IRS Ruling Could Ruin Dream of Home Ownership for Thousands
The Internal Revenue Service has stripped away the tax-exempt status of several agencies that provide gift-funds as a source of down-payment for thousands of new FHA homeowners each year. This will make buying a home much more difficult, if not impossible for many prospective home buyers.
May 9, 2006 – A recent ruling by the IRS against several major “non-profit” agencies will eliminate them from participating in providing down-payment “gifts” for FHA loan home buyers.
“For most new homeowners, the largest obstacle in getting into a home is the down payment itself,” says Chip Cummings, CMC, a 23-year mortgage industry veteran and best-selling author. “Without the tax-exempt status, these organizations will no longer be able to provide funds directly to borrowers – keeping them from realizing the dream of home ownership.”
Over the last 5 years, more than 625,000 home buyers have taken advantage of the availability of gift-funds to purchase a new home. Now that these agencies will no longer be able to provide these funds for FHA-insured loans, there will be a scramble to try and fill the gap.
Here are some other ways that potential homeowners can still obtain assistance for the down-payment and other required closing costs:
• Gifts from family members, relatives, churches, and other non-profit organizations can be used to finance up to 100% of the required funds
• Several conventional programs allow for up to 100% financing on a home, even with marginal credit scores.
• Many lenders are combining first and second mortgages up to and even exceeding 100%, with an attractive “blended” interest rate.
• Several state and local governments have programs that provide “forgivable loans” or grants.
• Several State housing development agencies provide second mortgages and special programs for low to moderate income families.
Bad news for homebuyers. Good news for small investors. Go get 'em.
Although theoretically these programs have sounded like good ideas, the reality is that in fact the IRS is right on the money here. The organization getting the exemption status has never been the “donor” it is the seller, with the organization getting a fee for putting it all together. In actuality the buyer themselves really just ended financing the down payment and the seller would raise the price of the home to still get their bottom line. As an agent I had two buyers in two different transactions use these programs, recommended by their lenders, and I always felt they were inappropriate. Your other options are certainly better for the buyer and less requiring of the seller, who usually has no personal attachment to the buyer and is being asked to be a sport.
Actually, the IRS is doing these people a favor. Due to the very lax lending policies of the past few years, millions of poeple bought homes that should not. These same people are now starting to lose these homes to foreclosure. Their credit and their lives are destroyed in many cases. So, I say good for the IRS.
This is just a precursor to HUD finally allowing 100% financing on FHA loans. There has been discussion of this for well over 2 years now.
Fannie Mae and Freddie Mac have been offering 100% financing for quite some time.
As one poster indicated before these DPA programs have been utilizing a loop-hole in the underwriting guidelines for FHA that allows for gifts from charitable organizations.
The real downside to these programs is not the 100% financing or the perceived default rates (DPA programs actually have a lower default rate than 97% financing with family gifts as donations, so that hypothesis isn’t entirely supported by fact). The real downside of these programs is the artificially inflated sales price by 3% to accomodate these programs. It’s not a giant margin but it is inflating these sales prices by exactly the amount needed to accomodate the ‘gift’ from the seller to the DPA ‘charity’.
Non-profits usually aren’t this savvy, or quick on the draw-- but they can’t provide assistance directly for home down payments doesn’t mean they can’t provide assistance. They could, for example, provide assistance with RENT for a year which could facilitate savings for a down payment-- or directly to a down payment in a rent to own situation.
DFW is correct. It is the artificial inflation of property values that is the real issue. If you inflate the value by 3% for the down payment, and by up to 6% for closing costs you are artificially raising values by a significant amount. Fannie Mae and Freddie Mac caught on to this before the IRS, and instituted a new appraisal form to stop this very same thing. Now an appraiser is required to state on the appraisal what the house was listed for. This way if the sales house is higher than the listing price they immediately catch on that something is not kosher.
Yes but then they may actually be a non-profit organization. They would provide tangible benefits to the borrower in the form of rent assitance. The problem currently is that the tangible benefit is to the seller/builder/dpa program. The buyer is financing in the 3% downpayment requirement and thus the benefit is lost.
In a rent-to-own situation this is moot as this type of transaction is not subject to FHA financing and thus the HUD rules governing this transaction do not matter.
That’s exactly what they do currently. There isn’t anything immoral or wrong with this as it’s standard to negotiations. However, the fact remains that by increasing the sales prices by seller concessions $ amounts and/or by DPA program $ amounts does inflate prices of comps.
But, that brings us back to the question of ‘what the house is worth’. Ultimately the house is worth what you’re willing to pay for it. So it’s not a question of worth. It’s a question of what the lender is willing to collateralize the houses value at.
Here in CA, people bid over the asking price and ask for cash back at closing. One of my co-workers was selling his house. 3/4 offers were that type. Investors buy a bunch of houses in an area and inflate the sales price $40k. Then they sell at a price above the inflated price since people want to get in before they get priced out.
If that is indeed the case then it would then be time for people to stop blaming ‘lenders’ for lending money on SISA, IO, Hybrid ARM programs for the ‘easy financing’ claims.
Fannie, Freddie, and Ginnie Mae all prohibit cash back at closing unless it’s from a bonafide family gift or part of recorded cash into the transaction by the buyer (i.e. you can get your earnest money back if you have 100% financing, but you can only get the money you already have into the transaction back NOT make a profit on the purchase).
You can’t stop people from doing these types of deals, but it’s defrauding the lenders and then blame should shift to them.
The short term pain might prevent some long term issues. Maybe the IRS has figured out that throwing money at people who were too undisciplined to save for a home eventually leads to homeowners who are too undisciplined to own one. What’s the point of down payment assistance that does nothing more than help some poor sap into a foreclosure situation.
I’m a pre-foreclosure investor (among other areas) and nothing would make me happier than to have that side of my business dry up. It would mean far greater economic opportunity in the big picture than what I make now essentially as a result of people’s misfortune.
Don’t take that last statement to mean that I believe we “take advantage of people that are down and out” or that I believe that people aren’t ultimately responsible for their choices. I’m merely pointing out that I can envision a real estate business where I’m not meeting every day with people having the worst possible experience of their lives.
There are two sides to personal responsibility-- and programs that purportedly “help” people with down payments, and a lending system that allows people to over-leverage themselves are partly to blame. What I mean by that is that lenders are responsible for THEIR actions, and actions have consequences. You wouldn’t make many of these loans as an individual because you could see the default coming-- why don’t the institutions see it?
The answer of course is that they DO see it, and they’re “playing the odds”. This is not only irresponsible to their share owners, but also to the folks who ultimately hold the debt-- US. The taxpayers who subsidize and back these loans.
Is it too radical to suggest that maybe it SHOULD take 10 or 15 years to own a home? That maybe homes would be more affordable if they weren’t artificially propped up by e-z credit?
I doubt they are using comforming loans. They’d run into the 20 loan limit if they do. These are very high-level investors since they are doing this with houses that are $600k+. They obviously have a lot of cash and credit to throw around to make it work. These are the type of people that make offers from out of state without ever seeing the property.
