Can't The Government Ever Make Sense?

Per the WSJ($):

The Internal Revenue Service dealt a serious blow to
organizations that provide down-payment assistance to home buyers in a
ruling that could curtail the ability of lower-income U.S. citizens to
purchase homes.

In the past eight years or so, a number of large
nonprofit organizations -- including Nehemiah Corp. of America, of
Sacramento, Calif., and AmeriDream Inc., of Gaithersburg, Md. -- have
doled out hundreds of millions of dollars of cash down-payment
assistance to mostly low- and moderate-income home buyers. According to
industry estimates, as many as 625,000 people were assisted by such
groups with their down payments between 2000-05. The programs have been
widely viewed as helping to increase the nation's homeownership rates,
which rose to 69% last year from 67% in 1999.

Why?  A lot of the tax code is skewed to promote home ownership.  So why is the IRS penalizing a program that seems to make a lot of sense?

In its ruling yesterday, the IRS said these aid groups funded largely
by home builders and other sellers no longer qualify for tax-exempt
status because the benefits of the programs are going to sellers and
profit-making entities. In its statement, the IRS said it has found
"that organizations claiming to be charities are being used to funnel
down-payment assistance from sellers to buyers through self-serving,
circular-financing arrangements."

Uh-oh.  Its those nasty profit making ventures again.  What's going on here?  Basically a home-builder gives the down payment for a home to a charity which in turn gives it to a buyer who in turn gives it back to the home-builder.  Let's say the down payment is 10%.  This arrangement acts as if the home-builder is giving the buyer a 10% discount, just circuitously.

So why is it so circuitous?  Why don't they just give the discount directly?  Is it some kind of tax dodge?  The answer to the latter is probably not.  From a corporate tax standpoint, the current circuitous charity method produces a 10% charitable donation on a 100% price sale.  The discount approach just produces a 90% price sale.  Tax wise, these are equivalent.  So why doesn't the home-builder, if it wants to be generous to low-income buyers, just give them the discount?

The answer is, because the government does not allow it! 

The majority of home buyers affected by this ruling are those who
qualify for mortgages insured by the Federal Housing Administration, a
federal agency responsible for aiding first-time and lower-income home
buyers. Under FHA guidelines, home buyers seeking mortgages must have
their own funds to use for a down payment or they can get assistance
from a relative, employer or a charity. They can't get assistance
directly from the seller.

The only argument against this practice made by the IRS is that the price of the house is increase by a fee added in the process by the charity that facilitates the transaction.  But this is one of those classic government regulatory jobs where the result that instead of getting a home with a bit of extra fee in the transaction, people will instead not be able to get a home at all.  No one points to anyone being hurt, and in fact the article points out that 35% of FHA loans depend on these charities for down payments.  (There is also some hint that this process may increase default rates, but the only evidence is that default rates for this type of transaction are up --  but default rates on mortgages are up across the board right now.)

And, by the way, what is wrong with charity by a business that, in addition to helping out a charitable cause, also helps out its business?  For example, my company gives coupons for free one-day jetski rentals at Lake Havasu all the time to charity auctions in our area.  We do it to support charity, but also because it provides us some free advertising and often people who win the certificate also show up with friends who become paying customers.  So what?  Is my charity tainted because I have created a win-win? 

  • markm

    "There is a hint that it might increase the default rate." I'd certainly expect that people who couldn't or wouldn't save for a down payment would be greater credit risks, and that those without money of their own in the house wouldn't work quite as hard to avoid defaulting. However, in general the bank would be able to judge the buyer's creditworthiness from other information, so the increase in risk should be pretty small. Banks will make loans to young people whose parents contributed the downpayments...

    "Basically a home-builder gives the down payment for a home to a charity which in turn gives it to a buyer who in turn gives it back to the home-builder. Let's say the down payment is 10%. This arrangement acts as if the home-builder is giving the buyer a 10% discount, just circuitously."

    I have no idea why a tax agency should be concerned with this, but the problem with this circuitous method of discounting is that it gives false information about the market value of the house to the mortgage issuers. If you give a 10% discount on a $100,000 house, the real market value is $90,000. If the buyers default soon and the house has to be repossessed, it's less likely that it will sell for even the full $90,000, let alone enough extra to cover the costs of repossession, cleanup, and sales.

    OTOH, this may be something the FHA should investigate, but not the IRS. Or maybe the IRS thinks it should be getting gift taxes?

    Finally, assuming that the FHA will be the ultimate loser when buyers default and the re-sale doesn't cover everything: I'd prefer the federal government didn't fund welfare at all, but of all the ways the government can and does spend money trying to help the poor, this seems likely to be one of the most effective and least likely to encourage further dependency...

  • Why? A lot of the tax code is skewed to promote home ownership. So why is the IRS penalizing a program that seems to make a lot of sense?

    That's a rhetorical question, right?

  • Next thing you know, they'll be prohibiting the Salvation Army from giving money to poor people, since they spent the money at the grocery store which makes profit from the food they sell.

    Worse yet, the store could be Wal-Mart! 😉

  • Clark

    There are a number of really bad downpayment assistance charities that should have been shut down a long time ago. But, there are also some that are doing some very good work.

    What's really interesting about this situation is the fact that the IRS and HUD have repeatedly approved this as a charitable model. Through these programs, hundreds of thousands of low income homebuyers have been able to purchase a home --- without government assistance.

    For the past three years HUD and FHA have been wanting to replace this program with one of their own --- at taxpayer expense, of course. Todate, HUD has been unable to get congressional support.

    Interesting isn't it that these programs that have been approved by both these agencies for nearly 10 years are now being label "scams".

    Watch for a push for a replacement FHA program that will cost the taxpayer and burden the low-income homebuyer with higher mortgage insurance premiums.

  • Clark

    Why Now?

    There are a number of really bad downpayment assistance charities that should have been shut down a long time ago. But, there are also some, like Nehemiah, that are doing some very good work, legitimately helping low and moderate income homebuyers and also doing innovative charitable work that extends beyond homeownership.

    What's interesting about this situation is that the IRS and HUD have repeatedly approved this as a charitable model. Through these programs, hundreds of thousands of low income homebuyers have been able to purchase a home --- without government assistance.

    For the past three years HUD and FHA have been wanting to replace this program with one of their own --- at taxpayer expense, of course. HUD has been unsuccessful at gaining the needed congressional support.

    Interesting isn't it that these programs that have been approved by both these agencies for nearly 10 years are now being label "scams".

    Watch for a push for a replacement FHA program that will cost the taxpayer and burden the low-income homebuyer with higher mortgage insurance premiums.

  • "Is my charity tainted because I have created a win-win?"

    Yes. Outcomes don't matter, only intentions, and yours are tainted by your own selfish interests. Unless you're talking about a government program/"charity", in which case neither outcomes nor selfish interests are as important as the money spent and the stated intentions of the legislators/regulators/administrators. Thus, public education is an incredible success story.

    Oh wait, I forgot, public education is a complete shambles because the president is a Republican, even though he is spending far more per student even after adjusting for inflation than his predecessor. So, let me amend that rule to add "if the legislators/administrators are of the same party as the person making the determination."

  • mike

    As a former banker, I can tell you the practice is as slimy as they come.

    The reason why the down payment is routed through Nehemiah instead of being discounted from the purchase price? To fraudulently qualify for taxpayer-backed mortgages. As soon as the mortgages are approved by the FHA, they are essentially equivalent to legal tender and can be sold into the wholesale market (in case of default, we taxpayers pick up the bill).

    It's bad enough (worth billions) having the government subsidize mortgages with implicit guarantees (ever wonder why Fannie Mae is always advertising what great things they do?). But actual fraud? C'mon.

    Nehemiah has made over $100MM from defrauding the FHA. I'm not about to quibble over which branch of the government gets credit for shutting down the scam.

  • Mike

    Nehemiah is a clear fraud, transferring money from taxpayers to homebuilders, homebuyers, and Nehemiah. Here's how it works:

    1) Home buyers sometimes pay their mortgages, sometimes they don't. So, their promise to pay (a "mortgage") is not ironclad.
    2) Someone substantial must stand behind the mortgage for it to be freely traded (and for the builder to get the sale price). While the private market can handle this, the government (in the form of FHA, Fannie Mae, Freddie Mac, etc.) subsidizes this function to the tune of billions per year in taxpayer dollars.
    3) The FHA subsidy is limited by a number of rules to ensure some creditworthiness, including making sure there's a substantial down payment.
    4) In this fraud, the builder raises the price and creates a discount. Nehemiah creates the appearance of a down payment from this discount.

    Net result: Nehemiah has made over $100MM from the fraud so far. The money has to come from somewhere. In this case, it is picked out of the taxpayer's pocket.

    Hard to see the libertarian case for this one.

    Mike

  • TC

    Reveloutions generallly happen for a reason,,,,, or two, or three or even more don't they?

    The members of congress take advantage of the tax code on a daily basis, are we to become enraged because somebody else does?

    Help to pass the FAIR tax..... Well if you desire true change!

    If not, then don't!

  • markm

    Mike: Why is the IRS involved in this instead of, say, the FBI and the FHA? It's job is collecting taxes, not investigating non-tax frauds.

  • Mike

    Markm -

    Not really sure why this scam falls into the IRS' lap - maybe because Nehemiah is laundering "donations"?

    I'm not too bothered by the IRS devoting some resources toward this - the scale of this ripoff is stupendous. I wasn't too bothered when I found out Al Capone went away on tax evasion, not murder, extortion, etc. - at least he went to jail.

    Mike

  • mike

    Markm -

    I'd also point out this program is not a great boon for the poor. Instead of renting (housing prices / rent are at all time highs), the new homeowner just hopped into home ownership. At least with with 0% down, he makes infinite returns when prices appreciate.

    Unfortunately, prices can also go down. And the homeowner (who has no cushion) goes bankrupt.

    I've got no problem with allowing adults to enter into messy situations. If someone needs money badly enough to go to a payday lender, I assume they've thought it through. But I'll be damned if we taxpayers should subsidize payday loans (or buying the zero down house or smoking crack).

    Mike

  • Phil

    Eric H said: "As a former banker, I can tell you the practice is as slimy as they come."

    Why? I work for one of these programs. The IRS gave us our non-profit status, and then inspected us and certified us as a non-profit within their guidelines three years ago. We've ALWAYS disclosed our process to them, HUD, and everyone else involved in the transaction. Far from slimy, it's always been fine with IRS until now, and as for HUD, it falls within their guidelines - or it would have been rejected from the beginning, NO?

    BTW, with these programs it's 3% down almost all the time. My typical "grant" is $3-5k. Yes, it takes buyers slightly longer to build equity, but not as long as it does renting.

    As for defaults, they're only slightly higher and HUD already has the means in place for handling lenders and originators who write shaky loans. Their default rates are constantly monitored and they lose their license when it goes too high.

    But this isn't about tax status or circular "schemes" or default rates. It's about a 100% FHA financing plan that can't make it out of committee. There's no pressure to approve the $600M plan (Congressional Budget Office estimate) so long as these downpayment programs are basically turning FHA's 97% into 100%. And if you want to talk about taxpayers subsidizing something- $600 million dollars sounds like a pretty big bill.

  • John Wyatt

    I wanted to clarify for the Banker that we as taxpayers pickup the bill for defaulted federally-insured mortgage whether a down payment assistance program (DPA) is used or not. The govenment decided a long time ago to use taxpayer money to cover the risk in the FHA mortgage portfolio.

  • Chris Russell

    As a founder and former CEO of one of these charity's, AmeriDream, I want to address several misconceptions and false statements made here.

    First, it is mostly false that the taxpayer's bear the risk of mortgage defaults under FHA backed mortgages. FHA is a "self-funding" insurance pool that guarantee's banks the riskiest portion of the mortgage in the event of default. The borrower pays the insurance in his monthly payment and it is called MIP or Mortgage Insurance Premium. Only after the borrower has paid down his mortgage to 80% of value, does the premium payment stop. Morever, they pay a substantial upfront premium. Only if FHA (this is a BIG IF) were to become insolvent, would the taxpayers be ultimately responsible for bailing them out.

    The same could be said of Fannie and Freddie too, even though they are not government agencies. Because of their size, affect on the economy and that they were established by Congress, most people assume the government would bail them out, as well. Yet, you can get a 125% mortgage from Fannie Mae. Why isn't anyone screaming about Fannie's "interest only" loans that have negative amortization and are burying people in their homes right now?

    FHA has been so profitable over the last eight years and their reserve fund has been so over-funded, that they have statutorily been required to lower the premiums FIVE times! Moreover, they have lowered the minimum downpayment from five percent to three percent. Now FHA wants to have its own 100% mortgage product and there is pending legislation in Congress to give it to them.

    FHA is overfunded again this year and there is talk again in congress of reappropriating the surplus into the general fund. This is wrong. they are essentially trying to make FHA a hidden and undisclosed tax program to generate money for the government.

    The IRS is involved because these organizations receive their tax-exempt status from the IRS. If there is tax fraud or criminal misbehavior, it is handed over to the FBI or Dept of Justice. One organization was telling home sellers that they could write of the fee they were paying as a charitable contribution. This is a no-no and they were dragged into court for it.

    No one is being ripped off, by this program existng. To date, there have been over 600,000 families that have purchased a home that otherwise couldn't. Further, the default rate is no different than government dpa programs. Plus, if you only focus on the default rate, you completely miss the fact that 92% of the people that purchased a home this way are paying on time - as agreed!