new programs. It also identifies operational failures that should be noted to prevent them from occurring if the FHA were to undertake similar ones in the future. The article first sets forth the dominant critique of the FHA and a history of its constantly changing role. It then addresses the dominant critique of the FHA and evaluates its priorities in the context of legitimate housing policy objectives. It concludes that the FHA has focused on an unthinking “more is better” approach to housing, but that the FHA can responsibly address objectives other than the provision of liquidity to the residential mortgage market.

Implications for Policy and Practice
Leading commentators on the FHA do not fully appreciate the extent to which down payment requirements alone drive the success and failure of new FHA initiatives. Central to any analysis of the FHA’s role is an understanding of its policies relating down payment size. Much of the FHA’s performance is driven by its down payment requirements, which have trended ever downward so that homeowners were able to get loans for 100% of the value of the house in recent times. As is obvious to all, the larger the down payment, the safer the loan. What appears to have been less obvious is that very small down payments are unacceptably risky. Given that the FHA insures 100% of the losses on its mortgages, the down payment requirement is a key driver of its performance. From an underwriting perspective, 20% is clearly desirable as the risk of default is very low even in a down market. But from an opportunity perspective, a 20% down payment requirement would keep large swaths of potential first-time homeowners from entering the market. If down payments are set too high, than an important social goal may be left by the wayside. So it is important that the public discourse weighs the costs and benefits of setting a fixed down payment requirement versus taking a risk layering approach to down payments. In either case, the FHA must balance the goal of safe underwriting with the goal of making homeownership available to households who could maintain it for the long term.