H.R. 600: The Down Payment Laundering Saga Continues . . .
Not to be dissuaded by the fact the IRS referred to seller-funded down payment grants as scams, Representatives Al Green (D-TX), Maxine Waters (D-CA) and Gary Miller (R-CA) continue to champion the cause of "laundered" down payments via H.R. 600.
On January 16, 2008, Rep. Al Green along with co-sponsors Waters and Miller introduced H.R. 600 to restore seller-funded down payment assistance. The proposed bill is similar to H.R. 6694, which was also sponsored by Representatives Green, Waters, and Miller. Although H.R. 6694 had gained support in the House due to the lobbying efforts of the assistance providers, it was cleared from the books after the 110th session of Congress came to an end. H.R. 600 is virtually identical to H.R. 6694 in regard to Sections 1 and 2. The difference between the two bills is that H.R. 6694's Section 3 Limitations on Risk-Based Pricing is excluded from H.R. 600. Most notably, refund of mortgage premiums as payment incentives has been removed from the legislation. Click here to view text of H.R. 600.
The purpose of H.R. 600 is to resuscitate seller-funded down payment assistance (SFDPA) that was recently prohibited under the Housing and Economic Recovery Act of 2008 (H.R. 3221). The prohibition against SFDPA contained in H.R. 3221 (HERA) was in response to HUD's repeated attempts to terminate seller funding of down payments due to excessive risks associated with the practice. HUD asserts that loans involving seller-funded down payment assistance have substantially higher delinquency and default rates than loans without SFDPA. HUD also cites studies from the OIG and GAO as support, and has published no less than 3 proposed rules to eliminate SFDPA since 1999. As a result of their attempts to eliminate SFDPA, HUD has been subjected to litigation from assistance providers who have been generating millions annually in processing fees. While proponents and providers of SFDPA state that HUD and government reports are exaggerated, they do acknowledge that SFDPA programs represent increased risk to FHA. In fact, both H.R. 6694 and H.R. 600 were designed to address the excess risk to FHA involved with SFDPA.
Despite the credit score protections proposed by H.R. 600, the bill specifically exempts borrowers with credit scores above 680 from paying higher risk-based premiums. The proposed legislation also limits credit scores to 620 for loans with SFDPA unless HUD is able determine a premium structure for these loans that would offset the risk to FHA. This is interesting because SFDPA providers cite that they assist minority and low-income borrowers. Yet, according to statistics taken from the "Brill Report" posted on the Ameridream website, 48% of borrowers using SFDPA included in the data set would have been displaced by H.R. 600 for having credit scores below 620. While it is not clear whether limiting credit scores would impact low income or minority borrowers, the opening statements of Maxine Waters at the Financial Services Oversight Hearing on "Credit-Based Insurance Scores" October 2007 is cause for alarm:
"But much more is going on here, clearly. The recent FTC report on the use of credit-based insurance scores in the automobile insurance industry concluded that: There is a strong correlation between credit-based insurance scores and race and ethnicity. More precisely, Blacks and Hispanics are over-represented in the low score percentiles and underrepresented in the higher credit percentiles—for example, 26 percent of blacks had scores in the lowest 10 percent, and 50 percent of blacks had scores in the bottom 23 percent." (Click here to view entire statement)
After reflecting on Waters' statements, I am at a loss to understand why she would support a bill that provides preferential treatment to borrowers with higher credit scores while burdening or displacing borrowers with lower scores. The question has been raised repeatedly without resolution whether credit scores are less favorable toward minority and socioeconomically disadvantaged groups. Based on research concluding that scores for minorities and low income groups are substantially lower, it would seem that credit scoring would not be the preferred criteria for establishing eligibility to assist low income and minorities buyers. Click here to read the report completed by the State of Missouri Department of Insurance titled: Insurance-Based Credit Scores: Impact on Minority and Low Income Populations in Missouri.
Aside from the issue of whether credit scores do or do not favor minorities, there is the issue of whether credit scores are reliable predictors of risk. In an article written by Yuliya Demyanyk, economist at the Federal Reserve Bank of St. Louis, Demyanyk questions credit scores as being an effective predictor of risk. According to Demyanyk:
"For borrowers with the highest credit scores (FICO scores above 700), the serious delinquency rate in 2007 was almost four times as large as in 2005—an increase of nearly 300 percent. In addition, the serious delinquency rate in 2007 for the best-FICO group was almost the same as the rate in 2005 for the worst-FICO group. "
Demyanyk concludes in the article:
'The evidence presented above seems to suggest that the credit score has not acted as a predictor of either true risk of default of subprime mortgage loans or of the subprime mortgage crisis. The subprime mortgage crisis is still a black box, and it requires more analysis to fully understand how the developments in the subprime mortgage market and a subsequent crisis have “subprimed” so many issues that used to be considered fundamental, like credit scoring. '
(The article references a research paper titled: 'Understanding the Subprime Mortgage Crisis' written in 2008 by Demyanyk and Otto Van Hemert that can be downloaded by clicking here).
This leads us to the question of whether it is reasonable to resort to a failed business practice (credit score based risk assessment) to justify engaging in another failed practice (Seller-Funded Down Payment Assistance)- especially when the failed practice is inherently dishonest. While the banking industry is fond of relying on credit scores to determine mortgage risk, credit scores are just a part of risk-assessment. Prior to the current mortgage debacle, risk evaluation which was based on the 5 "C's of credit. Clearly, basing risk on "credit scoring" rather than the 5 "C"s of credit is the type of practice that led to the massive failures in the mortgage industry. Debt to income ratios, balance left over for family support, savings history, reserves, increase to housing expense, and whether the borrower is a minimal or excessive user of credit are also important variables. Ironically, according to the FHA Mortgage Credit Analysis Handbook: 4155.1 Rev 1, Chapter 2, a hierarchy of credit evaluation exists that clearly cannot be ascertained solely through credit scores. According to Chapter 2, Section 1, 2-3, Paragraph 6:
The basic hierarchy of credit evaluation is the manner of payments made on previous housing expenses, including utilities, followed by the payment history of installment debts, and then revolving accounts. Generally, an individual with no late housing or installment debt payments should be considered as having an acceptable credit history, unless there is major derogatory credit on his or her revolving accounts.
Since most landlord and utility companies do not report to the credit bureaus, the most important information required for FHA credit evaluation isn't factored into the credit score. Surprisingly, credit scores are based only in part on payment history. Clearly, man cannot live by credit score alone. To do so is to invite financial bedlam as I am 'sure the banking system can tell you.
Regardless of how you spin it, at the end of the day SFDPA is still the glorified laundering of down payments for a fee. And by laundering, I mean using an intermediary (non profit) to disguise that the down payment is coming from an unacceptable source (seller). This raises the question of why members of the House of Representatives would support legislation that is outright deceptive.
Perhaps its possible to garner a clue from Ameridream and Nehemiah. According to the OpenSecrets website, both spent in excess of $300,000 each during the first 3 quarters of 2008 on lobbyist firms to preserve seller-funded down payment assistance; click here and here to view reports. There is also the email alert that was sent by Ameridream on January 14, 2008 announcing the soon to be proposed legislation. Click here to view Ameridream E-mail alert. H.R. 6694 was announced in a similar manner with both bills being published on the Ameridream website concurrently with being introduced to the House. Additionally, both Nehemiah and Ameridream are heavily involved with grassroots campaigns and maintain a pro-DPA legislation website.
If members of the House of Representatives were truly concerned with expanding housing opportunities, they would work with HUD and strive to create a program that does not involve dishonesty, unnecessary third party fees, funding from prohibited sources, increased sales prices, or exclusion of borrowers from the FHA program based solely on credit scores. Furthermore, to protect the interests of borrowers, taxpayers, and FHA, any program they presented with a reduced or no cash investment would carry a higher mortgage insurance premium without exception, limit total debt to income ratios to a maximum of 36% or other reasonable level, limit housing payment increase to 20%, require mandatory pre-purchase counseling, mandatory completion of budget/credit counseling, and a minimum of 2 months post-closing reserves in addition to predatory lending protections. But that is a topic for another article.
Instead of working on a palatable solution to bridge the housing gap, some members of the House of Representatives are promoting down payment shell games on the taxpayers dime.
