Order Code RS22934
Updated August 7, 2008
Treatment of Seller-Funded Downpayment
Assistance in FHA-Insured Home Loans
Bruce E. Foote
Analyst in Housing
Domestic Social Policy Division
Summary
In order to qualify for FHA-insured home loans, borrowers are required to
contribute a minimum amount to the cost of purchasing the home. Under certain
conditions the borrower’s required contribution may be paid by others. Can the
borrower’s required contribution be paid by a nonprofit agency that is later reimbursed
by the seller of the property? That has been the subject of regulation, litigation, and
legislation. The Housing and Economic Recovery Act of 2008, P.L. 110-289, effective
October 1, 2008, increases the borrower’s required contribution from 3% to 3.5% and
provides that the borrower’s required contribution towards the purchase of an FHA-
insured home may not be provided by the seller or by any third party that is being
reimbursed by the seller. Enactment of the law does not mean that sellers may not
provide downpayment assistance to borrowers obtaining FHA-insured home loans. It
will simply mean that any contribution by the sellers will not count towards the 3.5%
contribution required of the borrower. Current HUD rules provide that the seller or other
interested third parties may contribute up to 6% of the property’s sales price toward the
buyer’s costs. As introduced on July 31, 2008, H.R. 6694 would amend the new law to
provide exceptions to the prohibition on seller contributions. This report will be updated
as suggested by changes in law or regulation.1
The Housing and Economic Recovery Act of 2008
Under the Housing and Economic Recovery Act of 2008, P.L. 110-289, as enacted
on July 30, 2008, borrowers will be required to contribute at least 3.5% in cash or its
equivalent to the cost of acquiring a property with an FHA-insured mortgage. Amounts
borrowed from a family member will be considered as cash for this purpose. Prohibited
sources of funding for the required funds will be the seller or any entity that financially
1 For information on the FHA mortgage insurance program, please see CRS Report RS20530,
FHA Loan Insurance Program: An Overview, by Bruce E. Foote and Meredith Peterson.

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benefits from the transaction, or any third party that is directly or indirectly reimbursed
by the seller or by anyone that would financially benefit from the transaction. The law is
in effect for transactions entered into on or after October 1, 2008.
Enactment of the law does not mean that sellers may not provide downpayment
assistance to borrowers obtaining FHA-insured home loans. It will simply mean that any
contribution by the sellers will not count towards the 3.5% contribution required of the
borrower. As noted below, current HUD rules provide that the seller or other interested
third parties may contribute up to 6% of the property’s sales price toward the buyer’s
actual closing costs. Nonprofits may still provide gifts that would pay borrowers’ required
contributions, but the source of these gifts may not be the sellers. This might have
negative consequences on those nonprofits whose primary function was to act as
middlemen in providing assistance to borrowers that would otherwise be prohibited by
HUD rules.
Present Regulation
Except for veterans or for borrowers replacing homes that have been damaged or
destroyed by presidentially-declared disasters, the HUD regulation provides that
borrowers are required to contribute at least 3% in cash or its equivalent of the cost of
purchasing a home when the home is financed with an FHA-insured loan.2 The regulation
provides that, for borrowers aged 60 or more, or for certain homes provided through the
Homeownership and Opportunity Through HOPE Act3 (42 U.S.C. 1437aaa), the 3%
contribution may be obtained through a loan from a corporation or other person under
terms and conditions prescribed by HUD. For veterans or for borrowers replacing homes
that have been damaged or destroyed by presidentially-declared disasters, only a $200
investment is required.4 The regulation is silent regarding prohibited sources of funding.
Administrative Provisions
Revision 5 (REV-5) of HUD Handbook 4155.1 contains the underwriting guidelines
for single family mortgage loans insured under the National Housing Act.5 Although the
regulation and prior law were silent regarding prohibited sources of funding for the
2 24 CFR 203.19. This is based on prior law. Note that the law is amended to require a 3.5%
contribution, and the regulation will likely be updated to reflect this change.
3 Title IV of the Cranston-Gonzalez National Affordable Housing Act, P.L. 101-625. The title
authorizes HUD to make grants under the Homeownership and Opportunity for People
Everywhere (HOPE) programs to enable grantees to carry out homeownership programs in public
and Indian housing and in other multifamily housing projects.
4 Please note that this description is based on the regulation as published on April 1, 2007, which
differs from the regulation as published on April 1, 2008. As will be discussed below, the 2008
version of the regulation includes language from an amended regulation published on October
1, 2007, but the October regulation has been set aside by the court and remanded to HUD for
further action. This likely means that the 2008 version of the regulation is not in effect.
5 Mortgage Credit Analysis for Mortgage Insurance, One to Four Family Properties, Handbook
4155.1 REV-5, October 2003. [http://www.hud.gov/offices/adm/hudclips/handbooks/hsgh/
4155.1/41551HBHSGH.pdf]

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borrower’s required contribution, the Handbook establishes that HUD does not permit the
contributions to be made by the sellers of the property.6
Handbook 4155.1 REV-5 provides that the seller or other interested third parties
such as real estate agents, builders, developers, or a combination of parties, may
contribute up to 6% of the property’s sales price toward the buyer’s actual closing costs,
prepaid expenses, discount points, and other financing concessions.7 These provisions
may be included in the sales contract negotiated between buyers and sellers by the real
estate agents.
Though the Handbook permits third parties to make contributions towards the
buyer’s costs, the Handbook repeats the provisions of the regulation regarding the 3%
required contribution from the borrower. Contributions from third parties do not count
towards the buyer’s required contribution. The Handbook states, however, that an outright
gift of the required cash investment is acceptable if the donor is (1) the borrower’s
relative, (2) the borrower’s employer or labor union, (3) a charitable organization, (4) a
government agency or public entity that has a program to provide homeownership
assistance to low- and moderate-income families or first-time homebuyers, or (5) a close
friend with a clearly defined and documented interest in the borrower.8
The Handbook goes on to state that the donor may not be anyone with an interest in
the sale of the property, such as the seller, real estate agent, builder, or any entity
associated with the above. HUD considers gifts from these sources to be inducements to
purchase, and the amount of the gift must be subtracted from the sales price and this
reduces the maximum loan that FHA will insure on that property.
An FHA-insured loan on which the buyer has received a gift of the required funds
must be documented with a so-called “gift letter.” The letter must meet certain
requirements: (1) be signed by the donor and the borrower; (2) specify the amount of the
gift; (3) state that no repayment is required; (4) show the name, address, and phone
number of the donor; and (5) state the nature of the relationship between the donor and
borrower.
Downpayment Assistance Programs Sponsored by Nonprofits
As noted above, Handbook 4155.1 REV 5 provides that borrowers must contribute
at least 3% toward the purchase of the home, and that a nonprofit may provide a gift of
the required contribution as long as the funds are not provided by the sellers. In the
1990s, several nonprofits developed a form of seller-funded downpayment assistance
(DPA) program that worked around this HUD restriction on seller funding. The seller-
funded DPA programs were structured as follows: (1) the nonprofit would provide the
borrower with a gift of the required funds; (2) after completion of the home sale, the seller
of the home would make a donation to the nonprofit; and (3) the amount of the donation
6 Handbook 4155.1 REV 5, p. 1-8.
7 Handbook 4155.1 REV 5, p. 1-8.
8 HUD Handbook 4155.1 REV-5, p. 2-24.

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would be the amount the nonprofit had paid on behalf of the borrower plus a processing
fee for the nonprofit.
Since the borrower’s costs had already been paid by the nonprofit, technically, the
contribution from the seller was not paying that borrower’s costs, it was replenishing the
funds of the nonprofit and enabling the nonprofit to contribute to the downpayment of
some future borrower. Structured in this manner, the transaction did not appear to be
prohibited by HUD’s policy against having the borrower’s required contribution paid by
the sellers.
HUD, however, did not agree with this interpretation. The Nehemiah Progressive
Housing Development Corporation (Nehemiah) of Sacramento, CA, was given approval
of its DPA program by a local HUD office. The HUD national office reviewed the
paperwork and concluded that gifts to borrowers by Nehemiah would no longer be
counted as meeting the borrower’s contributions. Nehemiah filed a suit over HUD’s
decision.9 A settlement agreement was reached in 1998 whereby Nehemiah was permitted
to continue operation of its DPA program; and HUD reserved the right to take regulatory
actions with regard to DPA programs. The agreement also provided that if HUD took
regulatory action regarding HUD’s treatment of DPA providers, the applicability of the
changes to Nehemiah would occur six months from the effective date of the new rule.
The Nehemiah Program has expanded nationally and become the largest provider of
downpayment assistance for borrowers obtaining FHA-insured home loans. A number of
other nonprofit organizations have followed the Nehemiah pattern and offer similar
downpayment assistance programs.
Current Issues with Downpayment Assistance

IRS Ruling. In May 2006, the Internal Revenue Service (IRS) published 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. In its press announcement of the ruling, the
IRS 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.10
The ruling provides that an organization providing downpayment assistance does not
qualify as a 501(c)(3) organization if: (1) to finance its downpayment assistance activities,
the organization relies on sellers and other real-estate related businesses that stand to
benefit from the transactions the organization facilitates; (2) in deciding whether to
provide assistance to a low-income applicant, the organization’s staff knows the identity
of the home seller and may also know the identities of other interested parties and is able
to take into account whether the home seller or another interested party is willing to make
a payment to the organization; (3) the organization’s receipt of a payment from the home
9 Nehemiah Progressive Housing Corp. v. Andrew Cuomo, et al., Civ. S-97-1817-GEB/PAN
(E.D. Cal.).
10 [http://www.irs.gov/newsroom/article/0,,id=156675,00.html]

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seller is corresponding to the amount of the downpayment assistance in substantially all
of the transactions; (4) the organization’s reliance on these payments for most of its
funding indicates that the benefit to the home seller is a critical aspect of the
organization’s operations; (5) the organization is structured and operated to assist private
parties who are affiliated with those who fund the organization.11
The IRS noted that it is examining 185 organizations that operate downpayment
assistance programs. In addition, the agency noted that it has denied applications for tax
exemption from over 20 organizations that seek to provide this service.
Revisions to the HUD Regulations. Over the years, thousands of families have
become homeowners through FHA-insured loans using Nehemiah-type DPA programs.
Proponents of the programs point to these numbers and argue that, without cost to the
taxpayers, the programs have been able to provide homeownership opportunities to low-
and moderate-income families.
HUD argues, however, that the success of these seller-funded DPA programs has not
come without cost. HUD suggests that the programs have provided homeownership but
they have not provided sustainable homeownership in too many cases.12 HUD notes that
the rates of defaults, foreclosures, and claims have increased so dramatically that the
seller-funded DPAs jeopardize the solvency of the FHA insurance fund.13
Losses to the insurance fund could possibly be sustained if mortgages involving
seller-funded DPAs were a small part of the insurance pool. But borrowers receiving gifts
of the required funds have increasingly become a larger part of the FHA insurance pool.
In FY1996, borrowers who received gifts were 29% of FHA-insured loans. By FY2006
such borrowers had grown to nearly 42% of FHA-insured loans.14 About 50% of the gifts
received by borrowers in FY2006 and FY2007 were those from the sellers of the
property.15 HUD finds the default rate on loans with gifts from sellers to be nearly twice
the default rate on loans with gifts from family members.16
A primary concern of HUD is that the sales price is often increased on homes
financed through seller-funded DPA programs. Inflated sales amounts result in inflated
mortgage amounts, and this increases the size of claims against the FHA insurance fund
when the loans default.17 For these reasons HUD has sought to curtail the seller-funded
DPA programs.
11 IRS Revenue Ruling 2006-27 at [http://www.irs.gov/pub/irs-drop/rr-06-27.pdf].
12 72 FR 27047.
13 73 FR 33942.
14 FHA’s Quarterly Report to the Commissioner on FHA Business Activity, September 2007, p.
10.
15 An Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund,
prepared for the U.S. Department of Housing and Urban Development by Integrated Financial
Engineering, Inc., October 12, 2007, p. 68.
16 73 FR 33952.
17 72 FR 27049.

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On May 11, 2007, HUD published a proposed rule to 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).18 Only organizations that
qualify as tax-exempt charitable or educational organizations under Internal Revenue
Code Section 501(c)(3) would be eligible donors. This regulation was made final on
October 1, 2007, and had an effective date of October 31, 2007.19 For Nehemiah, the
effective date was March 31, 2008, because of the terms of the 1998 settlement
agreement between Nehemiah and HUD.
Nehemiah and several other organizations, whose nonprofit status might be
challenged by the IRS, filed suit to block HUD’s implementation of this new rule. The
United States District Court for the District of Columbia issued a ruling on November 1,
2007, temporarily enjoining HUD from implementing the downpayment assistance rule.
On March 5, 2008, the court vacated the final rule and remanded it to HUD for further
processing consistent with the court’s opinion.20
On June 16, 2008, HUD published a new proposed rule which reopens the comment
period on the May 7, 2007 proposed rule, as revised by the October 1, 2007 rule.21
Current Legislation
As introduced on July 31, 2008, H.R. 6694 would amend the new law to provide
exceptions to the prohibition on seller contributions. Sellers would be permitted to
contribute to the borrower’s required funds on certain mortgages: (1) mortgages under
which the borrower has a credit score in excess of 680; (2) mortgages under which the
borrower has a credit score between 620 and 680, and upon which the borrower is charged
a mortgage insurance premium that is high enough to permit the loan to be insured
without the need for an appropriation of credit subsidy; and (3) mortgages insured in
FY2010 or thereafter under which the borrower has a credit score of 619 or less, but only
if HUD certifies that such loans can be insured without the need for an appropriation of
credit subsidy. HUD would be authorized to use risk-based pricing of mortgage insurance
for borrowers with lower credit scores. Downpayment assistance entities would be
required to offer to make counseling available to the borrower regarding the
responsibilities and financial management involved in homeownership and to provide
such counseling if the borrower accepts the offer.
18 72 FR 27047.
19 72 FR 56002
20 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).
21 73 FR 33942.

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