Standards for Mortgagor's Investment in Mortgaged Property: Additional Public Comment Period, 33941-33955 [08-1356]

Agencies

• DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

[Federal Register Volume 73, Number 116 (Monday, June 16, 2008)]
[Proposed Rules]
[Pages 33941-33955]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 08-1356]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 203

[Docket No. FR-5087-N-04]
RIN 2502-AI52


Standards for Mortgagor's Investment in Mortgaged Property: 
Additional Public Comment Period

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

ACTION: Proposed rule; reopening of comment period.

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SUMMARY: This document provides additional background information and 
requests additional public comment for HUD's rulemaking on Standards 
for Mortgagor's Investment in Mortgaged Property.

DATES: Comment Due Date: August 15, 2008.

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 https://
www.regulations.gov. HUD strongly encourages commenters to submit 
comments electronically. Electronic submission 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 https://
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 https://www.regulations.gov. Comments are 
also available for public inspection and copying between 8 a.m. and 5 
p.m. weekdays at the Regulations Division.

[[Page 33942]]

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: Margaret Burns, Director, Office of 
Single Family Program Development, Department of Housing and Urban 
Development, 451 Seventh Street, SW., Washington, DC 20410; telephone 
number 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: 
    With this notice, HUD is republishing, for public comment, a 
proposed rule that would amend HUD policy concerning downpayment 
assistance for Federal Housing Administration (FHA) borrowers. HUD's 
current policies in connection with downpayment assistance have given 
rise to a practice known informally as seller-funded downpayment 
assistance that has resulted in disproportionately high borrower 
default and claim rates among FHA borrowers. Over time, the rate of 
defaults, foreclosures, and claims has increased so dramatically that 
the practice has significantly jeopardized FHA's ability to maintain 
the solvency, as discussed herein, of its insurance fund and to 
facilitate the provision of affordable home financing to millions of 
American families.
    HUD's proposal, if implemented, will without question exact a major 
change in its downpayment assistance policy. It would eliminate a 
practice that has heretofore been allowable and that has been actively 
engaged in for many years. Even so, the conceptual basis for the change 
is consistent with a downpayment assistance policy that has been in 
existence from the inception of the FHA single family insurance 
program.
    HUD's current policy disallows downpayment assistance directly from 
an entity, such as a seller of a home, that would derive a financial 
benefit from the sale. The basis for this policy is that such an 
entity, standing to derive a financial benefit from the sales 
transaction, may promote its own interest in the transaction to the 
detriment of the buyer. The current policy is aimed at ensuring that 
downpayment assistance is indeed a gift to the borrower and that it 
will not ultimately distort the economics of the transaction to the 
detriment of the borrower and HUD.
    HUD's proposal to amend its regulation is based on this same 
premise, and seeks to disallow downpayment assistance from any entity 
that stands to derive a financial benefit from the sales transaction. 
The major proposed change to HUD's downpayment assistance policy is 
that it would apply this prohibition irrespective of whether that 
assistance is made directly or indirectly to the homebuyer. The data 
displayed in this notice clearly demonstrates the adverse impact of 
allowing the current policy to continue. HUD is concerned not only 
about the practice itself, but also about the consequences of the 
practice on homebuyers participating in FHA insurance programs and on 
the FHA insurance fund that is there to serve those homebuyers. A 
practice simply cannot be tolerated when default rates and claim rates 
for more than a third of home purchase loans it insures range between 2 
and 3 times those applicable to the norm. The counterargument that many 
people have been helped into homeownership by this practice, even if 
accepted at face value, pales in light of the damage done to homebuyers 
who have not been able to retain their homes and to FHA's ability to 
meet its mission of increasing access to sustainable homeownership.
    Understanding that the current situation is untenable, HUD has 
grappled with the issue of how to best address the problem over a 
period of years. This is evidenced in actions, discussed in the text 
below, that include exploring rulemaking and legislative solutions that 
did not come to fruition. While HUD will consider alternative measures 
to eliminating the practice, piecemeal solutions do not cure but only 
postpone a viable solution, while extending the damage. In essence, 
borrowers are being harmed and the solution does not lie in spreading 
the damaging consequences among an even broader universe of borrowers. 
The FHA insurance fund is teetering on credit insolvency. Such a 
circumstance is never welcomed, but especially not when the FHA is 
trying to be a stabilizing force during the worst housing crisis in 
generations.
    Therefore, HUD is proposing an action that would advance the 
interests of the public and is a reasonable exercise of agency 
discretion.
    HUD's decision to publish this notice is responsive to court orders 
issued by the U.S. District Courts for the Eastern District of 
California, on February 29, 2008, and the District of Columbia, on 
March 5, 2008.
    On October 1, 2007, HUD published a final rule entitled ``Standards 
for Mortgagor's Investment in Mortgaged Property'' (72 FR 56002). Like 
the rule reproposed for comment here, that rule sought to eliminate the 
use of downpayment assistance from financially interested parties in 
FHA-insured single-family mortgages. The October 1, 2007, final rule 
was challenged in the U.S. District Court for the District of Columbia 
and in the U.S. District Court for the Eastern District of California 
by organizations that provide seller-funded downpayment assistance, as 
defined herein. On February 29, 2008, the U.S. District Court for the 
Eastern District of California set aside the final rule and remanded 
the matter to HUD for further action consistent with its order. 
Nehemiah Corporation of America v. Jackson, et al., No. S-07-2056 (E.D. 
Cal.). The court found, among other things, that HUD failed 
forthrightly to explain that the rule reversed its prior practice of 
allowing seller-funded downpayment assistance (Id. at 19-20) and that 
HUD failed to respond adequately to certain categories of comments (Id. 
at 21-24). The court also disqualified then-HUD Secretary Alphonso 
Jackson from participating in the remanded proceedings.
    After issuing an order on October 31, 2007, preliminarily enjoining 
HUD's enforcement of the final rule, on March 5, 2008, the U.S. 
District Court for the District of Columbia vacated the final rule and 
also remanded it to HUD for further proceedings consistent with that 
court's opinion. Ameridream Inc., et. al., v. Jackson, No. 07-1752 
(D.D.C. March 5, 2008) and Penobscot Indian Nation, et. al., v. HUD, 
No. 07-1282-PLF (D.D.C. March 5, 2008). The court found, among other 
things, that HUD violated the Administrative Procedure Act by failing 
to allow comment on critical factual material and by failing to offer a 
rational explanation for the final rule. Id. at 6. The court held that 
an internal analysis of HUD's loan portfolio referenced only in the 
final rule constituted critical factual information that, with at least 
a summary of the specific data and methodology on which the analysis 
relied, should have been disclosed during the rulemaking proceeding. 
Id. at 11-12. The court also held that HUD's explanation for the rule 
relied on sources that did not support its conclusions. Id. at 18.
    Pursuant to the courts' orders, this publication provides notice 
that now former Secretary Jackson, who resigned effective April 18, 
2008, has not participated in the further promulgation of the rule 
proposed on May 11, 2007, entitled ``Standards for Mortgagor's 
Investment in Mortgaged Property'' (72 FR 27048). HUD will separately 
publish

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a notice vacating the October 1, 2007, final rule. This publication 
also addresses the courts' concerns by acknowledging that the proposed 
rule marks a clear departure from HUD's prior practice. With respect to 
the concern that HUD previously had failed to provide critical factual 
information and otherwise provided an insufficient rationale for the 
rule, this notice provides additional explanation and data, including 
analyses of HUD's loan portfolio and access to the data on which those 
analyses rely. The Regulatory Flexibility Act section has been revised 
to address only the impact on entities that would be directly affected 
by the rule. This notice also reopens the comment period for 60 days 
for the submission of comments on that additional information and on 
the May 11, 2007, proposed rule, as revised by the October 1, 2007, 
rule. At the end of the comment period, HUD will review the comments 
and determine whether to issue a final rule, and will publish a 
response to significant comments as appropriate. To address the courts' 
concern with HUD's response to prior public comments, if HUD decides to 
issue a final rule, HUD will also provide additional responses to those 
significant comments submitted in response to the May 11, 2007, Notice 
of Proposed Rulemaking.
    If, after reviewing the comments, HUD issues a final rule, it would 
be effective 180 days from the date of publication with regard to all 
insured mortgages involving properties for which contracts of sale are 
dated on or after the effective date.

I. The Proposed Rule

    Section 203(b)(9) of the National Housing Act (12 U.S.C. 
1709(b)(9)) requires, for a mortgage to be eligible for insurance by 
FHA, the mortgagor (with narrow exceptions) to pay on account of the 
property at least 3 percent of the cost of acquisition. The current 
implementing regulations at 24 CFR 203.19 are silent about permissible 
or impermissible sources of the mortgagor's investment, although some 
sources are specifically permitted under the statute.\1\
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    \1\ 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).
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    Paragraph 2-10.C. of FHA's underwriting guidelines, HUD Handbook 
4155.1, has long provided that the 3 percent cost of acquisition, i.e., 
the downpayment, may include an ``outright gift'' to the borrower from 
relatives, charitable organizations, government entities, and certain 
others. (HUD Handbook 4155.1 is available at https://www.hud.gov/
offices/adm/hudclips/handbooks/hsgh/4155.1/index.cfm.) It further 
provides, however, that gifts may not be made by any person or entity 
with an interest in the sale of the property. Such payments are 
considered self-interested inducements to purchase a particular 
property rather than true gifts for the borrower's personal investment. 
In other words, downpayment assistance from those who receive a 
financial benefit from the sale may promote the sale on any terms, even 
terms that may be adverse to the sustainability of the borrower's 
mortgage and homeownership. A disinterested gift of downpayment funds, 
on the other hand, does not distort the fundamental economics of the 
transaction and so does not conflict with the borrower's interest in 
achieving sustainable homeownership.
    On May 11, 2007, HUD published a proposed rule to do two things: 
codify standards governing a mortgagor's investment in property with a 
mortgage insured by FHA, and specify prohibited sources for a 
mortgagor's investment. Specifically, the proposed rule would have 
codified HUD's longstanding practice of allowing a mortgagor's 
investment to be derived from gifts by family members and certain 
organizations, but not from gifts by sellers or other persons that 
financially benefit from the transaction. It had also been HUD's 
practice to permit a mortgagor's investment to be derived from funds 
provided by charitable organizations that were ultimately reimbursed 
directly or indirectly by sellers of the properties involved in the 
transactions. The May 11, 2007, proposed rule marked a clear departure 
from this last-noted practice. The rule would have established 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). 
Throughout this preamble, such a third-party payment as described in 
clause (2) is referred to as ``seller-funded downpayment assistance'' 
(SFDPA).
    HUD concluded that this practice permits the seller or other party 
that financially benefits from the transaction to accomplish indirectly 
what could not be done directly. For example, when funds are advanced 
to the buyer by a downpayment assistance provider that is reimbursed by 
the seller, there is a quid pro quo between the homebuyer's purchase of 
the property and the seller's ``contribution'' to the downpayment 
assistance provider. This scheme facilitates the sale at terms 
potentially more favorable to the seller and, because funds are 
fungible, it is reasonable to conclude that the donor's funds are the 
equivalent of the seller's funds. Viewed in this way, it becomes 
apparent that a prohibited inducement to purchase is present in these 
transactions, and HUD has concluded that such payments amount to an 
impermissible gift provided by a person or entity that financially 
benefits from the transaction. In a transaction involving SFDPA, both 
the seller, who is the ultimate source of the payment, and the entity 
that funnels or advances the payment for the seller to the homebuyer 
(and receives reimbursement and a fee from the seller for its role in 
the transaction) have an interest in the sale of the property that 
makes their payments an impermissible source of the buyer's equity 
investment.
    HUD's conclusion is reinforced by a report of the Government 
Accountability Office (GAO), Report No. 06-24, Mortgage Financing: 
Additional Action Needed to Manage Risks of FHA-Insured Loans with Down 
Payment Assistance (November 2005) (hereinafter, November 2005 GAO 
Report). At the request of Congress, GAO examined the trends in the use 
of downpayment assistance with FHA-insured loans, its impact on 
purchase transactions and house prices, and how it influenced the 
performance of FHA-insured loans. GAO found that downpayment assistance 
from seller-funded entities alters the structure of the purchase 
transaction in important ways. First, it creates an indirect funding 
stream from property sellers to homebuyers that does not exist in other 
transactions, even those involving some other type of downpayment 
assistance. Second, property sellers who provided downpayment 
assistance through nonprofit organizations often raised the sales price 
of the homes involved in order to recover the required payments that 
went to the organizations. GAO's analyses of empirical data showed that 
FHA-insured homes bought with seller-funded downpayment assistance 
appraised at and sold for higher prices than comparable homes bought 
without

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such assistance, resulting in larger loans for the same collateral and 
higher effective loan-to-value (LTV) ratios. That is, homebuyers had 
less equity in the transaction than would otherwise be the case.\2\
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    \2\ November 2005 GAO Report, pp. 3-4. This report can be found 
at https://www.gao.gov/new.items/d0624.pdf.
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    The original 60-day comment period provided in the May 11, 2007, 
proposed rule was extended by notice (72 FR 37500; July 10, 2007) for 
an additional 30 days. When the public comment period ended on August 
10, 2007, HUD had received approximately 15,000 public comments on the 
proposed rule, mostly brief statements in similar format and wording 
that opposed the rule and urged HUD not to eliminate downpayment 
assistance in connection with FHA-insured mortgages.
    On October 1, 2007, HUD promulgated the rule, with a few clarifying 
revisions, as a final rule to be effective October 31, 2007. The 
October 1, 2007, rule clarified that a tribal government or a tribally 
designated housing entity (TDHE), as defined at 25 U.S.C. 4103(21), is 
a permissible source of downpayment assistance if prerequisites in the 
rule were satisfied, and also more closely aligned the description of 
tax-exempt charitable organizations with the description used by the 
Internal Revenue Service (IRS) for such organizations. This rule never 
went into effect, however, since it was enjoined and then vacated by 
the courts.

II. Historical Policy Regarding Seller-Funded Downpayment Assistance

    The issue of SFDPA came to HUD's attention in the late 1990s. When 
this funding scheme first came into being, some local HUD offices 
approved mortgages with SFDPA for FHA insurance, and other HUD offices 
did not. As a result, in 1997, a provider of this type of assistance 
brought a lawsuit against HUD (Nehemiah Progressive Housing Development 
Corporation v. Cuomo, et al., No. S-97-2311-GEB/PAN (E.D. Cal.)) 
seeking consistent treatment. That suit was settled when the 
plaintiff's status was confirmed as a tax-exempt charitable 
organization under Internal Revenue Code (IRC) section 501(c)(3), a 
permissible source of assistance. HUD also acknowledged that based upon 
the program-specific information accompanying the plaintiff's 
submission to the IRS, the program complied with HUD's regulations and 
guidance pertaining to the source of funds for the borrowers' 
downpayments. Although downpayment assistance from charitable 
organizations is permitted, HUD continued to have concerns where the 
funds provided by an organization to the homebuyer were reimbursed by 
the seller in the transaction when the seller made a contribution of 
funds to the charitable organization, often after loan closing.
    HUD addressed the subject of prohibited sources of downpayment 
assistance in a 1999 proposed rule. (See HUD's proposed rule published 
on September 14, 1999, 64 FR 49956.) In 2001, HUD withdrew the 1999 
proposed rule, which had received a large number of public comments 
critical of the proposal. (See January 12, 2001, notice of withdrawal 
of proposed rule at 66 FR 2851.) At the time, the volume of loans with 
such assistance and their potential impact were small. Also, because 
the payment to the buyers did not come directly from the sellers, it 
was not clear that inducements to purchase were present in the 
transactions. Moreover, while FHA had serious concerns about SFDPA, it 
lacked the historical data to substantiate its adverse effects.
    By 2003, with the seller-funded downpayment assistance business 
growing exponentially, FHA had data tending to show that the 
performance of the loans made to borrowers relying on SFDPA was poor 
and that the program flaws could not be addressed with underwriting 
changes. FHA determined that the most feasible and appropriate solution 
was to create a new FHA insurance product to serve consumers who were 
unable to save funds for a downpayment, which would obviate the need 
for seller-funded downpayment assistance.
    In early 2004, a bill was introduced in Congress that would provide 
FHA with authority to insure a 100 percent financing product.\3\ At the 
same time, FHA commissioned an independent research firm, Concentrance 
Consulting Group, Inc., to conduct a comprehensive examination of 
downpayment gift programs administered by nonprofit organizations. The 
report was the culmination of a 10-month effort, beginning in January 
2004, to understand the influence of seller-funded nonprofit 
downpayment assistance on FHA-insured home loans. The study involved 
travel to 10 cities and interviews of more than 400 persons involved in 
mortgage transactions--from homebuyers and sellers to realtors, 
appraisers, underwriters, loan officers, builders, and downpayment 
assistance providers. Published on March 1, 2005, the report focused on 
the operational aspects of the programs in an effort to understand the 
financial relationships between the various parties involved. It 
highlighted the harmful features of the programs and concluded that the 
programs create unsustainable homeownership arrangements.\4\ The report 
served as the basis for FHA's strong push for new legislative authority 
to offer a 100 percent financing option to borrowers who might 
otherwise rely on a risky SFDPA program.
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    \3\ See H.R. 3755, Zero Downpayment Act of 2004, at https://
frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=108_cong_
bills&docid=f:h3755ih.txt.pdf.
    \4\ An Examination of Downpayment Gift Programs Administered by 
Non-Profit Organizations, Final Report, HUD Contract C-OPC-22550/
M0001, March 1, 2005. Available at: https://www.hud.gov/offices/hsg/
comp/rpts/dpassist/conmenu.cfm.
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    In June 2005, when Congress introduced another piece of Zero Down 
legislation, H.R. 3043,\5\ a reformulation of the previous bill, HUD 
supported the bill because an FHA Zero Down product would be a more 
affordable, yet still financially sound, alternative for families 
without savings for a downpayment.\6\
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    \5\ See H.R. 3043, Zero Downpayment Pilot Program Act of 2005, 
at https://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_
cong--bills&docid=f:h3043ih.txt.pdf.
    \6\ An FHA zero downpayment product would not pose the credit 
risks associated with SFDPA, for a number of reasons. First, 
homebuyers would understand upfront that they are buying a home with 
no initial equity and would have a realistic view of their options 
for resale. Also, underwriting requirements and insurance pricing 
are more easily developed and enforced when tied to a loan product 
than when tied to variable downpayment sources. In addition, the 
zero downpayment option is not tied to a particular property whose 
seller participates in an SFDPA program so that homebuyers can shop 
and negotiate with any number of sellers with the same bargaining 
power as a buyer with a true equity investment, which would also 
help prevent the concentration of 100 percent LTV loans in weak 
housing markets.
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    Also in 2005, the research arm of Congress, GAO, produced two 
reports concerning the risks associated with various proposed and 
existing FHA insurance products, including loans with zero downpayment 
and those with SFDPA.\7\ HUD agrees with the court, in Ameridream, 
Inc., v. Jackson and Penobscot Indian Nation v. HUD, that the first of 
these two reports (the February 2005 report discussing proposed FHA 
insurance products) provides little meaningful support for the current 
rule, which addresses the risks associated with SFDPA. However, the 
November 2005 GAO Report directly addressed the risks associated with 
loans with SFDPA and represents independent corroboration of the

[[Page 33945]]

findings of HUD's internal data analyses and the Concentrance study.
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    \7\ See Report No. 05-194, Mortgage Financing: Actions Needed to 
Help FHA Manage Risks from New Mortgage Loan Products (February 
2005); and November 2005 GAO Report.
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    The November 2005 GAO Report found that the problems associated 
with SFDPA loans (e.g., home price inflation and risk of defaults) are 
grave enough to merit an outright ban on SFDPA. The FHA Commissioner 
responded to the GAO's draft report in a letter dated October 25, 2005, 
which is incorporated in the final published report. The Commissioner 
acknowledged that GAO's findings confirmed FHA's own analysis and those 
of the Concentrance study, but expressed the agency's reasons for not 
pursuing GAO's recommended ban on SFDPA. The Commissioner expressed the 
agency's desire to provide safer financing without having to exclude 
traditional FHA borrowers, who are often in need of downpayment funds, 
and pointed to FHA's pursuit of a zero downpayment insurance product 
and higher insurance premiums as better alternatives to achieve those 
goals than banning SFDPA would be. The response to GAO also reiterated 
a legal opinion of HUD's Office of General Counsel that the structure 
and the timing of payments in SFDPA transactions did not violate the 
letter of HUD's underwriting guidelines.\8\
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    \8\ See November 2005 GAO Report, pp. 89-91.
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    For the reasons noted in the October 25, 2005, response letter to 
GAO, HUD continued to tolerate SFDPA programs, even though HUD had an 
ongoing concern about the risks inherent in SFDPA-generated loans, 
especially given the ever-increasing proportion of these loans in FHA's 
portfolio.
    In May 2006, the IRS issued Revenue Ruling 2006-27, which analyzed 
a model transaction typical of SFDPA programs and explained that 
organizations participating in such programs do not qualify as 
organizations described in IRC section 501(c)(3), because the 
assistance involved not a downpayment gift, but rather, ``represents a 
rebate or purchase price reduction.'' The Revenue Ruling stated that in 
these transactions, the so-called downpayment gifts ``do not proceed 
from detached and disinterested generosity, but are in response to an 
anticipated economic benefit, namely facilitating the sale of a 
seller's home.''
    HUD acknowledges the court's finding in Ameridream, Inc., v. 
Jackson and Penobscot Indian Nation v. HUD that IRS Revenue Ruling 
2006-27 on its face does not prove that seller-funded downpayment 
assistance loans are inherently and unacceptably risky. Nevertheless, 
the Revenue Ruling reinforced HUD's concerns with these transactions 
through its determination that they do not involve a gift, but a quid 
pro quo. The Revenue Ruling also highlighted an inconsistency in HUD's 
prior interpretation of these transactions with those of other 
Executive Branch agencies.
    HUD did not take regulatory action at any point in time from 1999 
through 2006, because the agency was anticipating a legislative 
solution to the problem. During that time frame, the portion of 
borrowers relying on SFDPA grew to represent over a third of all home 
purchase loans insured by FHA. As a result of the growth in the 
business and the poor performance, these loans have increased risk to 
FHA's fiscal soundness, a risk that threatens the opportunities of all 
(not just homeowners in need of downpayment assistance) to obtain 
single family FHA-insured financing. Because no legislative solution 
has yet materialized, HUD determined that the most prudent option was, 
and remains, to prohibit SFDPA through the rule that HUD initially 
proposed on May 11, 2007.

III. HUD's Analysis of Its Loan Portfolio Data

A. HUD's Database

    HUD, using information submitted by lenders, regularly monitors the 
performance of FHA-insured loans. Since the mid-1990s, FHA has 
maintained a Single Family Data Warehouse (SFDW), where data from its 
various program systems are uploaded on a monthly basis. At the present 
time, the SFDW contains 34,000,000 records, each capturing the 
characteristics and performance of a loan insured by FHA. Because each 
FHA program system uses the same case number for each insured loan, the 
SFDW is able to link more than 400 fields containing borrower 
demographic and loan application, origination, termination, and 
recovery data in one database. These data are used by an independent 
contractor to assess the performance of insured loans for the annual 
actuarial review of the Mutual Mortgage Insurance Fund (MMIF or Fund), 
FHA's largest insurance fund. These data are also used by HUD staff to 
calculate FHA's mortgage insurance liability for FHA's annual financial 
statements and to estimate credit subsidy for HUD's budget. For this 
reason, the data are audited by the independent auditor hired by HUD's 
Office of Inspector General and are closely reviewed by the Office of 
Management and Budget (OMB).
    For the single-family portfolio, HUD's monitoring includes tracking 
performance by source of downpayment funds, such as the borrower's own 
funds, or funds provided by family members, government agencies, or 
nonprofit organizations, as reported to HUD by lenders. The 
``nonprofit'' category source of downpayment funds consists of entities 
that hold the status of charitable organizations. Analysis of the data, 
however, indicates, by identifying the entities that provide the 
downpayment assistance, that more than 95 percent of the downpayment 
assistance provided under the ``nonprofit'' category is seller-
funded.\9\ Therefore, the term ``nonprofit,'' as used in this preamble 
discussion and tables, refers to organizations that hold the status of 
charitable organizations and provided SFDPA. Though HUD does not 
publish information on performance by downpayment source in formal 
reports, the data are regularly reviewed internally by HUD, and they 
have been made available at various times to GAO, OMB, and Congress. As 
demonstrated by the discussion in this preamble and the related tables 
included in the Appendix to this publication, loan performance data 
maintained by HUD on FHA-insured mortgages has provided a consistent 
story over time: Loans with nonprofit downpayment assistance, i.e., 
SFDPA, perform much worse than do other single family loans insured by 
FHA.
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    \9\ This comports with the November 2005 GAO Report indicating 
that about 93 percent of assistance from nonprofit organizations was 
funded by sellers. See November 2005 GAO Report, p. 14.
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    To give the public the opportunity to examine and comment fully on 
HUD's data analyses, HUD is making the underlying data available online 
during this additional comment period. The data files provide loan-
level records that will enable interested parties to explore issues 
regarding downpayment assistance provided to homebuyers utilizing FHA 
insured mortgage financing. The files are compressed using standard 
protocols that should be readable by a wide variety of software. The 
particular software product used to create these files is WinZip 9.0 
(SR-1). The URL for the FHA Purchase Loan Endorsement Data Web page is: 
https://www.hud.gov/offices/hsg/comp/rpts/pled/pledmenu.cfm.

B. Increase of Seller-Funded Downpayment Assistance Loans

    The substantial increase over time of loans with downpayment 
assistance from nonprofit groups (nonprofit-assisted loans) in the FHA-
insured single-family portfolio has dramatically changed the 
fundamental insurance risk

[[Page 33946]]

of that portfolio. As can be seen in Table 1 in the Appendix to this 
rule, these loans in Fiscal Year (FY) 2007 made up more than 35 percent 
of all home purchase loans insured by FHA. In FY 2000, they were less 
than 2 percent of FHA's single family purchase loan activity.
    As the discussion and data presented below demonstrate, the 
substantial increase over time of nonprofit-assisted loans has created 
a financially unsustainable situation for the FHA insurance fund. Table 
1, as noted, and all the other Tables referenced in this preamble 
discussion appear in the Appendix at the end of this document.

C. Default and Claim Rate Comparisons for Loans With Nonprofit 
Downpayment Assistance

1. Default Rates
    Tables 2, 3, and 4 provide a summary of default rates on home 
purchase loans insured by FHA. Default is measured here as a loan that 
is at least 90 days in arrears. Since the 1980s, loan servicers have 
reported to HUD all 90-day default events for FHA-insured loans. 
Activity on each default episode is reported to HUD until there is a 
final resolution, be that a cure of the default, a foreclosure, or some 
other outcome.\10\ Three summary statistics are used here--the early 
default rate, the ever-defaulted rate, and the current default rate. 
Each one is calculated separately by source of downpayment funds used 
to purchase the home, and shown by year of insurance endorsement (i.e., 
an ``insurance cohort''). The left half of each table lists the 
calculated default rates, and the right half provides a direct 
comparison of the performance of loans receiving each type of 
downpayment assistance with the performance of loans in which borrowers 
use their own funds for the downpayment. The comparisons in each table 
show that nonprofit downpayment-assisted loans have the highest default 
rates among all FHA-insured home-purchase loans.
---------------------------------------------------------------------------

    \10\ Since October 2006, HUD has collected information on all 
loan defaults, starting at 30-days delinquency. Ninety-day 
delinquencies, however, are an industry standard for defining the 
point at which foreclosure (and insurance claim payment) become a 
significant concern. Therefore, HUD analysis of the potential risk 
of insurance claim payments continues to use 90-day delinquency as 
the defining metric of default.
---------------------------------------------------------------------------

    The first default statistic, shown in Table 2, is the early default 
rate. It measures the share of loans that experience a (90-day) default 
within the first 24 months of scheduled mortgage payments, and is 
calculated by dividing the number of such loans by the total number of 
insured loans in an insurance cohort. HUD uses this statistic as a 
first indication of the level of claim payments that might be expected 
from any given insurance cohort. The ratios found on the right-hand 
side of Table 2 are calculated by dividing the early-default rate for 
each type of downpayment assistance by the default rate for loans with 
borrower-funded downpayments, within each insurance cohort.
    The early default rate of loans with nonprofit downpayment 
assistance has consistently been more than twice the rate found on 
loans with borrower-funded downpayments, with the average multiple 
across the FY 2000-2005 period being 2.43. The early default rate for 
loans with nonprofit downpayment assistance is also nearly twice that 
of loans with downpayments provided by a family member. These early 
default rate comparisons are a leading indicator of eventual 
foreclosure and claim rate patterns, as will be seen in Tables 5 and 6. 
Loans with nonprofit downpayment assistance have elevated foreclosure 
and claim rates commensurate with their elevated early default rates.
    The second default statistic, found in Table 3, is the ever-
defaulted rate. This measures the share of borrowers who have ever had 
a delinquency that extended beyond 90 days. It is calculated by 
dividing the number of borrowers with at least one (90-day) default 
since loan origination by the number of insured loans in an insurance 
cohort. The ratios on the right-hand side of Table 3 are calculated 
like those in Table 2. The ratio of the ever-defaulted rate for 
nonprofit downpayment-assisted homebuyers, to that of homebuyers with 
FHA-insured loans using their own downpayment funds, is at or above 
2.00 for all insurance cohorts since FY 2003 and close to that mark for 
FY 2002. The FY 2007 insurance cohort shows the same pattern as have 
earlier insurance cohorts. The second default statistic shows that, for 
loans endorsed from 2000 to 2005, between approximately 24 and 29 
percent of loans with seller-funded assistance had experienced a 90-day 
delinquency, compared to approximately 11 to 16 percent of loans 
without downpayment assistance. This default statistic is consistent 
with GAO's findings in 2005 that loans with downpayment assistance from 
seller-funded nonprofit organizations do not perform as well as loans 
with downpayment assistance from other sources. GAO used samples of 
FHA-insured, single family purchase money loans endorsed in 2000, 2001, 
and 2002 and concluded that between 22 and 28 percent of loans with 
seller-funded assistance had experienced a 90-day delinquency, compared 
to 11 to 16 percent of loans with downpayment assistance from other 
sources and 8 to 12 percent of loans without downpayment 
assistance.\11\
---------------------------------------------------------------------------

    \11\ November 2005 GAO Report, pp. 26-27.
---------------------------------------------------------------------------

    The last default statistic shown in the Appendix is the current 
default rate (Table 4). That measure is a snapshot at a point in time 
that focuses on all loans still active on a given date. The date used 
for this snapshot is February 29, 2008. The current default rate is 
computed by dividing the number of loans in default on that date by the 
number of loans active on the same date in an insurance cohort. The 
``Nonprofit'' column in the right-hand side (``Ratios* * *'') of Table 
4 shows that the share of loans with nonprofit downpayment assistance 
that were in default on the snapshot date was near or above two times 
that of home-purchase loans with borrower-funded downpayments for all 
insurance cohorts since FY 2001. One will notice that the current-
default-rate ratios for older insurance cohorts are somewhat smaller 
than those for new insurance cohorts. This difference is primarily due 
to the fact that the weakest loans in those older insurance cohorts 
have already gone to foreclosure and claim, leaving fewer weak loans to 
default in the present. When the entire nonprofit downpayment 
assistance portfolio is compared to the entire borrower-funded 
downpayment assistance portfolio, across all insurance cohort years, 
the default-rate ratio on February 29, 2008, was 1.80. The actual 
default rate for loans with nonprofit downpayment assistance shown on 
the left-hand side of Table 4 was 11.19 percent and that for borrower-
funded purchase loans was 6.22 percent.
2. Historical Claim Rates
    Table 5 focuses on the insurance claim-payment experience of FHA, 
comparing home purchase loans by source of downpayment funds and by 
year of insurance cohort. Claims generally are paid by FHA to lenders 
after a lender acquires title to a property, generally through a 
foreclosure process.\12\ The metric used in the left-hand panel of 
Table 5 is the to-date claim rate, which measures the number of 
insurance claims paid as a percentage of all loans insured by FHA, as 
of a given date. The date used here

[[Page 33947]]

is February 29, 2008. Insurance cohorts that are older will have had 
more time for borrowers whose defaults result in foreclosure and an FHA 
insurance claim. Consequently, to-date claim rates for the FY 2000 and 
FY 2001 insurance cohorts are greater than those for more recent 
insurance cohorts.
---------------------------------------------------------------------------

    \12\ The lender/servicer bids at the foreclosure auction. Once 
the foreclosure has been completed, the lender/servicer, as the 
winning bidder, usually transfers title of the property to HUD. FHA 
then pays an insurance claim to the lender upon conveyance of 
acceptable title to HUD.
---------------------------------------------------------------------------

    The data in Table 5 indicate that when nonprofit downpayment 
assistance is provided, borrowers, as a group, are less likely to 
sustain the financial responsibilities of a home mortgage than are 
borrowers receiving downpayment funds from other sources. With to-date 
claim rates that exceed three times those of borrower-funded purchase 
loans, the insurance risk is higher than FHA has ever considered 
acceptable. Such high claim rates cause significant harm to families 
who are displaced by foreclosures, and they also have the potential of 
destabilizing neighborhoods.
3. Projected Lifetime Claim Rates
    Each year, HUD hires an independent contractor to perform a full 
actuarial study of its single family insured portfolio. That study, 
which is required by law, covers all insurance programs under the 
umbrella of the MMIF. The Fund encompasses around 90 percent of all FHA 
single family insurance activity. Loans not included are those for 
condominiums and section 203(k) purchase-and-rehabilitation loans, 
along with some minor targeted programs.\13\ The formal Actuarial 
Review published from the actuarial study measures to-date performance 
of each insurance cohort, and provides projections of ultimate claim 
rates over the 30-year life of each insurance cohort. That Actuarial 
Review is forwarded to Congress each year. The work of the independent 
contractor is also scrutinized each year by independent auditors hired 
by the Office of the Inspector General at HUD.
---------------------------------------------------------------------------

    \13\ These other loans are insured under the General and the 
Special Risk Insurance Funds.
---------------------------------------------------------------------------

    For the last 3 years, the actuarial study contractor has identified 
nonprofit downpayment assistance as adding an especially high risk 
factor to the FHA portfolio. First, in the FY 2005 Actuarial Review 
(available at https://www.hud.gov/offices/hsg/comp/rpts/actr/
2005actr.cfm), statistical results were presented that showed the 
additional risk of claim in any given calendar quarter arising from 
various forms of downpayment assistance. The additional risk posed by 
nonprofit downpayment assistance was measured as three times that from 
family downpayment assistance, and 1.5 times that from government 
assistance.\14\ The FY 2006 Actuarial Review (available at https://
www.hud.gov/offices/hsg/comp/rpts/actr/2006actr.cfm) alerted HUD that 
continued high concentrations of business coming from loans with 
nonprofit downpayment assistance would cause FHA to suffer net 
losses.\15\
---------------------------------------------------------------------------

    \14\ See Exhibit A-2 on p. A-19 of the FY 2005 Actuarial Review.
    \15\ See discussion on p. 49 of the FY 2006 Actuarial Review, 
and Exhibit V-5 on p. 50.
---------------------------------------------------------------------------

    The FY 2007 actuarial study and Actuarial Review provide a new 
level of analysis on expected claim rates over the life of FHA-insured 
loans. Since the statistical model that predicts claims now includes a 
factor for borrower credit scores, the actuarial study contractor was 
able to provide HUD with projections of lifetime claim rates by cross-
sections of credit-score and loan-to-value (LTV) classes. Table 6 shows 
such cross-sections for loans insured in 3 recent years, FY 2005, FY 
2006, and FY 2007. High-LTV loans are separated into those with 
nonprofit downpayment assistance, and those without. Only the high-LTV 
group (above 95% LTV) needs this separation because property sellers 
that participate in, and contribute to the nonprofit programs, 
generally provide only the minimum required 3 percent downpayment. The 
ratio of projected claim rates on nonprofit assisted loans to other 
above-95%-LTV loans is presented in the last column of Table 6.
    Comparisons found in Table 6 show smaller differences in lifetime 
claim rates than might be inferred from differences in the to-date 
claim rates presented in Table 5. One reason for the difference is the 
comparison in Table 6 is made only on high-LTV loans, which have higher 
claim rates than do lower-LTV loans. Comparisons in Tables 2, 3, 4, and 
5, however, are across all LTV ranges. Nevertheless, for all three 
insurance cohorts shown in Table 6, loans with nonprofit downpayment 
assistance are more than twice as likely to go to foreclosure and FHA 
insurance claim over their lifetime as all other high-LTV loans.
    As claim rates rise for all loans insured during housing market 
downturns, such as FY 2007, the high insurance claim ratio for loans 
with nonprofit downpayment assistance and the large share of loans 
utilizing those downpayment assistance programs present a severe 
financial challenge to FHA. The expected lifetime claim rate on loans 
with nonprofit downpayment assistance in the FY 2005 insurance cohort 
is close to 17 percent, and for FY 2007 is above 28 percent. The 16.79 
percent for FY 2005 contrasts with a 6.94 percent expected lifetime 
claim rate for other high-LTV loans insured during the same period. FY 
2007 is a particularly challenging year as it starts with a decline in 
home prices across much of the nation. The 28.49 percent expected claim 
rate on loans with nonprofit downpayment assistance insured in FY 2007 
contrasts with a 12.25 percent expected claim rate on all other high-
LTV loans. It is not possible under current law to charge insurance 
premiums in an amount sufficient to cover this increased insurance 
claim risk, even if the maximum allowable insurance premiums were 
charged to all FHA-insured homebuyers.\16\
---------------------------------------------------------------------------

    \16\ See mortgage insurance premium rates at 12 U.S.C. 
1709(c)(2).
---------------------------------------------------------------------------

    The claim rates shown in Table 6 are under the base case economic 
scenario of August 2007, which relied upon forecasts of house prices 
and interest rates provided by Global Insight Inc. Since that time, 
housing market conditions have deteriorated more than was expected, and 
the projected claim rates on the FY 2005 to FY 2007 insurance cohorts 
are now even higher than those shown in Table 6. Because the expected 
claim rates on loans with nonprofit downpayment assistance are well 
above the rate that can be supported by reasonable premium charges in 
normal economic conditions, the financial problems caused by these 
loans are only compounded during housing market downturns.
4. Higher Losses on Claims
    An additional problem with loans with nonprofit downpayment 
assistance is that homes purchased using this form of assistance are 
often purchased at inflated prices. The price increase is made, or the 
seller refrains from accepting a lower price that would have been 
acceptable in an arms-length transaction, so that the seller can 
receive the same net proceeds from selling to the homebuyer needing 
downpayment assistance, as the seller would receive from a buyer 
without downpayment assistance. This business practice was confirmed in 
a field study performed for HUD by an independent contractor, and 
statistically validated in research performed by the GAO.\17\
---------------------------------------------------------------------------

    \17\ The contractor study is that of Concentrance Consulting 
Group, Inc., An Examination of Downpayment Gift Programs 
Administered by Non-Profit Organizations, ibid. The GAO study is in 
the November 2005 GAO Report.
---------------------------------------------------------------------------

    In the November 2005 GAO Report, the GAO analyzed ``a sample of 
FHA-insured loans settled in March 2005,'' and found that ``for loans 
with seller-funded down payment assistance, the

[[Page 33948]]

appraised value and sales price were higher as compared with loans 
without such assistance.''\18\ The March 2005 study by Concentrance 
Consulting Group, commissioned by HUD, interviewed more than 400 
persons involved in the mortgage industry and corroborates GAO's 
assessment. The Concentrance study ``found overwhelming evidence that 
the cost of the seller-funded down payment assistance is added to the 
sales price, which then increases the allowable FHA loan amount and 
eliminates any borrower equity in the property.'' \19\ Such an inflated 
sale price does not represent the true value of the property and leads 
to a higher mortgage amount.
---------------------------------------------------------------------------

    \18\ November 2005 GAO Report, pp. 22-23.
    \19\ Concentrance Consulting Group Report, p 6.
---------------------------------------------------------------------------

    The effect on FHA, in addition to an increase in the amount of 
insurance claim payments, is increased net losses after disposing of 
foreclosed properties. Not only do loans with nonprofit assistance have 
significantly elevated insurance claim rates, 76 percent greater 
according to the same GAO study,\20\ but FHA ultimately suffers greater 
losses on those claims. The FY 2006 Actuarial Review documents 
differentiate net loss rates--as a percentage of the unpaid loan 
balance at the time of default and claim by loans having or not having 
nonprofit downpayment assistance (see Appendix B of the FY 2006 
Actuarial Review).
---------------------------------------------------------------------------

    \20\ November 2005 GAO Report, p. 32.
---------------------------------------------------------------------------

D. FHA Insurance Fund Solvency

    FHA program data is used by an independent contractor to conduct 
the annual actuarial review of the MMIF, FHA's largest insurance fund. 
MMIF programs are required to be self-supporting and to generate 
sufficient receipts to fund a Capital Reserve Account in an amount 
equal to at least 2 percent of its outstanding insurance-in-force. (See 
12 U.S.C. 1711(f).) This Account provides a vehicle for recording the 
balance of payments between MMIF programs and the federal budget over 
time. Growth of the Reserve Account occurs as MMIF programs generate 
budget receipts and as Account balances earn interest over time. 
Reserve Account balances fall when HUD needs to fund unexpected claims 
on outstanding loan guarantees. In its 74-year history, the MMIF has 
always been self-supporting and never required additional 
appropriations beyond its initial capitalization in 1934, which was 
paid back by FHA decades ago.
    All funds associated with MMIF insurance program operations--
including premium collections, claim payments, and proceeds from the 
sale of foreclosed properties--flow through a separate MMIF Financing 
Account. In accordance with the Federal Credit Reform Act of 1990, 2 
U.S.C. 661, et seq., which requires agencies to estimate the long-term 
cost to the government of guaranteeing credit (referred to as ``the 
subsidy cost''), FHA must maintain a balance in the MMIF Financing 
Account for each insurance cohort (i.e., the loans endorsed in a single 
fiscal year) sufficient to cover the net cash outflows projected for 
the insurance cohort over its lifetime. Each year, in the course of 
preparing the President's Budget, FHA estimates the subsidy cost for 
the upcoming insurance cohort. As long as expected premium revenues 
outweigh expected claim costs, HUD can fund the required Financing 
Account balance and provide net budget receipts that help build Capital 
Reserve Account balances. Were a situation to arise in which expected 
premium revenues could not cover expected claim costs, then FHA 
programs would require a budget appropriation from Congress to help 
fund the required Financing Account balance.
    In order for FHA MMIF programs to both maintain required capital 
reserves and avoid budgetary appropriations, they must be managed in 
such a way that generates what is called a ``negative credit subsidy 
rate.'' The credit subsidy rate (CSR) is the ratio of expected budget 
outlays or receipts to expected loan volumes. The CSR also is the 
government's estimated long-term cost, excluding administrative costs, 
as a percentage of the amount of loans guaranteed. The rate is 
calculated on a net present value basis over the life of the loans 
guaranteed in a given fiscal year. The CSR is thus a helpful summary 
measure of actuarial soundness.
    HUD currently has an internal target for a normal-economy CSR of 
around -1.00 percent for MMIF programs in an insurance cohort. The 
negative sign means negative outlays, which translates into positive 
budget receipts. Having such a target provides a cushion for economic 
downturns, minimizing the chance that the CSR could actually turn 
positive. Such a target, however, is impossible to achieve today with 
the resource drain caused by SFDPA. Taken as a whole, loans with SFDPA 
have a CSR of over +6.00 percent, which means that supporting them 
costs the FHA program 6 cents for every dollar of these insured loans. 
Current premium rates cannot cover the cost of such a large CSR for 
these downpayment-assisted loans. HUD is at the point where continuing 
to support loans with SFDPA will require budget appropriations for all 
of the FHA MMIF loans.
    On the basis of the FY 2007 independent Actuarial Review, FHA has 
estimated its credit subsidy requirements for FY 2009. FHA has 
concluded that if it continued to charge the same 1.5 percent up-front 
and 50 basis point annual insurance premiums, and continued to serve 
the same mix of borrowers it served in FY 2007, including the same 
share using SFDPA, the MMIF program would have a positive credit 
subsidy rate of 1.12 percent. Assuming estimated loan-guarantee 
obligations of $110 billion, the MMIF program would require a credit 
subsidy appropriation of $1.4 billion in order to begin operations in 
FY 2009. To ward off this eventuality, HUD is proposing to eliminate 
SFDPA.

E. Sustainable Cross-Subsidization

    The data presented above in HUD's analysis of its loan portfolio 
shows the poor performance of loans with SFDPA relative to loans 
without such assistance. Due to this poor performance, borrowers with 
SFDPA require an unsustainable level of premium cross-subsidies from 
other borrowers. Any attempt to raise premiums to help to cover part of 
that cost could result in other borrowers being discouraged from using 
financing with FHA mortgage insurance by the high relative cost to them 
of providing cross-subsidies to the seller-funded portfolio. This 
phenomenon is known as ``adverse selection'' and results in the need to 
continually raise premiums when the pool of cross-subsidizing borrowers 
declines with each round of price/premium increases. By proposing to 
eliminate FHA insurance on loans with SFDPA, FHA is endeavoring to 
reestablish a sustainable level of cross-subsidization in its portfolio 
so that it can serve more homebuyers, including first-time and minority 
homebuyers, without the continual need for appropriations. Avoiding a 
general premium-rate increase is all the more important because lower-
income borrowers, who benefit most from FHA's MMIF program, are 
concentrated in its less risky credit score and loan-to-value 
categories of borrowers, i.e., the categories that would be discouraged 
from using the program by higher premium rates. See Table 7.
    Table 8 shows the distribution of FHA-insured purchase loans in FY 
2007, over FICO \21\ and loan-to-value ratio categories. Purchase loans 
with

[[Page 33949]]

SFDPA appear in the SFDPA row. In FY 2007, such homebuyers constituted 
over 33 percent of FHA-insured homebuyers (see Table 8).
---------------------------------------------------------------------------

    \21\ FICO is a credit score developed by the Fair Isaac 
Corporation and is an acronym for it.
---------------------------------------------------------------------------

    Table 9 shows the expected lifetime claim rates for purchase loans 
in each of the FICO and LTV categories defined in Table 8. Expected 
claim rates increase with increases in LTV and with decreases in FICO 
scores. That is, they rise as one moves from the upper left to the 
lower right of the table. Some of these groups of borrowers have 
excessively high claim rates--above 25 percent. HUD has determined that 
such high rates are incompatible with homeownership sustainability. In 
the worst case, borrowers with SFDPA who have FICO scores below 500 
have expected claim rates of 61.4 percent. While these borrowers 
constituted only 0.6 percent of all purchase loans endorsed in FY 2007 
(see Table 8), for all homebuyers with SFDPA, the weighted average 
expected claim rate was over 28 percent.
    Even a small number of borrowers with very high expected claim 
rates places a substantial burden on the remaining borrowers who must 
provide premium revenues sufficient to cover losses incurred on the 
high claim-rate group. Table 10 shows credit subsidy rates calculated 
for loans in each FICO and LTV grouping. It shows that credit subsidy 
rates for different categories of borrowers vary between -2.95 percent 
and +20.41 percent. A credit subsidy rate of -2.0 percent generates 
$2,000 in receipts on a $100,000 loan and $4,000 on a $200,000 loan. On 
the other hand, a credit subsidy rate of +20.4 percent requires $20,400 
in subsidies--from some combination of higher premiums on all borrowers 
and direct budget appropriations--for a $100,000 loan and $40,800 in 
subsidies for a $200,000 loan. With such high positive credit subsidy 
requirements, too many borrowers with good credit are needed to offset 
the cost of higher-risk, and frequently higher-income, borrowers. Under 
current law, FHA is prevented from raising up-front premiums above 2.25 
percent or annual premiums above 55 basis points. (See 12 U.S.C. 
1709(c)(2).) Nevertheless, one might ask whether it would be possible 
to charge sufficient premiums for loans with SFDPA so that they would 
not require cross-subsidization. Table 11 shows break-even up-front and 
annual premiums for SFDPA loans by FICO score category. Except for 
borrowers with FICO scores greater than 680, up-front and annual 
premiums would have to be raised to very high levels for example, 5.56 
percent upfront and 0.55 percent annually for borrowers with FICO 
scores between 640 and 680, and 12.09 percent up-front and 2.0 percent 
annually for borrowers with FICO scores between 500 and 560. Therefore, 
under the current law, it is not possible to fully offset the risk of 
SFDPA simply by raising premiums. Even if there were no statutory cap 
on premium rates charged by FHA, however, it is unlikely that borrowers 
would opt for an FHA-insured mortgage if the insurance premiums were 
raised as high as needed to ensure the sustainability of the insurance 
fund in a scenario where SFDPA is allowed to continue. The large up-
front premiums alone, when added to the initial loan balance, would 
increase expected claim rates even more, as borrowers could have to 
wait many years before they could sell their properties free-and-clear. 
Therefore, raising premium rates to extraordinary levels would not be a 
viable solution, even if the Congress were to authorize such.

IV. Downpayment Assistance From Nonprofits or Any Other Sources--
Financial Benefit Prohibited

    Although the data and discussion above demonstrating the negative 
default, claim, and other adverse effects of SFDPA are focused on 
nonprofit organizations, the rule, if implemented, would have broader 
application. It would prohibit a mortgagor's required cash investment 
from consisting, in whole or part, of funds provided by the seller, or 
any other person or entity that financially benefits from the 
transaction, or any third party or entity reimbursed by the seller or 
other person or entity that financially benefits from the transaction. 
HUD has determined that this broader prohibition is appropriate and 
justified, as discussed below.
    HUD is not singling out nonprofit organizations in proposing to 
prohibit SFDPA because the same scheme of funneling or advancing funds 
for the seller, through an intermediary, to the homebuyer can be 
accomplished using any person or entity as the intermediary or using 
any number or layers of intermediaries. HUD's rule would apply to all 
such transactions. Whenever the funds for the homebuyer's required 
investment in the property are provided by a party that financially 
benefits from the sale of the property, the transaction is distorted by 
the provider's interest in inducing a purchase on any terms, in 
conflict with the borrower's and FHA's interest in achieving 
sustainable homeownership through a sustainable mortgage. This conflict 
is not abated when such funds are provided by an intermediary 
reimbursed by the party that financially benefits. It is present 
whether the seller provides the funds directly to the homebuyer or 
indirectly through an intermediary to the homebuyer.
    Further, when the source of downpayment funds financially benefits 
from the transaction, the downpayment amount is likely to be added to 
the sales price to ensure that the funder's net benefit is not 
diminished. Any cost to the buyer added to the transaction adds to the 
long-term financial burden to the mortgagor and increases the loan 
amount insured by HUD, thereby increasing HUD's risk exposure in the 
event of an insurance claim.
    While it is not certain that the downpayment funder's cost will be 
added dollar for dollar to the transaction in every instance, it would 
be an extreme administrative burden to HUD, i