United States Government Accountability Office

GAO Testimony 

Before the Subcommittee on Housing and 

Community Opportunity, Committee on 

Financial Services, House of 

Representatives

MORTGAGE FINANCING

Seller-Funded DownPayment Assistance 

Changes the Structure of 

the Purchase Transaction 

and Negatively Affects Loan 

Performance 

Statement of William B. Shear, Director 

Financial Markets and Community Investment 

For Release on Delivery

Expected at 10:00 a.m. EDT 

Friday, June 22, 2007

 

GAO-07-1033T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

June 22, 2007

MORTGAGE FINANCING 

Seller-Funded Down-Payment Assistance 

Changes the Structure of the Purchase 

Transaction and Negatively Affects Loan 

Performance 

Highlights of GAO-07-1033T, a testimony 

before the Subcommittee on Housing and 

Community Opportunity, Committee on 

Financial Services, House of 

Representatives 

The Federal Housing 

Administration (FHA) differs from 

other key mortgage industry 

participants in that it allows 

borrowers to obtain down-payment 

assistance from nonprofit 

organizations (nonprofits) that 

operate programs supported partly

by property sellers. Research has

raised concerns about how this 

type of assistance affects home

purchase transactions. To assist 

Congress in considering issues

related to down-payment 

assistance, this testimony provides 

information from GAO’s November 

2005 report, Mortgage Financing: 

Additional Action Needed to 

Manage Risks of FHA-Insured 

Loans with Down Payment 

Assistance (GAO-06-24). 

Specifically, this testimony 

discusses (1) trends in the use of 

down-payment assistance with 

FHA-insured loans, (2) the impact

that the presence of such

assistance has on purchase 

transactions and house prices, and 

(3) the influence of such assistance 

on loan performance. 

What GAO Recommends

In the report discussed in this 

testimony, GAO made

recommendations designed to

better manage the risks of loans 

with down-payment assistance 

generally and from seller-funded 

nonprofits in particular. Consistent 

with our recommendations, HUD 

recently issued a proposed rule 

that would prohibit the use of 

seller-funded down-payment 

assistance with FHA-insured loans. 

The proportion of FHA-insured purchase loans that were financed in part by 

down-payment assistance increased from 35 percent to nearly 50 percent 

from 2000 through 2004. Assistance from nonprofit organizations that 

received at least part of their funding from property sellers accounted for 

much of this increase, growing from about 6 percent of FHA-insured 

purchase loans in 2000 to approximately 30 percent in 2004. More recent 

data indicate that in 2005 and 2006, the percentages of FHA-insured loans 

with down-payment assistance from all sources and from seller-funded 

nonprofits were roughly equivalent to 2004 levels. 

Assistance from seller-funded nonprofits alters the structure of the purchase 

transaction in important ways. First, because many seller-funded nonprofits 

require property sellers to make a payment to their organization, assistance 

from these nonprofits creates an indirect funding stream from property 

sellers to homebuyers. Second, GAO analysis indicated that FHA-insured 

homes bought with seller-funded nonprofit assistance were appraised at and 

sold for about 2 to 3 percent more than comparable homes bought without 

such assistance. 

Regardless of the source of assistance and holding other variables constant, 

GAO analysis indicated that FHA-insured loans with down-payment 

assistance have higher delinquency and insurance claim rates than do similar 

loans without such assistance. Furthermore, loans with assistance from 

seller-funded nonprofits do not perform as well as loans with assistance 

from other sources (see fig.). This difference may be explained, in part, by 

the higher sales prices of comparable homes bought with seller-funded 

assistance and the homebuyers having less equity in the transaction.

Effect of Down-Payment Assistance on the Probability of Delinquency and Claim 

No downpayment assistanceNonseller-funded 

assistance 

Seller-funded 

assistance 

Percentage 

Source: GAO. 

Relative delinquency probability Relative claim probability 

Note: Loans without assistance are set at 100 percent. Data are from a national sample of FHAinsured loans from 2000, 2001, and 2002; and the analysis controlled for selected variables.

0

50

100

150

200

250

www.gao.gov/cgi-bin/getrpt?GAO-07-1033T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact William B. 

Shear at (202) 512-8678 or shearw@gao.gov. 
Madam Chairwoman and Members of the Subcommittee: 

I am pleased to be here today to discuss issues concerning down-payment 

assistance for homebuyers. Making a down payment on a mortgage can 

benefit both the homebuyer and the mortgage provider. For example, a 

down payment creates “instant equity” for the new homeowner, and we 

and others have shown that mortgage loans with greater owner investment 

generally perform better.1

 However, many families have difficulty saving

sufficient funds for a down payment and loan closing costs. One way to 

make homeownership affordable to more families is to allow homebuyers 

to obtain these funds from third parties such as relatives, employers, 

government agencies, and nonprofit organizations (nonprofits). 

Like many conventional lenders, the Federal Housing Administration 

(FHA) of the Department of Housing and Urban Development (HUD) 

allows down-payment assistance from third-party sources. One of the 

primary goals of FHA, which insures single-family mortgages made by 

private lenders, is to expand homeownership opportunities for first-time 

homebuyers and other borrowers who would not otherwise qualify for 

conventional mortgages on affordable terms. FHA borrowers often have

limited resources to meet the 3 percent borrower investment FHA requires 

and many obtain down-payment assistance. Unlike other key mortgage 

industry participants, FHA allows borrowers to obtain this assistance from 

nonprofits that operate programs supported partly by financial 

contributions and service fees from participating property sellers. 

My testimony today is based on a report we issued in November 2005 on 

down-payment assistance used with FHA-insured mortgages.2

 My 

discussion will focus on (1) trends in the use of down-payment assistance 

with FHA-insured loans, (2) the impact that the presence of such 

assistance has on purchase transactions and house prices, and (3) the 

influence of such assistance on loan performance. 

In preparing our November 2005 report, we analyzed loan-level data from 

HUD on single-family home purchase mortgages. These data included two

samples of FHA-insured loans from fiscal years 2000, 2001, and 2002—a 

 1

For example, see GAO, Mortgage Financing: Actions Needed to Help FHA Manage Risks 

from New Mortgage Loan Products, GAO-05-194 (Washington, D.C.: Feb. 11, 2005).

2

GAO, Additional Action Needed to Manage Risks of FHA-Insured Loans with Down 

Payment Assistance, GAO-06-24 (Washington, D.C.: Nov. 9, 2005).

Page 1 GAO-07-1033T 
national sample and a sample from three metropolitan statistical areas 

(MSA) with high rates of down-payment assistance—and performance 

data on those loans as of June 30, 2005.3

 We reviewed FHA reports and 

guidance for loans with down-payment assistance and examined practices 

used by other mortgage industry participants for loan products that permit 

similar assistance. We also examined the sales prices of homes by the use 

and source of down-payment assistance using property value estimates 

derived from an Automated Valuation Model (AVM).4

 Finally, we 

interviewed real estate agents, lenders, appraisers, and other key players 

involved in transactions with down-payment assistance. 

In summary, we found that: 

• The proportion of FHA-insured purchase loans that were financed in part

by down-payment assistance from various sources increased from 35 

percent to nearly 50 percent from 2000 through 2004, while the overall

number of loans that FHA insured fell sharply. Assistance from nonprofit 

organizations funded by property sellers accounted for a growing 

percentage of that assistance. More specifically, about 6 percent of FHAinsured loans in 2000 received down-payment assistance from sellerfunded nonprofits, but by 2004 nonprofit assistance had grown to about 30 

percent. More recent data indicate that in 2005 and 2006, the percentages 

of FHA-insured loans with down-payment assistance from all sources and 

from seller-funded nonprofits were roughly equivalent to 2004 levels. 

• Down-payment assistance provided by a seller-funded nonprofit can alter 

the structure of the purchase transaction in important ways. First, when 

homebuyers receive such assistance, many of the nonprofits require 

property sellers to make a payment to the nonprofit that equals the 

amount of assistance the homebuyer receives, plus a service fee, after the 

closing. This requirement creates an indirect funding stream from property 

sellers to homebuyers that does not exist in other transactions, even those 

involving some other type of down-payment assistance. Second, according

to mortgage industry participants and a HUD contractor’s study, property 

sellers that have provided down-payment assistance through nonprofits 

 3

The data consisted of purchase loans insured by FHA’s 203(b) program, its main singlefamily program, and its 234(c) condominium program. The three MSAs were Atlanta,

Indianapolis, and Salt Lake City. All years are fiscal years unless otherwise indicated. 

4

AVMs encompass a range of computerized econometric models that use property 

characteristics and trends in sales prices to provide estimates of residential real estate 

property values. AVMs are widely used in the mortgage industry for quality control and 

other purposes. 

Page 2 GAO-07-1033T 
then often raised the sales prices of the homes involved in order to recover 

the required payments to the organizations.5

 Similarly, our analysis found 

that FHA-insured homes bought with seller-funded nonprofit assistance 

were appraised at and sold for about 2 to 3 percent more than comparable 

homes bought without such assistance. 

• Loans with down-payment assistance do not perform as well as loans 

without down-payment assistance. This may be partially explained by the 

homebuyer having less equity in the transaction. Holding other variables 

constant, our analysis indicated that FHA-insured loans with downpayment assistance had higher delinquency and insurance claim rates than 

similar loans without such assistance. For example, we found that the 

probability that loans with down-payment assistance from a seller-funded 

nonprofit would result in insurance claims was 76 percent higher in the 

national sample and 166 percent higher in the MSA sample than it was for 

comparable loans without assistance. These differences in performance 

may also be explained, in part, by the higher sales price of comparable 

homes bought with seller-funded down-payment assistance. Due partly to

the adverse performance of loans with seller-funded down-payment 

assistance, FHA has estimated that in the absence of program changes its 

single-family mortgage insurance program would require a subsidy—that 

is, appropriations—in 2008. 

Our 2005 report made recommendations designed to better manage the 

risks of loans with down-payment assistance generally and from sellerfunded nonprofits specifically. Consistent with our recommendations, 

HUD, among other things, recently issued a proposed rule that would 

prohibit the use of seller-funded down-payment assistance in conjunction 

with FHA-insured loans.6

Congress established FHA in 1934 under the National Housing Act (P.L. 73-

479) to broaden homeownership, protect and sustain lending institutions, 

and stimulate employment in the building industry. FHA’s single-family 

programs insure private lenders against losses from borrower defaults on

mortgages that meet FHA’s criteria for properties with one to four housing 

units. FHA historically has played a particularly large role among minority, 

Background 

 5

Concentrance Consulting Group, An Examination of Downpayment Gift Programs

Administered by Nonprofit Organizations, prepared for the U.S. Department of Housing 

and Urban Development (Washington, D.C.: March 2005). 

6

See 72 Fed. Reg. 27048 (May 11, 2007). 

Page 3 GAO-07-1033T 
lower-income, and first-time homebuyers. In 2006, 79 percent of FHAinsured home purchase loans went to first-time homebuyers, 31 percent of 

whom were minorities. 

In recent years, FHA’s volume of business has fallen sharply. More 

specifically, the number of single-family loans that FHA insured fell from 

about 1.3 million in 2002 to 426,000 in 2006. To help FHA adapt to recent 

trends in the mortgage market, in 2006 HUD submitted a legislative 

proposal to Congress that included changes that would adjust loan limits 

for the single-family mortgage insurance program, eliminate the 

requirement for a minimum down payment, and provide greater flexibility 

to FHA to set insurance premiums based on risk factors. According to 

HUD, a zero-down-payment mortgage product would provide FHA with a 

better way to serve families in need of down-payment assistance. 

As previously noted, some nonprofits that provide down-payment 

assistance receive contributions from property sellers. When a homebuyer

receives down-payment assistance from one of these organizations, the 

organization requires the property seller to make a financial payment to 

their organization. These nonprofits are commonly called “seller-funded” 

down-payment assistance providers. A 1998 memorandum from HUD’s 

Office of the General Counsel found that funds from a seller-funded 

nonprofit were not in conflict with FHA’s guidelines prohibiting downpayment assistance from sellers.7

 FHA does not approve down-payment 

assistance programs administered by nonprofits. Instead, lenders are 

responsible for assuring that down-payment assistance from a nonprofit 

meets FHA requirements. 

 7

HUD Office of the General Counsel, April 7, 1998; Memorandum; Subject: Nehemiah 

Homeownership 2000 Program—Downpayment Assistance. 

Page 4 GAO-07-1033T 
Loans with down-payment assistance have come to constitute a 

substantial portion of FHA’s portfolio in recent years, particularly as the

number of loans without such assistance has fallen sharply. For example, 

from 2000 to 2004, the total proportion of FHA-insured single-family 

purchase loans that had a loan-to-value (LTV) ratio greater than 95 percent 

and that also involved down-payment assistance from any source grew 

from 35 to nearly 50 percent.8

 Assistance from nonprofit organizations, 

about 93 percent of which were funded by sellers, accounted for an 

increasing proportion of this assistance. Approximately 6 percent of FHAinsured loans received down-payment assistance from nonprofit 

organizations in 2000, but, by 2004 this figure had grown to about 30 

percent. FHA data for 2005 and 2006 indicate that the percentages of loans 

with down-payment assistance from any source and from seller-funded 

nonprofits remained at roughly 2004 levels. 

Growth in the number of seller-funded nonprofit providers and the greater 

acceptance of this type of assistance have contributed to the increase in 

the use of down-payment assistance. According to industry professionals, 

relatives have traditionally provided such assistance, but in the past 

decade or so other sources have emerged, including not only seller-funded 

nonprofit organizations but also government agencies and employers. The 

mortgage industry has responded by developing practices to administer 

this type of assistance, for instance, FHA policies require gift letters and 

documentation of the transfer of funds. Lenders also reported that sellerfunded down-payment assistance providers have developed practices 

accepted by FHA and lenders. For example, seller-funded programs have 

standardized gift letter and contract addendum forms for documenting 

both the transfer of down-payment assistance funds to the homebuyer and 

the financial contribution from the property seller to the nonprofit 

organization. As a result, for FHA-insured loans, lenders are increasingly 

aware of and willing to accept down-payment assistance, including from

seller-funded nonprofits. 

We found that states that have higher-than-average percentages of FHAinsured loans with nonprofit down-payment assistance, primarily from 

seller-funded programs, tended to be states with lower-than-average house 

Purchase Loans with 

Seller-Funded DownPayment Assistance 

Have Become a 

Substantial Part of 

FHA’s Portfolio and 

Are More Prevalent in 

Areas with Lower 

House Price 

Appreciation 

 8

LTV ratio is the loan amount divided by the sales price or appraised value of the property.

The data sample we relied on included only FHA-insured, single-family purchase loans with

an LTV ratio greater than 95 percent. Loans with an LTV ratio greater than 95 percent 

account for almost 90 percent of FHA’s portfolio. 

Page 5 GAO-07-1033T 
price appreciation rates.9

 From May 2004 to April 2005, 35 percent of all

FHA-insured purchase loans nationwide involved down-payment 

assistance from a nonprofit organization, and 15 states had percentages 

that were higher than this nationwide average. Fourteen of these 15 states 

also had house price appreciation rates that were below the median rate

for all states. In addition, the eight states with the lowest house price 

appreciation rates in the nation all had higher-than-average percentages of

nonprofit down-payment assistance. Generally, states with high 

proportions of FHA-insured loans with nonprofit down-payment 

assistance were concentrated in the Southwest, Southeast, and Midwest. 

The presence of down-payment assistance from seller-funded nonprofits 

can alter the structure of purchase transactions. When buyers receive 

assistance from sources other than seller-funded nonprofits, the home 

purchase takes place like any other purchase transaction—buyers use the 

funds to pay part of the house price, the closing costs, or both, reducing 

the mortgage by the amount they pay and creating “instant equity.” 

However, seller-funded down-payment assistance programs typically

require property sellers to make a financial contribution and pay a service 

fee after the closing, creating an indirect funding stream from property 

sellers to homebuyers that does not exist in a typical transaction 

(see fig. 1).10

Seller-Funded 

Assistance Affects 

Home Purchase 

Transactions and Can 

Raise House Prices 

 9

We measured house price appreciation using data from Global Insight, Inc., for the end of 

the fourth quarter of 2003 to the end of the fourth quarter of 2004. 

10Organizations commonly require property sellers to provide both a financial payment

equal to the amount of assistance paid to the homeowner and a service fee.

Page 6 GAO-07-1033T 
Figure 1: Structure of FHA Individual Purchase Transaction, with Nonseller-Funded Down-Payment Assistance and with

Seller-Funded Down-Payment Assistance

Buyer 

$100K 

$3K 

Sold: 

$103K 

Lender 

Appraiser FHA 

Real estate 

agents

Seller 

Source: 

• Seller-funded 

 nonprofit 

 organization 

$3K 

Source: GAO. 

Nonseller-funded down-payment assistance Seller-funded down-payment assistance

$ Downpayment 

$ FHA-insured mortgage through lender 

$ Monthly mortgage payments on principal and interest 

Potential sources of down-payment assistance

Buyer 

$97K 

Sold: 

$100K 

Lender 

Appraiser FHA 

Real estate 

agents

Seller 

$3K 

$ $ 

Fee 

+ 

Property appraisal: $100K Property appraisal: $103K 

Source: 

• Nonseller-funded 

 nonprofit organization 

• Relative 

• Other (employer, 

government agency, etc.) 

Our analysis indicated, and mortgage industry participants we spoke with 

reported, that property sellers often raised the sales price of their 

properties in order to recover the contribution to the seller-funded 

nonprofit that provided the down-payment assistance. Marketing materials 

from seller-funded nonprofits often emphasize that property sellers using 

these down-payment assistance programs earn a higher net profit than 

property sellers who do not. These materials show sellers receiving a 

higher sales price that more than compensates for the fee typically paid to 

the down-payment assistance provider. Several mortgage industry 

participants we interviewed noted that when homebuyers obtained downPage 7 GAO-07-1033T 
payment assistance from seller-funded nonprofits, property sellers 

increased their sales prices to recover their payments to the nonprofits 

providing the assistance. An earlier study by a HUD contractor 

corroborates the existence of this practice.11 Some mortgage industry 

participants we met with told us that they viewed down-payment 

assistance from seller-funded nonprofits as a seller inducement. However, 

FHA has not viewed such assistance as a seller inducement and therefore

does not subject this assistance to the limits that it otherwise places on 

contributions from sellers. 

Some mortgage industry participants told us that homes purchased with 

down-payment assistance from seller-funded nonprofits might be 

appraised for higher values than they would be without this assistance. 

Appraisers we spoke with said that lenders, realtors, and sellers 

sometimes pressured them to “bring in the value” in order to complete the 

sale. The HUD contractor study corroborates the existence of these 

pressures. Our analysis of a national sample of FHA-insured loans 

endorsed in 2000, 2001, and 2002 suggested that homes with seller-funded 

assistance were appraised and sold for about 3 percent more than 

comparable homes without such assistance. Additionally, our analysis of 

more recent loans—a sample of FHA-insured loans settled in March 

2005—indicated that homes sold with nonprofit assistance were appraised 

and sold for about 2 percentage points more than comparable homes 

without nonprofit assistance.12

 11Concentrance Consulting Group, An Examination of Downpayment Gift Programs

Administered by Nonprofit Organizations.

12To perform this analysis, we contracted with First American Real Estate Solutions to 

provide estimates of the value of homes in a sample of FHA-insured loans. The values were

calculated for the month prior to the closing, using an AVM. 

Page 8 GAO-07-1033T 
We found that FHA-insured loans with down-payment assistance do not 

perform as well as loans without it. As part of our evaluation, we analyzed 

loan performance by source of down-payment assistance, controlling for 

the maximum age of the loan, as of June 30, 2005. We used two samples of 

FHA-insured purchase loans from 2000, 2001, and 2002—a national sample 

and a sample from three MSAs with high rates of down-payment 

assistance. We grouped the loans into the following three categories: loans 

with assistance from seller-funded nonprofit organizations, loans with 

assistance from nonseller-funded sources, and loans without assistance. 

As shown in figure 2, in both samples and in each year, loans with downpayment assistance from seller-funded nonprofit organizations had the 

highest rates of delinquency and insurance claims, and loans without 

assistance the lowest. Specifically, between 22 and 28 percent of loans 

with seller-funded assistance had experienced a 90-day delinquency, 

compared with 11 to 16 percent of loans with assistance from other 

sources and 8 to 12 percent of loans without assistance. The claim rates 

for loans with seller-funded assistance ranged from 6 to 18 percent, for 

loans with other sources of assistance from 5 to 10 percent, and for loans 

without assistance from 3 to 6 percent. 

FHA-Insured Loans 

with Down Payment 

Assistance, 

Particularly from 

Seller-Funded 

Nonprofits, Do Not 

Perform as Well as 

Similar Loans without 

Assistance 

Page 9 GAO-07-1033T 
Figure 2: Delinquency and Claim Rates, by Maximum Age of Loan and Source of Down-Payment Funds 

Delinquency rates Claim rates

0 

5 

10 

15 

20 

25 

30 

3 years 4 years 5 years

MSA 

Percentage 

0 

5 

10 

15 

20 

25 

30 

3 years 4 years 5 years

National 

Percentage 

0 

5 

10 

15 

20 

25 

30 

3 years 4 years 5 years

MSA 

Percentage 

0 

5 

10 

15 

20 

25 

30 

3 years 4 years 5 years

National 

Percentage 

No down-payment assistance

Nonseller-funded assistance 

Seller-funded assistance 

Source: GAO. 

Maximum age of loan 

Note: Analysis based on data from two samples of loans drawn for a file review study funded by HUD

and conducted by the Concentrance Consulting Group. The sampled loans were purchase money 

loans endorsed in 2000, 2001, and 2002 with LTV ratios greater than 95 percent. The national 

sample consisted of just over 5,000 loans, and the MSA sample consisted of 1,000 loans for each of 

the three MSAs: Atlanta, Indianapolis, and Salt Lake City. 

In addition, we analyzed loan performance by source of down-payment 

assistance holding other variables constant. Here we found that FHAinsured loans with down-payment assistance had higher delinquency and 

claim rates than similar loans without such assistance (see fig. 3). The 

results from the national sample indicated that assistance from a sellerfunded nonprofit raised the probability that the loan had gone to claim by 

76 percent relative to similar loans with no assistance. Differences in the 

MSA sample were even larger; the probability that loans with seller-funded 

nonprofit assistance would go to claim was 166 percent higher than it was 

Page 10 GAO-07-1033T 
for comparable loans without assistance. Similarly, results from the 

national sample showed that down-payment assistance from a sellerfunded nonprofit raised the probability of delinquency by 93 percent 

compared with the probability of delinquency in comparable loans without 

assistance. For the MSA sample, this figure was 110 percent. 

Page 11 GAO-07-1033T 
Figure 3: Effect of Down-Payment Assistance on the Probability of Delinquency and 

Claim, Controlling for Selected Variables 

No down-payment assistance

Nonseller-funded assistance 

Seller-funded assistance 

Relative 

delinquency 

probabilities

Percentage 

Relative 

claim probabilities

Percentage 

Source: GAO. 

0 

50 

100 

150 

200 

250 

300 

0 

50 

100 

150 

200 

250 

300 

MSA National MSA National 

Note: Loans without down-payment assistance are set at 100 percent. The results show the effect of 

a change in the variable on the odds ratio—that is, the probability of a claim (or delinquency) divided 

by the probability of not experiencing a claim (or delinquency). However, the probability of 

experiencing a claim or delinquency in any given quarter is fairly small; so, the change in the odds

ratio is very close to the change in the probability. The analysis is based on data from two samples of

loans drawn for a file review study funded by HUD and conducted by the Concentrance Consulting 

Group. The loans in the samples were endorsed in 2000, 2001, and 2002 and had LTV ratios greater

than 95 percent. The national sample consisted of just over 5,000 loans and the MSA sample 

consisted of 1,000 purchase money loans for each of the three MSAs: Atlanta, Indianapolis, and Salt 

Lake City. The loan performance data (current as of June 2005) are from HUD’s Single-Family Data

Warehouse. 

The weaker performance of loans with seller-funded down-payment 

assistance may be explained, in part, by the higher sales prices of homes 

bought with this assistance and the homebuyer having less equity in the 

transaction. The higher sales price that often results from a transaction 

involving seller-funded down-payment assistance can have the perverse 

Page 12 GAO-07-1033T 
effect of denying buyers any equity in their properties and creating higher 

effective LTV ratios. FHA has requirements which have the effect of 

ensuring that FHA homebuyers obtain a certain amount of “instant equity”

at closing, but seller-funded down-payment assistance effectively 

undercuts these requirements. That is, when the sales price represents the 

fair market value of the house, and the homebuyer contributes 3 percent

of the sales price at the closing, the LTV ratio is less than 100 percent. But 

when a seller raises the sales price of a property to accommodate a 

contribution to a nonprofit that provides down-payment assistance to the 

buyer, the buyer’s mortgage may represent 100 percent or more of the 

property’s true market value. Our prior analysis has found that, controlling 

for other factors, high LTV ratios lead to increased claims. 

The adverse performance of loans with seller-funded down-payment 

assistance has had negative consequences for FHA. FHA has estimated 

that its single-family mortgage insurance program would require a 

subsidy—that is, appropriations—in 2008 in the absence of program 

changes. According to FHA, the growing share of FHA-insured purchase 

loans with seller-funded assistance has contributed to FHA’s worsening 

financial performance. 

Our 2005 report made recommendations designed to better manage the 

risks of loans with down-payment assistance generally and from sellerfunded nonprofits specifically. We recommended that FHA consider risk 

mitigation techniques such as including down-payment assistance as a 

factor when underwriting loans. We also recommended that FHA take 

additional steps to mitigate the risk associated with loans with sellerfunded down-payment assistance, such as treating such assistance as a 

seller inducement and therefore subject to the prohibition against using 

seller contributions to meet the 3 percent borrower contribution 

requirement. 

Consistent with our recommendations, FHA is testing additional predictive

variables, including source of the down payment, for inclusion in its 

mortgage scorecard (an automated tool that evaluates the default risk of 

borrowers). Additionally, in May 2007 HUD issued a proposed rule that 

would prohibit the use of seller-funded down-payment assistance in

conjunction with FHA-insured loans. FHA also has been anticipating a 

reduction in the number of loans with down-payment assistance from 

seller-funded nonprofit organizations as a result of actions taken by the 

Internal Revenue Service (IRS). Citing concerns about seller-funded 

nonprofits raised by our report and the 2005 HUD contractor study, IRS 

issued a ruling in May 2006 stating that these organizations do not qualify

Page 13 GAO-07-1033T 
as tax-exempt charities, thereby making loans with such assistance 

ineligible for FHA insurance. In a press announcement of the ruling, IRS 

stated that funneling down-payment assistance from sellers to buyers 

through “self-serving, circular-financing arrangements” is inconsistent with 

operation as a charitable organization. According to FHA, as of June 2007,

IRS had rescinded the charitable status of three of the 185 organizations 

that IRS is examining. 

Madam Chairwoman, this concludes my prepared statement. I would be 

happy to answer any questions at this time. 

For further information on this testimony, please contact William B. Shear 

at (202) 512-8678 or shearw@gao.gov. Individuals making key 

contributions to this testimony included Steve Westley (Assistant 

Director), Emily Chalmers, Chris Krzeminski, and Andy Pauline. 

Page 14 GAO-07-1033T 

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