We Need to Bring Back Down Payment Assistance

We have seen an upturn in the starter home market as those first time buyers are taking advantage of the 8,000.00 tax credit. However, that shot in the arm ends in November, what will help sustain the industry when it is gone? What we need to do is look at a program that worked very well for years, the Down Payment Assistance programs, they produced over 50,000 home sales per month across the nation. When you take that many out of the market, it is going to have an negative market effect.

July of 2008 the proverbial baby was thrown out with the bathwater in the "Housing Bail Out Bill." Down Payment Assistance programs such as Nehemiah, AmeriDream, and others were outlawed and blamed for the high rate of foreclosures that melted down our housing market. The reality is that the Down Payment Assistance programs, or DPAs were not the problem. If we look at the loans that foreclosed in the sub-prime market, none of them used DPAs. It was FHA loans that were tied to DPA programs, in fact nearly 80% of all FHA loans were actually tied to an DPA, it was these down payment programs that kept FHA alive during the mortgage industries deep dive into the sub-prime lending market.

However there are many both in and out of our industry who are more than happy to not do the mental exercise to understand the true causes, and take the intellectually lazy approach of blaming the DPA as well. I have heard countless Realtors, some lenders, and even the president of one of the builders who fell victim to this downturn blame them, and parrot the phrase and idea of "skin in the game." There is a belief by many that "if these buyers only had some skin in the game," if only they had put some of their own money down they wouldn't have gone into foreclosure. It is possible that there could have been a small percentage who this might have made a difference, but I strongly doubt it. The problem is with this theory is that the math simply doesn't add up. We need to take the emotion out, and look at the math, if we do logic might prevail.

Let's look at what happened on the bulk of those DPA loans that did foreclose. First of all, the DPA was attached to a much bigger factor, they were used with FHA 2-1 buydowns. When this was the most popular loan it was because the seller/builder could legally pay up to 6 points or 6% of the mortgage up front to buy down the interest rate 2 points for the first year, 1 for the second, and then the loan would go to a standard rate the third year through the 30th. The FHA allowed the buyer to be qualified at the first year rate, not considering the increase in the rate guaranteed to come the very next year. Houston, we now have a problem. Then we combine that with too many builders who simply broke the existing laws, that were part of the DPA programs to begin with, by raising the purchase price 4% to "give" a tax deductible "gift" to the buyers through the DPA. The law clearly stated that the price couldn't be raised to use for DPA, it had to be a gift. Yet, builders would show this increase directly on their purchase agreements openly flaunting the law. They also raised the price 6% to buy down the rate. This caused a 100,000.00 home to be sold to the buyer for 110,000.00 with a mortgage of 107,000.00, and the buyer had "no skin in the game."

Now for that math I was promising you, and proof from my perspective, that DPAs were not part of the problem, but can be part of the solution.

Starting in Indianapolis, yes we were the first to really see this play out, and were the #1 city in foreclosures for several years ahead of the rest of the nation. There were a handful of builders, and then spin off Real Estate companies who worked a system of one size fits all mortgages. If you dealt with them you were going to be looking at a Nehemiah and FHA 2-1 buydown, it mattered not if it was a logical loan for your income and job situation, it allowed you to buy more so that it what you got. I actually left the industry in 2003 after my builder was purchased by one of those who pushed this program, and started a Real Estate business advertising myself as "The Educator" begging you not to go in alone. I refused to put people in this program, unless it actually fit, like all loans they are developed for specific needs, but are often abused by the industry. I can see that this message is going to need to be multiple posts, so I will show you the math here and revisit it later.

Here is an example:

100,000.00 retail purchase price of new home.
4,000.00 added to purchase price by builder to pay for "gift" to DPA company. (illegal)
6,000.00 added to purchase price by builder to pay for max 2-1 buydown.
110,000.00 New purchase price
3,800.00 Gift toward down payment paid by builder to DPA company.
500.00 kept by DPA company as fee.
3,300.00 down payment given to buyer through mortgage company by DPA company.

106,700.00 mortgage amount of loan.

I won't add in Mortgage Insurance, Homeowner's Insurance, or HOA fees since they are more or less static throughout these examples.

1st Year Payment 4% 2nd Year Payment 5% 3rd-30 Year Payment 6%
509.40 p & i 572.79 p & i 639.72 p & i
10.00 tax 10.00 tax 233.33 tax

519.40 / mo 582.79 / mo 870.05 / mo

Even if the seller raised the price to "gift" the down payment, which they shouldn't have, but often did, there is no way the 19.79 /mo (the amount of payment that would have been reduced if the buyer put up their own 3,300.00 put them under. Any more than those who were deficit spending 350.00/mo were going to worry about the "skin in the game" and not go into foreclosure.

What happened here is that the buyer was qualified at the first year payment no matter the status of their jobs and potential income growth, or not. The first year in Indiana, you pay for the bare land on taxes, the second year you will owe for the home, but it likely won't be assessed yet. The buyer should be taught to set up a savings account to put an extra 100.00 a month to pay for the second year taxes when due. However, since this usually wasn't done they owe two years in their account the third year. If you look at this you will see that their payment that they qualified for is now 350.65/month lower than the payment they now have, a 68% increase. If they survive that third year the taxes will lower 116.67/mo in year four. Unfortunately many were not able to weather that storm.

Now the next part of the equation. They decide, "We can't afford this house, let's sell it." More bad news. Remember they paid 110,000.00 for a 100,000.00 home. By the time they paid for a Realtor to help them sell it, the seller's closing costs, they were probably upside down about 19,000.00. Meaning they would have to write a check for 19,000.00 to sell it, so they just gave the lender back the keys.

HR-600 is back in committee in the House that would allow DPAs to return. It has provisions attached to it that would carry 1,000,000.00 $ penalties if sellers, lenders, or appraisers manipulated the pricing to add the DPA to the loan, and not use it as the true gift it was always intended. It also has tiered mortgage insurance pricing tied to credit rates. It is a good bill, that would allow thousands of otherwise qualified buyers back into the market. It would be good for them, good for their families, good for our communities, and good for the overall American economy.

Please write your Congressman and ask them to support HR-600.