Mortgage Financing:

Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance

GAO-06-24, Nov 9, 2005

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The Federal Housing Administration (FHA) permits borrowers to obtain down payment assistance from third parties; but, research has raised concerns about the performance of loans with such assistance. Due to these concerns, GAO examined the (1) trends in the use of down payment assistance with FHA-insured loans, (2) the impact that the presence of such assistance has on purchase transactions and house prices, (3) how such assistance influences the performance of these loans, and (4) FHA's standards and controls for these loans.

Almost half of all single-family home purchase mortgages that FHA insured in fiscal year 2004 had down payment assistance. Nonprofit organizations that received at least part of their funding from sellers provided assistance for about 30 percent of these loans and represent a growing source of down payment assistance. However, assistance from seller-funded nonprofits alters the structure of the purchase transaction. First, because many seller-funded nonprofits require property sellers to make a payment to their organization; assistance from these nonprofits creates an indirect funding stream from property sellers to homebuyers. Second, GAO analysis indicated that FHA-insured homes bought with seller-funded nonprofit assistance were appraised at and sold for about 2 to 3 percent more than comparable homes bought without such assistance. Regardless of the source of assistance and holding other variables constant, GAO analysis indicated that FHA-insured loans with down payment assistance have higher delinquency and claim rates than do similar loans without such assistance. Furthermore, loans with assistance from seller-funded nonprofits do not perform as well as loans with assistance from other sources. This difference may be explained, in part, by the higher sales prices of comparable homes bought with seller-funded assistance. Although FHA has implemented some standards and controls on loans with down payment assistance, stricter standards and additional controls could help in managing the risks these loans pose. FHA standards permit assistance from seller-funded nonprofits; in contrast, mortgage industry participants restrict such assistance. Further, government guidelines call for routine identification of risks that could impede meeting program objectives; however, FHA has not conducted routine analysis of the performance of loans with down payment assistance.

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  • Review Pending-GAO has not yet assessed implementation status.
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    Recommendations for Executive Action

    Recommendation: To balance the goals of expanding homeownership and sustaining the actuarial soundness of the Fund by managing the risks associated with loans that involve "gifts" of down payment assistance from nonprofit organizations that receive funding from sellers, the Secretary of HUD should direct the Assistant Secretary for Housing (Federal Housing Commissioner) to ensure that appraisers have the information necessary to establish the market value of the properties by requiring lenders to inform appraisers about the presence of down payment assistance from a seller-funded source.

    Agency Affected: Department of Housing and Urban Development

    Status: Closed - Implemented

    Comments: The intent of the recommendation was met by provisions in the Housing and Economic Recovery Act of 2008, which prohibits seller-funded down payment assistance in conjunction with mortgages insured by the Federal Housing Administration.

    Recommendation: To better understand and manage risks posed by loans with down payment assistance, from any source, the Secretary of HUD should direct the Assistant Secretary for Housing (Federal Housing Commissioner) to more accurately reflect the impact that down payment assistance has on loan performance, and continue to include the presence and source of down payment assistance in future loan performance models. To enhance the actuarial reviews' estimates of claims, the Secretary should also consider including in the annual review of actuarial soundness, the impact that the presence and source of down payment assistance has on claim severity.

    Agency Affected: Department of Housing and Urban Development

    Status: Closed - Implemented

    Comments: Consistent with our recommendation, the contractor that performs actuarial reviews of FHA's insurance fund has continued to include source of down payment as an explanatory variable in its loan performance models. Additionally, in 2009, the contractor incorporated source of down payment as an explanatory variable in its loss severity model.

    Recommendation: To better understand and manage risks posed by loans with down payment assistance, from any source, the Secretary of HUD should direct the Assistant Secretary for Housing (Federal Housing Commissioner) to ensure that FHA has an ongoing understanding of the impact that down payment assistance has on loan performance, implementing routine and targeted performance monitoring of loans with down payment assistance, including analyses that consider the source of assistance.

    Agency Affected: Department of Housing and Urban Development

    Status: Closed - Implemented

    Comments: In response to our recommendation, FHA enhanced its quarterly reports to the FHA Commissioner to include tables showing the number and performance of FHA-insured mortgages with down payment assistance, by source of assistance. Additionally, in its fiscal year 2009 budget submission, HUD established a new risk category for mortgages with seller-funded down payment assistance and estimated a separate credit subsidy rate for those loans.

    Recommendation: To better understand and manage risks posed by loans with down payment assistance, from any source, the Secretary of HUD should direct the Assistant Secretary for Housing (Federal Housing Commissioner) to more fully consider the risks posed by down payment assistance when underwriting loans, including the presence and source of down payment assistance as a loan variable in FHA's Technology Open to Approved Lenders Mortgage Scorecard during the underwriting process.

    Agency Affected: Department of Housing and Urban Development

    Status: Closed - Implemented

    Comments: Consistent with our recommendation, in 2009, HUD began including the presence and source of down payment assistance as a loan variable in FHA's Technology Open to Approved Lenders Mortgage Scorecard during the underwriting process.

    Recommendation: To better understand and manage risks posed by loans with down payment assistance, from any source, the Secretary of HUD should direct the Assistant Secretary for Housing (Federal Housing Commissioner) to provide FHA with data that would permit the agency to identify whether down payment assistance is from a seller-funded down payment assistance provider, modify FHA's "gift letter source" categories to include "nonprofit seller-funded" and "nonprofit nonseller-funded" and requiring lenders to accurately identify and report this information when submitting loan information to FHA.

    Agency Affected: Department of Housing and Urban Development

    Status: Closed - Implemented

    Comments: The intent of the recommendation was met by provisions in the Housing and Economic Recovery Act of 2008, which prohibits seller-funded down payment assistance in conjunction with mortgages insured by the Federal Housing Administration.

    Recommendation: To balance the goals of expanding homeownership and sustaining the actuarial soundness of the Fund by managing the risks associated with loans that involve "gifts" of down payment assistance from nonprofit organizations that receive funding from sellers, the Secretary of HUD should direct the Assistant Secretary for Housing (Federal Housing Commissioner) to revise FHA standards to treat assistance from seller-funded nonprofits as a gift from the seller and, therefore, subject to the prohibition against using seller contributions to meet the 3 percent borrower contribution requirement because down payment assistance provided by seller-funded entities is, in effect, a seller inducement.

    Agency Affected: Department of Housing and Urban Development

    Status: Closed - Implemented

    Comments: The intent of the recommendation was met by provisions in the Housing and Economic Recovery Act of 2008, which prohibits seller-funded down payment assistance in conjunction with mortgages insured by the Federal Housing Administration.