Saved by the courts

A federal court has temporarily prevented the Department of Housing and Urban Development from fixing a gaping loophole in the federal program that encourages lending to lower-income families.

The Federal Housing Administration insures loans to lower-income families, promising to pay lenders if borrowers don't. That encourages more lending. As for borrowers, there's only one major restriction on participation: They need to make a 3 percent down payment.

An entire industry grew up over the last decade to subvert this requirement. The government allows borrowers to make the down payment with a gift from a non-profit. Companies such as Nehemiah Corporation of America collected 'contributions' from sellers, plus a fee, and then made gifts to borrowers in the same amounts. The practice was particularly popular among homebuilders, who simply built the cost of the contribution into the price of the home.

The solution has been obvious for almost as long: Ban indirect gifts from sellers. But the Clinton administration never quite pulled the trigger. In one of its first acts in office, the Bush Administration canceled a proposed rule banning the gifts.

The result? By 2004, nearly 50 percent of all FHA home-purchase loans involved a down payment 'gift.' Several federal reports, including two by the GAO (summarized here), have found that people who receive down payment gifts are more likely to lose their homes to foreclosure. They are less financially prepared for ownership, and less motivated to stay in the home. The counterargument is that more people get to own homes, but that would appear to be a mixed blessing.

This summer, HUD acted to end the practice. The companies that profit by serving as conduits challenged HUD in court. A judge in the U.S. District Court for the District of Columbia granted a temporary injunction Wednesday. And so the gifts can keep on coming for now.

Nehemiah's comment on the ruling is here.