Residential: Behind the scenes of FHA’s down payment assistance updates

The Federal Housing Administration’s (FHA) abrupt changes to its down payment assistance requirements, issued in late April, came as a surprise. “While FHA has long indicated plans to revise its down payment assistance guidelines, the way those changes were introduced caught the industry off guard,” said Megan Bartlett, Vice President and Managing Consultant at The Collingwood Group.

FHA published the updates in Mortgagee Letter 19-06, Downpayment Assistance and Operating in a Government Capacity, presenting them as a clarification of existing policy, rather than a full policy change. “This might explain why they did not use the rulemaking and comment process as they had previously indicated they would,” said Bartlett.

The mortgagee letter holds that a government entity may only provide funds for a borrower’s statutorily required minimum down payment investment when it is acting in its “governmental capacity,” and defines that capacity in a way that would make certain nationwide down payment programs, most notably the Chenoa Fund, ineligible. The fund is operated by the Cedar Band, a recognized American Indian group, that responded to the policy clarification with a lawsuit against the Department of Housing and Urban Development (HUD).

The lawsuit alleges violations of the tribe’s constitutional due process, the Administrative Procedure Act, and the National Housing Act. The matter is scheduled for a June hearing. HUD has since delayed the changes to an effective date of July 23, 2019, which was announced in Mortgagee Letter 2019-07.

“Regardless of the legal outcome, there are certain provisions of this letter that are likely to go into effect in one form or another,” said Bartlett. “This goes back to conflict between FHA and HUD’s Office of Inspector General (OIG) over government entity down payment assistance.”

OIG has taken the stance that FHA has inadequate controls in place to ensure that funds for the minimum down payment requirement come from approved sources. OIG’s interpretation challenges the eligibility of many state Housing Finance Authority (HFA) homeownership programs. FHA has repeatedly disagreed with that view, most clearly with its 2012 Interpretive Rule, and by issuing Mortgagee Letter 2013-14, which required government entities to incur a legal obligation to provide the funds. ML 19-06 goes further, requiring that the down payment be provided regardless of any subsequent transfer of the FHA-insured mortgage.

“The new requirement may resolve the OIG-FHA conflict, but it could introduce new challenges,” said Bartlett, particularly for HFAs that typically require lenders to table fund the down payment assistance, and reimburse funds only when the first mortgage is purchased. The National Council of State Housing Agencies (NCSHA) has written a letter to HUD suggesting alternative language to allow down payment assistance funding to be contingent on transferring the first mortgage to the government entity providing the assistance. It is unclear if FHA can or will revise this part of the guidance.

This issue is likely to develop further as the lawsuit progresses. HUD has also invited public comment on the policy clarifications before the effective date.

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