Downpayments, Tax Credits and Foreclosures: the Stats

Posted by: Theo Francis on June 03

A new Federal Housing Administration program to subsidize homebuyers’ closing costs directly with federal tax credits — instead of making the buyers wait to file a tax return — is drawing some heat.

Critics say subsidizing downpayments and closing costs is likely to attract buyers who otherwise couldn’t afford a house — repeating some of the sins of the housing bubble. So just how much does it matter where a homeybuyer’s downpayment comes from?

Quite a bit, to judge by numbers the FHA sent over late this afternoon.

There are two parts to this: What the source of a downpayment does to foreclosures and defaults, and the resulting exposure to the FHA.

First, the source of a downpayment can make a big difference. For FHA-backed mortgages made in fiscal 2000, the foreclosure rate was 5.95% when homebuyers made the downpayment -- but 7.9% when it came from the buyer's family and 15% when it came, indirectly, from the seller in a practice that is now banned. When downpayment assistance came from a government agency -- eg, a state housing finance agency -- the default rate was 13.1%, more than double the rate when homebuyers coughed up the downpayment themselves.

Similar ratios hold true for loans in more recent years, though the foreclosure rate is lower, since there has been less time for homeowners to fall seriously behind. But the bottom line is clear: Foreclosures are more likely when someone other than the buyer pays the downpayment -- including when that someone is a government agency, as would be the case under the FHA's new program. Much the same is true according to a study in the fall issue of the Journal of Housing Research by Austin Kelly, associate director of model risk for the Federal Housing Finance Agency (Fannie Mae & Freddie Mac's regulator).

Still unclear: How much difference it makes if homebuyers get assistance with other closing costs.

So how much difference does this make for the FHA? It depends when you're talking about.

Historically, borrowers paid the vast majority of downpayments under FHA-backed mortgages. Indeed, the agency formally requires a 3.5% downpayment, and allows only a select group to help the buyer meet this figure -- family, government agencies, employers and nonprofits. That last one allowed a loophole for a number of years, in which sellers funneled money to nonprofits, which then subsidized the downpayment for buyers.

As a result, downpayment assistance from "nonprofits" soared in recent years -- rising to more than a third of all FHA-backed mortgages in early 2008 from just 1.7% in 2000. Borrower downpayments fell to 46% from 76%. Kelly's research, and the FHA's analysis, found that this didn't so much lower costs for buyers and inflate prices for sellers, and Congress recently closed the spigot.

But other downpayment-assistance is scant: Families accounted for 12% to 15% of downpayment help in the last five years, and peaked in recent years at 20% in 2000. Government agencies have never accounted for more than about 5% of downpayments; employers don't even crack 0.2%.

In other words, foreclosure and default risk soars when someone other than the buyer makes the downpayment. But, except for the most recent years, such assistance occurs only in a relatively small proportion of loans, which could limit the FHA's -- and taxpayers' -- overall exposure.

Time will tell if the new push to "monetize" the homebuyer's tax credit changes things.