How Does FHA Downpayment Assistance Work?

History

FHA started in 1934, as a means of putting the real estate industry back on track. During the recession, construction workers had no jobs and most Americans rented, since there were no viable financing options to help them buy homes. Interest rates were through the roof, lenders made it difficult to qualify and loan terms were bad. By insuring the loans, FHA made it possible for lenders to set more reasonable rates and exercises flexibility in their standards. Over the years, FHA has helped to recuperate housing markets in difficult times.

"HUD has long recognized the important role that down payment assistance through secondary financing plays in providing affordable housing opportunities," says the department's website. The mechanism by which homebuyers obtain money from a third party organization to offset the costs of buying a home, is formally known as "Downpayment Assistance through Secondary Financing Providers (DAP)," according to HUD, though the real estate industry commonly refers to them simply as "down payment assistance programs." A HUD-approved DAP supplements financing in conjunction with an FHA-insured first mortgage.

According to HUD, there are three categories of DAP assistance providers: nonprofit and nonprofit instrumentality of government DAPs; government entity DAPs; and gift programs. Nonprofits, with approval form HUD, may administer down payment assistance with FHA. As a nonprofit organization or government instrumentality they may provide assistance in the form of a lien in conjunction with an FHA first lien. Government entities, state or local, may provide secondary financing in the form of a lien subordinate to an FHA first mortgage lien. HUD maintains a list of approved providers on the Nonprofit Organization Roster, at its website. Finally, charitable organizations that comply with HUD's existing policy guidelines and regulations, may give cash gifts to eligible homebuyers. The grant money from federal tax-exempt parties can be used for all, or part, of the borrower's down payment, according to HUD.

Federal, state and local governments as well as nonprofit agencies considered instrumentalities of government may provide secondary financing for the borrower's entire amount of required funds to close, according to the FHA Handbook. The borrower may not receive cash-back as a result of secondary financing or down payment assistance. The sum of the liens may not exceed the cost to acquire the property and may exceed the appraisal value in certain cases---for instance, FHA revitalization loans. Down payment assistance works with one- to four-unit family residences in conjunction with fixed or adjustable rate FHA first mortgages. It may also be used with condominiums or town homes located within FHA-certified projects. Certain DAPs may require a minimum borrower contribution.

In 2008, FHA did away with a type of down payment assistance program that allowed sellers to contribute funds to a low or moderate-income buyer through a non-profit organization. In addition to paying a fee, the seller would "donate" the necessary funds to close, essentially restructuring the purchase so the price of the home would absorb the cost of the seller's contributions. The buyer could then obtain an FHA first lien with minimal investment. Nehemiah and AmeriDream were two of the most notable non-profits who assisted buyers in this process, according to businessweek.com. Because FHA noticed a disproportionate rate of default among borrowers who obtained their homes this way, it banned the practice, prohibiting sellers from contributing to the purchase of their propertys through down payment assistance.