Loan Programs
Down Payment Assistance Changes
By Dan Smith

Down Payment Assistance Programs

One of the effects of the recent $300 billion mortgage bail out bill has been a change to down payment assistance programs (DAPs) and their relative availability. For those who don’t know, DAPs were designed to assist borrowers with no down payment in purchasing a new home. The DAP provides an alternative source of funds to cover the minimum 3 percent down payment that FHA (and some conventional) loans require. DAPs come in two basic flavors. There is the secondary financing (a second lien/mortgage) option from either a non-profit or government entity. Or the second option is an out right grant from a non-profit or government entity, otherwise known as a gift. It is within the latter category where legislators made distinct changes.

Within the “gift” category was the widely popular “seller funded” DAP. And here is where the controversy begins. You see, FHA has long held that a gift from a charity is a legitimate source of funds for down payment. They also have always maintained a strict prohibition against the seller “gifting” the down payment to a buyer. So what is a seller funded DAP, you ask? Under this scheme, the seller makes a contribution to a specific predetermined charity. The amount of the contribution is equal to the amount of the buyer’s required down payment, plus a small administrative fee. The charity then retains the administrative fee and “gifts” the down payment to the buyer at closing. But as anyone can see, this “laundering” of funds through a charity flies in the face of the strict prohibition against seller provided down payments.

It should be noted that FHA has protested this abuse from early on. At their urging, the IRS stepped into the fray in May of 2006 when it ruled: “…seller-funded programs are not charities because they do not meet the requirements of section 501(c)(3).  Increasingly, the IRS has found that organizations claiming to be charities are being used to funnel down-payment assistance from sellers to buyers through self-serving, circular-financing arrangements.” This ruling revoked the non-profit status of many DAP programs and prevented sellers from deducting this “contribution” from their income taxes. However, it did not stop seller funded DAPs.

Now according to a provision of the mortgage bail out bill, seller funded DAPs will be going away, effective October 1, 2008. (Never a moment too late like most government action … ) So, in what is otherwise a colossal tax being passed on to the average consumer, at least this change creates one small bright spot of real reform.