IRS Ruling Threatens Use of No Down Payment Florida Home Loans

For years, it had been possible for buyers to acquire a Florida home loan without a down payment. This made it easier for many in the middle or lower classes to afford a new house - but those days may be coming to an end.

The Internal Revenue Service (IRS) wants to close a loophole that has allowed hundreds of thousands of families to follow the aforementioned course of action. Could no money down Florida home loans be extinct in the near future?

The IRS ruled this month that nonprofit down-payment-assistance programs don’t qualify for tax exemptions if they transfer money from the seller to the buyer. In the last decade, these nonprofits have helped about 600,000 families buy homes without saving the three percent down payment that the Federal Housing Administration (FHA) requires.

Effect of this ruling on unique Florida home loans

Such a ruling could lead to the destruction or disruption of the down-payment-assistance industry. IRS examiners will use the ruling to decide whether to strip organizations of their tax-exemption statuses. Thus far, none have lost that status.

“I think it would have a huge effect on consumers, because this has been such a great tool for FHA home buyers,” says David Ahrens, president of Buyers Fund, a major nonprofit down-payment-assistance program.

As a result of this decision, Ahrens adds, the average first-time home buyer could be pushed into other Florida home loans, such as 80-20 products or interest-only loans, neither of which would be as advantageous.

Lenders require mortgage insurance on Florida home mortgage loans in which the buyer makes a down payment of less than 20 percent. Some borrowers avoid mortgage insurance by getting two loans (aka a “piggyback Florida home loan“) - one for 80 percent of the purchase price, and a second mortgage for up to 20 percent of the price.

The role of down payments with charities

Some companies will insure a mortgage for 100 percent of the home’s value - in other words, without a down payment. But the FHA requires a down payment of at least 3 percent. FHA Florida home loan borrowers tend to have flawed credit, and a lot of them have trouble saving the minimum down payment. That’s where nonprofit down-payment-assistance programs come in.

Unlike private mortgage insurers, the FHA allows borrowers to receive some or all of their down payment money in the form of gifts from family, government, employers or nonprofit organizations. The down payment can’t come directly from the seller. On the other hand, until recently, nothing prevented a nonprofit from giving a down payment to the buyer, and then immediately collecting the money from the seller.

The down-payment-assistance industry was born in the 1990s to exploit the loophole. The buyer and seller would agree to use a down payment program as a conduit for the money. Everyone won: The real estate agents got their commissions, the nonprofit got an administrative fee, the lender got a Florida home loan, the seller got the proceeds from the sale and the buyer got a house. In the last year, about 40 percent of FHA-insured loans included down-payment assistance.

Critics of these Florida home loan programs

Critics had concerns from the beginning. Those from the Department of Housing and Urban Development and the Government Accountability Office concluded that borrowers were more likely to end up falling behind on their monthly payments if they had accepted down payment money from sellers through nonprofits. They said some buyers ended up paying more than market value for their houses.

On May 4, the IRS stepped in with Revenue Ruling 2006-27, which says that a nonprofit which transfers down payment money from seller to buyer “is not operated exclusively for charitable purposes, and, consequently, does not qualify for exemption from federal income tax.”

The ruling sets forth guidelines that pin a target on nonprofit down-payment-assistance programs. Anticipating the ruling, a small player, Houston-based United American Housing and Education Foundation, announced that it was terminating its down payment program to take “a new direction.” Most nonprofits continue to operate because they still have tax-exempt status while the IRS examines them. Therefore, FHA mortgages do still exist at the moment.

If the IRS does revoke an organization’s tax-exempt status, the nonprofit may appeal administratively and in federal courts.

Ahrens says rhetoric that labels assistance programs as “scams” surprises him, because the Bush administration has placed so much importance on housing. The president wants 5.5 million minority households to become homeowners this decade. “And I think we’ve played a huge role in that,” Ahrens says. “They wanted the private sector to step up and provide some solutions, and I think we’ve done that.”

None of this bodes too well for those seeking affordable Florida home loans. The housing market will continue to favor the upper class if government assistance is terminated.