Our country suffered the worst economic downturn in living memory as a result of the financial markets crash in 2007-2008, precipitated in part by the housing and mortgage market collapse. Homeownership rates fell from 69% in 2007, to a decades low rate of 62.8% in 2017, with minority communities hit even harder.
Most attribute the housing collapse to the loose lending practices broadly described as subprime loans. When the loans failed to perform, the value of the securities backing these loans deteriorated in value, which led to the federal government bailing out Freddie and Fannie Mae, as well as a number of banks who were “too large to fail” who were heavily invested in mortgage backed securities.
Even FHA’s insurance fund came close to needing a bailout. Some attributed the problems in FHA’s portfolio to the high incidence of seller funded down payment assistance (SFDPA). This type of down payment assistance occurred when a 501(c)(3) non-profit organization provided a borrower the 3% required (at that time) for down payment, on condition the seller agreed to reimburse those funds from the proceeds of the sale of the home the borrower was purchasing. Early critics were concerned that the lack of “skin in the game” from these borrowers would put the insurance fund at risk.
Starting in the 1998, programs such as Nehemiah, Ameridream, and Neighborhood Gold put the “skin-in-the-game” theory to the test. Despite efforts by the founders of each of these organizations to create industry standards by which the use of DPA could be governed, the proliferation of SFDPA led to an overuse of these programs especially in the years leading up to the real estate crash in 2007-8. At their height, it is estimated that 30,000-40,000 households received such assistance monthly. As the mortgage crisis unfolded, defaults on the underlying FHA loans began to rise.
At the time, critics of SFDPA and FHA were quick to point to certain practices which led to higher defaults, such as appraisal inflation occurring when sellers increased the price of their home in order to pay the required fee to the non-profit organization. In addition, underwriting practices were loose, allowing most anyone to be qualified to buy a home. By October 2008 and due to growing defaults, the HERA Act was signed into law, which ended SFDPA.
Some industry observers draw a correlation between SFDA and the housing market crash. In reality, the truth is more complex. By ending SFDPA, tens of thousands of potential buyers were unable to purchase homes, likely contributing to, and exacerbating the developing housing and mortgage meltdown. Fewer qualified buyers leads to fewer sellers able to sell homes. More inventory led to lower prices and an eventual collapse of values in most markets. In other words, it can be argued that the elimination of SFDPA led to a worsening market, when tens of thousands of potential buyers were shut out. Extreme market conditions led to extreme measures by Congress, which led to throwing the baby out with the bathwater when Congress decided to end of SFDPA.
Had the industry adopted best practices and been prudent in lending decisions, perhaps a different outcome would have resulted. Instead we’ve seen homeownership rates plummet to decades low rates, with minorities being hit the hardest, with African Americans currently at 42%. As a nation, we must balance the economic and social benefits of higher homeownership rates with the perceived risks of down payment assistance.