Standards for Mortgagor's Investment in Mortgaged Property, 27048-27051 [E7-9067]

Agencies

• DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Federal Register Volume 72, Number 91 (Friday, May 11, 2007)]
[Proposed Rules]
[Pages 27048-27051]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-9067]



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Part IV





Department of Housing and Urban Development





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24 CFR Part 203



 Standards for Mortgagor's Investment in Mortgaged Property; Proposed 
Rule

Federal Register / Vol. 72, No. 91 / Friday, May 11, 2007 / Proposed 
Rules

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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR PART 203

[Docket No. FR-5087-P-01]
RIN 2502-AI52


Standards for Mortgagor's Investment in Mortgaged Property

AGENCY: Office of the Assistant Secretary for Housing--Federal Housing 
Commissioner, HUD.

ACTION: Proposed rule.

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SUMMARY: Through this proposed rule, HUD submits, for public comment, 
specific standards governing a mortgagor's investment in property for 
which the mortgage is insured by the Federal Housing Administration 
(FHA). Specifically, this proposed rule would codify HUD's longstanding 
practice, authorized by statute, of allowing a mortgagor's investment 
to be derived from gifts by family members and certain organizations.
    The standards would address a situation in which the mortgagor's 
investment is derived from a gift, loan, or other payment that is 
provided by any donor, including an individual or an organization, and 
would also specify prohibited sources for a mortgagor's investment. The 
proposed rule would establish that a prohibited source of downpayment 
assistance is a payment that consists, in whole or in part, of funds 
provided by any of the following parties before, during, or after 
closing of the property sale: (1) The seller, or any other person or 
entity that financially benefits from the transaction; or (2) any third 
party or entity that is reimbursed directly or indirectly by any of the 
parties listed in clause (1).

DATES: Comments Due Date: July 10, 2007.

ADDRESSES: Interested persons are invited to submit comments regarding 
this rule to the Regulations Division, Office of General Counsel, 
Department of Housing and Urban Development, 451 Seventh Street, SW., 
Room 10276, Washington, DC 20410-0500. Communications should refer to 
the above docket number and title.
    Comment by Mail. Please note that due to security measures at all 
federal agencies, submission of comments by mail often results in 
delayed delivery.
    Electronic Submission of Comments. HUD now accepts comments 
electronically. Interested persons may now submit comments 
electronically through the Federal eRulemaking Portal at 
www.regulations.gov. HUD strongly encourages commenters to submit 
comments electronically. Electronic submission of comments allows the 
commenter maximum time to prepare and submit a comment, ensures timely 
receipt by HUD, and enables HUD to make them immediately available for 
public viewing. Commenters should follow the instructions provided at 
www.regulations.gov to submit comments electronically.
    No Facsimile Comments. Facsimile (Fax) comments are not acceptable. 
In all cases, communications must refer to the docket number and title.
    Public Inspection of Public Comments. All comments and 
communications submitted will be available, without revision, for 
inspection and downloading at www.regulations.gov. Comments are also 
available for public inspection and copying between 8 a.m. and 5 p.m. 
weekdays at the Office of Regulations. Due to security measures at the 
HUD Headquarters building, please schedule an appointment to review the 
comments by calling the Regulations Division at (202) 708-3055 (this is 
not a toll-free number).

FOR FURTHER INFORMATION CONTACT: James Beavers, Acting Director, Office 
of Single Family Program Development, Department of Housing and Urban 
Development, 451 Seventh Street, SW., Washington, DC 20410; telephone 
(202) 708-2121 (this is not a toll-free number). Persons with hearing 
or speech impairments may access this number through TTY by calling the 
toll-free Federal Information Relay Service at (800) 877-8339.

SUPPLEMENTARY INFORMATION: 

Background

    In order for a mortgage to be eligible for insurance by the Federal 
Housing Administration (FHA), section 203(b)(9) of the National Housing 
Act (12 U.S.C. 1709(b)(9)) requires the mortgagor (with narrow 
exceptions) to pay on account of the property at least 3 percent of the 
cost of acquisition. The statute and the implementing regulation at 24 
CFR 203.19 are silent about permissible or impermissible sources of the 
mortgagor's investment, except that some loans are permitted sources 
under the statute. For example, section 203(b)(9) of the National 
Housing Act permits family members to provide loans to other family 
members, and permits the mortgagor's downpayment to be paid by a 
corporation or person other than the mortgagor in certain 
circumstances, such as when the mortgagor is 60 years of age or older, 
or when the mortgage covers a housing unit in a homeownership program 
under the Homeownership and Opportunity through HOPE Act (Title IV of 
Pub. L. 101-625, 104 Stat. 4148, approved November 28, 1990).
    In a 1999 proposed rule, HUD addressed the subject of prohibited 
sources of downpayment assistance. At that time, downpayment assistance 
from seller-funded or reimbursed charitable organizations was a matter 
of concern to HUD. (See HUD's proposed rule published on September 14, 
1999, 64 FR 49956.) In 2001, HUD withdrew the 1999 proposed rule. (See 
January 12, 2001, notice of withdrawal of proposed rule at 66 FR 2851.) 
The matter, however, remains of concern to HUD. Gifts for homeowners' 
downpayments from charitable organizations have continued to raise 
concerns in those cases in which the seller, or any party that 
financially benefits from the transaction, contributes funds to the 
mortgagor's downpayment. A party that might benefit from the 
transaction may be a family member of the seller, a real estate agent, 
or a broker.
    Although FHA has attempted to preclude downpayment funding derived 
from contributions of the seller of the property, some charitable 
organizations have been able to circumvent these restrictions in 
various ways, including the establishment of a fund that provides the 
so-called ``gift'' to the homebuyer. The situations that cause FHA 
concern are primarily those in which the fund is replenished after loan 
closing by the seller who provides a ``charitable donation'' and, in 
some cases, pays a ``service fee'' to the organization from the 
proceeds of the sale of the house and does so only if the homebuyer is 
using the charitable organization's downpayment assistance program. In 
these cases, there is a clear quid pro quo between the homebuyer's 
purchase of the property and the seller's ``contribution'' or payment 
to the charitable organization. This is also true if the contribution 
to the charitable organization comes from an entity other than the 
seller that has an expectation of being reimbursed by the seller. 
Often, these contributions function as an inducement to purchase the 
home.
    FHA's primary concern with these transactions is that the sales 
price is often increased to ensure that the seller's net proceeds are 
not diminished, and such increase in sales price is often to the 
detriment of the borrower and FHA. A Government Accountability Office 
(GAO) report released in 2005 entitled ``Mortgage Financing Actions 
Need to Help FHA Manage Risks from New Loan Products'' (GAO Mortgage 
Financing Report) stated that Fannie Mae and Freddie Mac do not allow

[[Page 27049]]

seller-related contributions to the downpayment, and that seller-
related contributions could contribute to an overvaluation of the price 
of the property (GAO Mortgage Financing Report at page 16).
    In May 2006, the Internal Revenue Service (IRS) addressed these 
same concerns by issuing Revenue Ruling 2006-27, which provides 
guidelines on organizations that may provide downpayment assistance to 
homebuyers and qualify as tax-exempt charitable or educational 
organizations under Internal Revenue Code (IRC) section 501(c)(3), and 
those that do not qualify for this tax-exempt status. The IRS, in its 
press announcement of the ruling, stated that funneling downpayment 
assistance from sellers to buyers through ``self-serving, circular-
financing arrangements'' is inconsistent with operation as a section 
501(c)(3) charitable organization. The IRS stated that, in a typical 
scheme, there is a direct correlation between the amount of the 
downpayment assistance provided to the buyer and the payment received 
from the seller, the seller pays the organization only if the sale 
closes, and the organization usually charges an additional fee for its 
services. The IRS noted that so-called charities that manipulate the 
system do more than mislead honest homebuyers; these organizations 
ultimately cause an increase in the cost of the home and damage the 
image of honest, legitimate charities. (See IRS News Release of May 4, 
2006, at https://www.irs.gov/newsroom/article/0,id=156675,00.html.)
    As the IRS also noted in its press release, inflated sales prices 
are often found on properties purchased with downpayment assistance 
from seller-funded nonprofit programs. Unlike true gifts that reduce 
the amount of the purchase price financed by the homeowner, such seller 
contributions increase the sales price of the home and result in higher 
mortgage payments. As noted by the revenue ruling, inflated sales 
prices result in inflated mortgage amounts, which increase the severity 
of individual claims on the FHA Insurance Fund and FHA losses on claims 
paid on such mortgages. Given that seller-funded gift programs thrive 
in stagnant or depreciating housing markets, the risk to FHA increases 
if FHA cannot recover the full amount owed when FHA acquires and 
resells a home that had been purchased by a participating borrower who 
had defaulted on the FHA-insured loan.

This Proposed Rule

    This proposed rule would codify standards regarding the use of 
gifts as a source of the mortgagor's investment in the mortgaged 
property, and would also specify prohibited sources for a mortgagor's 
investment. Permissible sources of gifts as a source of the mortgagor's 
investment include a family member, a governmental or public agency, 
the borrower's employer or labor union, and a charitable organization 
that qualifies as a tax-exempt charitable or educational organization 
under section 501(c)(3) of the IRC of 1986. The proposed rule would 
establish that a prohibited source of downpayment assistance is a 
payment that consists, in whole or in part, of funds provided by any of 
the following parties before, during, or after closing of the property 
sale: (1) The seller, or any other person or entity that financially 
benefits from the transaction; or (2) any third party or entity 
(referred to as a ``donor'') that is reimbursed directly or indirectly 
by any of the parties listed in clause (1). The use of the term 
``indirectly'' in this proposed rule precludes the seller from 
providing the donor with funds through an individual or organization 
other than the seller, such as a family member of the seller. The use 
of the term ``financially benefits'' in this proposed rule is intended 
to capture, for example, real estate agents or real estate brokers who 
would benefit from the sale of the home to the mortgagor. The concern 
is that the problems with seller-funded contributions, as described 
earlier in this preamble, exist regardless of the route by which the 
funds are provided to the mortgagor.
    A prohibited source of downpayment assistance, as defined in this 
rule, would apply to sales of existing homes by private sellers as well 
as sales by builders, developers, and others involved in new 
construction, or any party that financially benefits from the 
transaction. HUD would not allow any form of downpayment assistance, in 
any of its programs, if the downpayment assistance is derived, in whole 
or in part, directly or indirectly, from prohibited funds as described 
in this rule.
    While the proposed rule is intended to prevent sellers from funding 
downpayments in their own home sales transactions, the proposed rule is 
not intended to preclude sellers from contributing to charitable 
organizations, which are often sources of donor downpayment assistance, 
that provide downpayment assistance that is unrelated in any manner to 
any properties sold by the seller. In addition, the rule is not 
intended to preclude reasonable assistance with closing costs not 
related to the minimum investment, which may be permitted under local 
practice. Nothing in this rule proposes to change HUD's policy of 
allowing builders and other sellers to offer cash incentives to 
homebuyers, provided that any cash or cash equivalent given to a 
homebuyer before, at, or after closing results in a proportionate 
reduction to the mortgage; an amount which the homebuyer then would 
have to provide as additional funds at closing. The primary focus of 
this rule is to establish appropriate standards for downpayment 
assistance to a homebuyer that is categorized as a gift.
    HUD currently requires that the gift to the borrower that is to 
serve as an investment in the property to be purchased must be 
documented in writing. The lender must document the gift funds through 
a letter signed by the donor and the borrower specifying, among other 
things, information about the donor, that no repayment by the borrower 
is required, and describing the relationship between the donor and the 
borrower. This proposed rule does not propose to change these current 
practices. Therefore, given the continued concerns about gifts based on 
seller-funded contributions, this rule proposes the following 
regulatory changes to 24 CFR 203.19.
    HUD's current regulation of the mortgagor's minimum payment 
requirement is found at 24 CFR 203.19. As proposed to be revised by 
this rule, Sec.  203.19 would have the following organization:
    Paragraph (a) would require a mortgagor to have the funds needed to 
complete the transaction (payment of purchase price and settlement 
costs) in addition to the funds provided by the insured mortgage. This 
basic policy was previously stated only in a handbook rather than a 
regulation, but it is a basic requirement of mortgage lending and does 
not represent a new substantive policy.
    Paragraph (b) would correspond with the first part of section 
203(b)(9) of the National Housing Act by stating the basic rule for a 3 
percent mortgagor cash investment. The statute and the current 
regulation give HUD the discretion to require more than 3 percent, but 
it is no longer necessary to reserve this discretion in regulations. In 
practice, HUD has not required more than 3 percent, except as needed to 
satisfy the basic requirement for cash sufficient to close the 
transaction (as stated in proposed new paragraph (a)). Both the statute 
and the current regulation exempt the following from the 3 percent 
requirement: (1) Veterans who can qualify under section 203(b)(2) of 
the

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National Housing Act and (2) disaster victims who can qualify for 100 
percent mortgage financing under section 203(h) of the National Housing 
Act. However, HUD's current regulation in Sec.  203.19(a)(2) imposes a 
$200 minimum cash investment requirement for those mortgagors. That 
$200 requirement is no longer meaningful in relation to vast increases 
in home values and mortgage amounts since the $200 requirement was 
adopted, and HUD proposes to delete it from the regulations in the 
interest of simplifying mortgage processing.
    Paragraph (c) of the proposed rule would establish prohibited 
sources of downpayment assistance, as discussed in this preamble. HUD, 
however, has recognized local market practices in which sellers 
customarily agree to pay some of the buyer's closing costs. Beginning 
in the mid-1980's, HUD's administrative policies reflected in mortgagee 
letters and handbooks have permitted some seller contributions, 
consistent with local market practices that would be reflected in local 
appraisal practices, but never more than 6 percent of the purchase 
price. Proposed paragraph (c) will not prohibit reasonable seller 
contributions to closing costs.
    Paragraph (d) would state the general policy that funds from loans 
or gifts may not be used for any part of the mortgagor's minimum 
investment, unless otherwise permitted by the rule.
    Paragraph (e), like current Sec.  203.19(b), would identify certain 
loan sources authorized by statute. The paragraph would clearly state 
HUD's historical understanding of the congressional intent behind 
section 203(b)(9) of the National Housing Act, which is that loans are 
a forbidden source of the 3 percent minimum investment unless a statute 
provides otherwise.
    Paragraph (e) would also include certain statutory authorizations 
on which HUD relies, but which are currently not stated or referenced 
in regulations (family loans and government loan programs). Although 
paragraph (e) would restrict only the use of loans for the 3 percent 
minimum cash investment and would not apply to the rest of the required 
investment, it is important to note that 24 CFR 203.32 contains 
restrictions on secondary financing that is unsecured or secured by the 
home. Paragraph (e) would not supersede Sec.  203.32.
    Finally, paragraph (f) would list the limited permissible sources 
of gifts.

Findings and Certifications

Regulatory Planning and Review

    The Office of Management and Budget (OMB) reviewed this rule under 
Executive Order 12866, Regulatory Planning and Review. OMB determined 
that this rule is a ``significant regulatory action,'' as defined in 
section 3(f) of the Order (although not an economically significant 
regulatory action under the Order). The docket file is available for 
public inspection in the Regulations Division, Office of General 
Counsel, Room 10276, 451 Seventh Street, SW., Washington, DC 20410-
0500. Due to security measures at the HUD Headquarters building, please 
schedule an appointment to review the docket file by calling the 
Regulations Division at (202) 708-3055 (this is not a toll-free 
number).

Environmental Review

    A Finding of No Significant Impact is not required for this 
proposed rule. Under 24 CFR 50.19(b)(6), this proposed rule is 
categorically excluded from the requirements of the National 
Environmental Policy Act (42 U.S.C. 4332 et seq.).

Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) (5 U.S.C. 601 et seq.) 
generally requires an agency to conduct a regulatory flexibility 
analysis of any rule subject to notice and comment rulemaking 
requirements, unless the agency certifies that the rule will not have a 
significant economic impact on a substantial number of small entities.
    The purpose of this rule, as noted in the preamble, is to establish 
standards regarding the use of gifts by borrowers with an FHA-insured 
mortgage--primarily standards that would address gifts by charitable 
organizations--as a source of an FHA mortgagor's investment in the 
mortgaged property. To date, HUD's practice has been to limit 
permissible sources of gifts to family members, governmental agencies, 
employer of the mortgagor, labor union of the mortgagor, or charitable 
organizations. HUD is not narrowing the sources of gifts through this 
rulemaking but rather striving to ensure that gifts are gifts and that 
especially in the situation of gifts from charitable organizations, the 
gift is not a quid pro quo between the homebuyer's purchase of the 
property and the seller's ``contribution'' or payment to the charitable 
organization.
    The prohibited sources of downpayment assistance, as structured in 
this proposed rule, are narrow and should not encompass a substantial 
number of small entities that are engaged in downpayment assistance to 
homebuyers, which, to date, have primarily been charitable 
organizations with tax-exempt status.
    As noted earlier in this preamble, the IRS, in Revenue Ruling 2006-
27, has ruled that an organization that relies ``on sellers and other 
real-estate related businesses that stand to benefit from the 
transaction'' to finance downpayment assistance provided as part of the 
same transaction does not qualify as charitable organizations described 
in section 501(c)(3) of the IRC. Organizations that meet the criteria 
of section 501(c)(3) qualify for exemption from federal income taxation 
pursuant to IRC section 501(a). HUD's proposed rulemaking will not have 
any significant economic impact on small entities that qualify as 
charitable organizations described in section 501(c)(3) of the IRC and 
are exempt from tax under section 501(a) of the IRC because existing 
law prevents those organizations from providing seller-financed 
downpayment assistance while maintaining their tax-exempt status.
    The IRS ruling also describes two organizations that provide 
downpayment assistance and qualify as charitable organizations 
described in section 501(c)(3) of the IRC and are exempt from tax under 
section 501(a) of the IRC. These organizations do not accept 
contributions from sellers that are contingent upon the sale of the 
seller's property. They follow additional policies and procedures that 
ensure that any benefit to sellers or other parties with an interest in 
selling homes is incidental to any transaction in which the charitable 
organization provides downpayment assistance. The organizations will 
accept contributions from property sellers, but only if the 
contributions are not contingent on the sale of the seller's property 
or a quid pro quo for the sale of the property. HUD's proposed rule 
permits downpayment assistance to be provided by section 501(c)(3) 
organizations in a manner consistent with the IRS ruling.
    Charitable organizations, large or small, remain eligible to 
provide downpayment assistance to FHA mortgagors, subject to meeting 
the requirements of Sec.  203.19, as proposed to be revised by this 
rule. HUD's proposed rule does not preclude gifts from charitable 
organizations that provide housing assistance in a manner that is 
consistent with operation for exclusively charitable purposes.
    Accordingly, the undersigned certifies that this rule will not have 
a significant economic impact on a substantial number of small 
entities.

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Notwithstanding this determination, small entities are specifically 
invited to comment on whether this proposed rule will significantly 
affect them, and to make any recommendations on alternatives for 
compliance with the requirements of this rule. Comments should be 
submitted in accordance with the instructions in the DATES and 
ADDRESSES sections in the preamble of this proposed rule.

Executive Order 12612, Federalism

    The General Counsel, as the Designated Official under section 6(a) 
of Executive Order 12612, Federalism, has determined that this proposed 
rule would not have ``federalism implications'' because it does not 
have substantial direct effects on the states (including their 
political subdivisions), or on the distribution of power and 
responsibilities among the various levels of government. This proposed 
rule solely addresses requirements under HUD's FHA mortgage insurance 
programs.

Unfunded Mandates Reform Act

    Title II of the Unfunded Mandates Reform Act of 1995 (Pub. L. 104-
4, approved March 22, 1995) established requirements for federal 
agencies to assess the effects of their regulatory actions on state, 
local, and tribal governments, and the private sector. This proposed 
rule does not impose any federal mandates on any state, local, or 
tribal governments or the private sector within the meaning of the 
Unfunded Mandates Reform Act of 1995.

Catalog of Federal Domestic Assistance

    The Catalog of Federal Domestic Assistance Number for the principal 
FHA single-family mortgage insurance program is 14.117. This proposed 
rule would also apply through cross-referencing to FHA mortgage 
insurance for condominium units (14.133), and other smaller single-
family programs.

List of Subjects in 24 CFR Part 203

    Loan programs--housing and community development, Mortgage 
insurance, Reporting and recordkeeping requirements.

    Accordingly, the Department proposes to amend 24 CFR part 203, as 
follows:

PART 203--SINGLE FAMILY MORTGAGE INSURANCE

    1. The authority citation for part 203 continues to read:

    Authority: 12 U.S.C. 1709, 1710, 1715b, 1715z-16, and 1715u; 42 
U.S.C. 3535(d).

    2. Section 203.19 is revised to read as follows:


Sec.  203.19  Mortgagor's investment in the property.

    (a) Required funds. The mortgagor must have available funds equal 
to the difference between:
    (1) The cost of acquisition, which is the sum of the purchase price 
of the home and settlement costs acceptable to the Secretary; and
    (2) The amount of the insured mortgage.
    (b) Mortgagor's minimum cash investment. The required funds under 
paragraph (a) of this section must include an investment in the 
property by the mortgagor, in cash or cash equivalent, equal to at 
least 3 percent of the cost of acquisition as determined by the 
Secretary, unless the mortgagor is:
    (1) A veteran meeting the requirements of Sec.  203.18(b); or
    (2) A disaster victim meeting the requirements of Sec.  203.18(e).
    (c) Restrictions on seller funding. Notwithstanding paragraphs (e) 
and (f) of this section, the funds required by paragraph (a) of this 
section shall not consist, in whole or in part, of funds provided by 
any of the following parties before, during, or after closing of the 
property sale:
    (1) The seller or any other person or entity that financially 
benefits from the transaction; or
    (2) Any third party or entity that is reimbursed, directly or 
indirectly, by any of the parties described in paragraph (c)(1) of this 
section.
    (d) Gifts and loans usually prohibited for minimum cash investment. 
A mortgagor may not use funds for any part of the minimum cash 
investment under paragraph (b) of this section if the funds were 
obtained through a loan or a gift from any person, except as provided 
in paragraphs (e) and (f) of this section, respectively.
    (e) Permissible sources of loans.
    (1) Statutory authorization needed. A statute must authorize a loan 
as a source of the mortgagor's minimum cash investment under paragraph 
(b) of this section.
    (2) Examples. The following loans are authorized by statute as a 
source for the minimum investment:
    (i) A loan from a family member, a loan to a mortgagor who is at 
least 60 years old when the mortgage is accepted for insurance, or a 
loan that is otherwise expressly authorized by section 203(b)(9) of the 
National Housing Act;
    (ii) A loan made or held by, or insured by, a federal, state, or 
local government agency or instrumentality under terms and conditions 
approved by the Secretary; and
    (iii) A federal disaster relief loan.
    (f) Permissible sources of gifts. The following are permissible 
sources of gifts or grants used for the mortgagor's minimum investment 
under paragraph (b) of this section:
    (1) Family members and governmental agencies and instrumentalities 
eligible under paragraphs (e)(2)(i) and (ii) of this section;
    (2) An employer or labor union of the mortgagor;
    (3) Charitable organizations exempt from taxation under section 
501(a), pursuant to section 501(c)(3) of the Internal Revenue Code of 
1986, subject to paragraph (c) of this section;
    (4) Disaster relief grants; and
    (5) Other sources as may be approved by the Secretary on a case-by-
case basis.

    Dated: April 13, 2007.
Brian D. Montgomery,
Assistant Secretary for Housing-Federal Housing Commissioner.
 [FR Doc. E7-9067 Filed 5-10-07; 8:45 am]
BILLING CODE 4210-67-P