[Federal Register Volume 77, Number 234 (Wednesday, December 5, 2012)]
[Rules and Regulations]
[Pages 72219-72223]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-29361]



24 CFR Part 203

[Docket No. FR-5679-N-01]

Federal Housing Administration: Prohibited Sources of Minimum 
Cash Investment Under the National Housing Act--Interpretive Rule

AGENCY: Office of the General Counsel, HUD.

ACTION: Interpretive rule.


SUMMARY: HUD is issuing this interpretive rule to clarify the scope of 
the provision in the National Housing Act that prohibits certain 
sources of a homebuyer's funds for the required minimum cash investment 
for single family mortgages to be insured by the Federal Housing 
Administration (FHA). Uncertainty has arisen as to the effect of this 
provision on State and local governments and their agencies' and 
instrumentalities' homeownership programs that provide funds for the 
minimum cash investment. This rule provides HUD's interpretation that 
this statutory provision does not remove the availability of FHA 
insurance for use in conjunction with State and local government 
programs that provide funds toward the required minimum cash 
investment. Although interpretive rules are exempt from public comment 
under the Administrative Procedure Act, HUD nevertheless invites public 
comment on the interpretation provided in this rule.

DATES: Effective Date: November 29, 2012. Comment Due Date: January 4, 

ADDRESSES: Interested persons are invited to submit comments regarding 
this rule to the Regulations Division, Office of General Counsel, 
Department of Housing and Urban Development, 451 7th Street SW., Room 
10276, Washington, DC 20410-0500. Communications must refer to the 
above docket number and title. There are two methods for submitting 
public comments. All submissions must refer to the above docket number 
and title.
    1. Submission of Comments by Mail. Comments may be submitted by 
mail to the Regulations Division, Office of General Counsel, Department 
of Housing and Urban Development, 451 7th Street SW., Room 10276, 
Washington, DC 20410-0500.
    2. Electronic Submission of Comments. Interested persons may submit 
comments electronically through the Federal eRulemaking Portal at 
www.regulations.gov. HUD strongly encourages commenters to submit 
comments electronically. Electronic submission of comments allows the 
commenter maximum time to prepare and submit a comment, ensures timely 
receipt by HUD, and enables HUD to make them immediately available to 
the public. Comments submitted electronically through the 
www.regulations.gov Web site can be viewed by other commenters and 
interested members of the public. Commenters should follow the 
instructions provided on that site to submit comments electronically.

    Note:  To receive consideration as public comments, comments 
must be submitted through one of the two methods specified above. 
Again, all submissions must refer to the docket number and title of 
the rule.

    No Facsimile Comments. Facsimile (FAX) comments are not acceptable.
    Public Inspection of Public Comments. All properly submitted 
comments and communications submitted to HUD will be available for 
public inspection and copying between 8 a.m. and 5 p.m. weekdays at the 
above address. Due to security measures at the HUD Headquarters 
building, an appointment to review the public comments must be 
scheduled in advance by calling the Regulations Division at 202-708-
3055 (this is not a toll-free number). Individuals with speech or 
hearing impairments may access this number via TTY by calling the 
Federal Relay Service at 800-877-8339. Copies of all comments submitted 
are available for inspection and downloading at www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Millicent Potts, Associate General 
Counsel for Insured Housing, Office of General Counsel, U.S. Department 
of Housing and Urban Development Room 9226, 202-708-2212. Hearing or 
speech impaired individuals may access these numbers via TTY by calling 
the toll free Federal Relay Service at 800-877-8339.


I. Background

A. The National Housing Act Prohibition on Certain Sources of Cash 

    To qualify a mortgage for FHA mortgage insurance, section 
203(b)(9)(A) of the National Housing Act (12 U.S.C. 1709(b)(9)) 
requires the homebuyer to

[[Page 72220]]

pay ``in cash or equivalent on account of the property an amount equal 
to not less than 3.5 percent of the appraised value of the property.'' 
Some homebuyers obtain this minimum amount from sources other than 
their own earnings or savings; for example, a relative may give or loan 
them this money or some part of it. However, section 203(b)(9)(C) of 
the National Housing Act provides that no part of this required minimum 
investment may consist of funds provided by the seller of the property 
or any other person or entity who benefits financially from the sale of 
the property, or any person who is reimbursed by any such person or 

B. Federally Funded Homeownership Programs

    Governments--Federal, State, and local--and their agencies and 
instrumentalities have provided assistance toward the minimum cash 
investment as part of homeownership programs from various public funds, 
including appropriated funds, operating tax revenues, taxable and tax-
exempt general obligation bonds, and surplus revenues (for example, 
excess reserves). Federal homeownership assistance programs that have a 
cash investment component include HUD's Neighborhood Stabilization 
Program, Community Development Block Grant (CDBG) program, and HOME 
Investment Partnerships program, as well as the Department of Veterans 
Affairs Home Loan Guaranty Service and U.S. Department of Agriculture's 
Rural Development Housing and Community Facilities program. These 
Federal homeownership assistance programs have specified public 
purposes, such as revitalizing communities affected by foreclosures and 
vacancy, increasing the homeownership rate in particular geographies, 
making homeownership affordable to underserved populations and in high-
cost markets.
    For these Federal assistance programs, Congress has authorized 
funds to be distributed from the Treasury, often through State and 
local governments or their instrumentalities, for purposes of 
supporting homeownership programs. At the same time, section 
203(b)(9)(C) of the National Housing Act raises the question whether 
the distribution of these same Federal funds would cause the mortgages 
originated on the basis of support from such funds not to qualify for 
FHA insurance. Reading the prohibition in section 203(b)(9)(C) to 
include other Federal agencies, State and local governments, or their 
instrumentalities disbursing government funds in accordance with the 
requirements of government assistance programs would place these 
governments and instrumentalities in an untenable position of having 
governmental authority to provide assistance toward the minimum cash 
investment on the one hand, but being unable to use FHA-insured 
mortgage financing on the other. To do so would also frustrate the 
statutory purpose of these programs and of the FHA to encourage and 
support homeownership.\1\

    \1\ In providing an overview of the Housing and Economic 
Recovery Act if 2008 (HERA), the Congressional Research Service in 
an August 19, 2008 report for Congress on HERA [RL34623] notes that 
HERA authorizes $4 billion for state and local governements to 
purchase and rehabilitate abandoned and foreclosed houisng and that 
this housing would be sold or rented to low- and moderate-income 
individuals and families. See http://assets.opencrs.com/rpts/RL34623_20080819.pdf.

C. Other Government Funded Homeownership Assistance Programs

    Another key source of homeownership assistance programs, such as 
assistance with closing costs, or rehabilitation, is provided by State 
and local governments, primarily through housing finance agencies 
(HFAs). According to the National Council of State Housing Finance 
Agencies, HFAs are generally State-chartered authorities established by 
State governments to help meet the affordable housing needs of State 
residents.\2\ Although HFAs vary widely in characteristics such as 
their relationship to State government, most are independent entities 
that operate under the direction of a board of directors appointed by 
their respective State governors. They administer a wide range of 
affordable housing and community development programs.\3\ Using housing 
bonds, low-income housing tax credits, HOME program funds, and other 
Federal and State resources, HFAs have crafted hundreds of housing 
programs, including homeownership, rental, and all types of special-
needs housing. HFAs have provided affordable mortgages to 2.6 million 
families to buy their first homes through mortgage revenue bond 

    \2\ See http://answers.usa.gov/system/selfservice.controller?CONFIGURATION=1000&PARTITION_ID=1&CMD=VIEW_ARTICLE&USERTYPE=1&LANGUAGE=en&COUNTRY=US&ARTICLE_ID=10182.
    \3\ See http://www.ncsha.org/about-hfas/hfa-programs.
    \4\ See http://www.ncsha.org/about-hfas.

    A recent study of HFAs found that 100 percent of the 51 HFAs 
surveyed said that part of their mission is ``to assist low- and 
moderate-income residents to purchase homes and be successful 
homeowners.'' \5\ A majority of those programs--in 2011, 88 percent (45 
of 51) of State HFAs--include minimum cash investment as a part of 
advancing their mission.\6\ Federally backed mortgage insurance is also 
a critical part of the HFAs' strategy. Of HFA loan production in 2011, 
86 percent involved FHA, Veterans Administration (VA), or Rural Housing 
Service loan or loan insurance programs.

    \5\ See http://www.chfainfo.com/documents/HFA_HEC_Report_March2012.pdf at 1.
    \6\ Id. at 1.

    Many HFAs administer other State and Federal housing assistance 
programs such as homeless assistance, CDBG, and State housing trust 
funds. Local housing finance agencies operate similarly but at the 
county, city, or other municipal-entity level. In many cases, a local 
agency may be the local government itself. HFAs provide various 
services to assist citizens within their jurisdictions in attaining 
affordable housing options. These services include providing access to 
affordable mortgage loans for purchasing a home, counseling, money and 
other resources for closing costs, and assistance for any required 
investment in the mortgaged property. Such funds come from numerous 
sources. Program beneficiaries are usually low- and moderate-income 
individuals and families who have gone through homeownership counseling 
through which they receive training on money management, use of credit, 
and home maintenance.

D. FHA and Minimum Cash Investment Requirements

    Since its enactment, the National Housing Act (NHA) has required 
the mortgagor to have a minimum investment in the property being 
purchased. For many years, the required minimum investment was 3 
percent of the cost of acquisition, and is currently 3.5 percent of the 
home's appraised value. Prior to 2008, the statute and regulations 
regarding the required investment were silent, with minor exceptions, 
as to permissible sources of the mortgagor's required investment. 
However, FHA's single family mortgage credit handbook, Handbook 
4155.1,\7\ provided administrative guidance to approved mortgagees as 
to permissible sources of the funds that a homebuyer could use for the 
required minimum investment. HUD's policy under the handbook provisions 
was to permit the minimum cash investment to be financed by sources 
including a family

[[Page 72221]]

member, the borrower's employer or labor union, a governmental entity, 
a charitable organization, or a close friend with a clearly defined and 
documented interest in the borrower. HUD's policies have always 
expressly prohibited the seller from financing or providing a gift of 
the required investment.

    \7\ See http://www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4155.1/41551HSGH.pdf.

    In the 1990s, several nonprofit entities developed an approach to 
funding homebuyers' cash investments that circumvented the handbook 
prohibition. These entities obtained charitable status from the 
Internal Revenue Service, and then encouraged home sellers to use their 
services and provided homebuyers with all or part of the required cash 
investment amount. After the funds were provided by the nonprofit 
entity to the homebuyer, the seller made a donation to the nonprofit 
entity of the amount of the assistance plus a fee. The donated funds 
were directed to subsequent homebuyers for the cash investment on their 
homes. The nonprofit does not conduct broad-based fundraising but 
instead relies on sellers and other businesses in real estate for 
financial support. In effect, sellers and other donors were indirectly 
funding the homebuyer's required minimum investment by reimbursing the 
nonprofit entity for each transaction.\8\

    \8\ See IRS Ruling 2006-27, available at http://www.irs.gov/pub/irs-drop/rr-06-27.pdf.

    As the prevalence of channeling funds from sellers through 
nonprofit entities increased, FHA became concerned that this practice 
as applied to homebuyers with FHA-insured mortgages could result in FHA 
insuring riskier loans. In response, FHA published a proposed rule in 
1999 to prohibit this source of the minimum cash investment.\9\ Under 
the proposed rule, a gift of the buyer's required minimum cash 
investment would disqualify the loan from FHA insurance if the entity 
providing the gift received funds directly or indirectly from the 
seller of the property. However, the proposed rule expressly included 
funds provided by a ``State or local government agency or 
instrumentality'' in the category of permissible sources of funds that 
the homebuyer can apply toward the minimum investment requirement.\10\ 
HUD withdrew the rule in January 2001 in light of widespread opposition 
to the rule as proposed.\11\

    \9\ See Sources of Homeowner Downpayment, 64 FR 49956 (proposed 
Sept. 14, 1999).
    \10\ See id. at 49958.
    \11\ See Withdrawal of Proposed Rule on Sources of Homeowner 
Downpayment Pursuant to Section 203 of the National Housing Act, 66 
FR 2851 (January 12, 2001).

    The direct and indirect financing of homebuyers' minimum cash 
investment by sellers continued to be a source of concern following the 
withdrawal of the proposed rule. In 2005, the Government Accountability 
Office (GAO) published a report on the risks raised by the 
reimbursement of nonprofit entities by sellers.\12\ The GAO findings 
noted that sales prices were increased commensurately to cover the cost 
incurred by the seller, and thus resulted in homeowners having less 
actual equity in the newly acquired home.\13\ The GAO report also found 
that the default and claim rate for homes purchased with charitable 
gifts where the nonprofit entity was reimbursed by the seller was much 
higher than in those cases where the homebuyer provided his or her own 
money for the required investment.\14\

    \12\ See United States Government Accountability Office, 
``Mortgage Finance--Additional Action Needed to Manage Risk of FHA-
Insured Loans with Down Payment Assistance,'' (Nov. 2005) available 
at http://www.gao.gov/new.items/d0624.pdf.
    \13\ See id. at 25.
    \14\ See id. at 3-4.

    Moreover, the IRS found that organizations claiming to be charities 
were being used to funnel money from sellers to buyers through self-
serving, circular-financing arrangements, and that in a typical scheme, 
there is a direct correlation between the amount of the funds provided 
to the buyer and the payment received from the seller.\15\ On May 4, 
2006, the IRS issued Revenue Ruling 2006-27, which determined that 
organizations that indirectly provide cash investments funded by 
sellers to homebuyers do not qualify as tax-exempt charities.\16\ In 
the press announcement accompanying the ruling, the IRS stated that the 
ruling makes clear that organizations operating seller-funded programs 
are not charities because they do not meet the requirements of section 
501(c)(3) of the Internal Revenue Code.\17\ The IRS also found that the 
seller pays the organization only if the sale closes, and the 
organization usually charges an additional fee for its services.\18\

    \15\ See http://www.irs.gov/Charities-&-Non-Profits/Seller-Funded-Down-Payment-Assistance-Programs-Are-Not-Tax-Exempt.
    \16\ See http://www.irs.gov/pub/irs-drop/rr-06-27.pdf.
    \17\ See http://www.irs.gov/uac/IRS-Targets-Down-Payment-Assistance-Scams;-Seller-Funded-Programs-Do-Not-Qualify-As-Tax-
    \18\ Id.

    On May 11, 2007, HUD again published a proposed rule that 
prohibited funds provided by the seller as a source for the minimum 
cash investment.\19\ This provision, entitled ``Restrictions on Seller 
Funding,'' proposed to prohibit cash investment amounts 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 * * * that is reimbursed 
directly or indirectly by any of the parties listed in clause (1).'' 
\20\ Once again, the May 2007 proposed rule expressly exempted funds 
from ``a federal, state, or local government agency or 
instrumentality'' from the category of prohibited sources for funds 
toward the required minimum investment.\21\ HUD published its final 
rule on October 1, 2007.\22\ On the effective date of the rule, a 
lawsuit challenging the rule was filed against HUD in the U.S. district 
court for the Eastern District of California, and in February 2008 the 
court set aside the final rule.\23\

    \19\ See Standards for Mortgagor's Investment in Mortgaged 
Property, 72 FR. 27048 (proposed May 11, 2007).
    \20\ See id. at 27049.
    \21\ See id. at 27051.
    \22\ See Standards for Mortgagor's Investment in Mortgaged 
Property, 72 FR 56002 (final Oct. 1, 2007).
    \23\ See Nehemiah Corp. of America v. Jackson, 546 F. Supp. 2d 
830, 848 (E.D. Cal. 2008).

    The 2005 GAO report, the 2006 IRS Ruling, and the judicial 
invalidation of HUD's final rule eventually led to congressional action 
on the issue in 2008. Section 2113 of the Housing and Economic Recovery 
Act of 2008 (HERA), signed into law on July 30, 2008, amended the NHA 
with language that is identical in relevant part to the language in 
HUD's 2007 final rule. Section 2113 of HERA amended section 203(b)(9) 
of the NHA to provide that mortgages eligible for FHA insurance must 
``[b]e executed by a mortgagor who shall have paid in cash or its 
equivalent, on account of the property an amount equal to not less than 
3.5 percent of the appraised value of the property or such larger 
amount as the Secretary may determine.'' Section 203(b)(9) was also 
amended to include a new subparagraph (9)(C), which specifies 
prohibited sources for a mortgagor's minimum investment. Section 
203(b)(9)(C) of the NHA states:

    PROHIBITED SOURCES.--In no case shall the funds required by 
subparagraph (A) consist, in whole or in part, of funds provided by 
any of the following parties before, during, or after closing of the 
property sale:
    (i) The seller or any other person or entity that financially 
benefits from the transaction.
    (ii) Any third party or entity that is reimbursed, directly or 
indirectly, by any of the parties described in clause (i).

    Since HERA's enactment, FHA has not replaced the regulation that 

[[Page 72222]]

vacated by the district court in February 2008. However, Mortgagee 
Letter 2008-23 provides notification of the statutory revisions to the 
cash investment requirements imposed by HERA.\24\ Instead of 3 percent 
of the cost of acquisition, the required investment was changed by HERA 
to 3.5 percent of the appraised value of the property. Aside from the 
statement that closing costs (i.e., the present allowed seller 
incentive of 6 percent) could not be used to meet the 3.5 percent 
appraised value minimum investment requirement, the Mortgagee Letter is 
silent regarding the source of the required cash investment by the 

    \24\ See Mortgagee Letter 2008-23, available at http://portal.hud.gov/hudportal/documents/huddoc?id=DOC_19737.pdf.

II. This Interpretive Issue

A. Conjunction of Government Housing Assistance Programs and FHA-
Insured Mortgages

    It is HUD's interpretation that section 203(b)(9)(C) of the NHA 
does not prohibit FHA from insuring mortgages originated as part of the 
homeownership programs of Federal, State, or local governments or their 
agencies or instrumentalities when such agencies or instrumentalities 
also directly provide funds toward the required minimum cash 
investment.\25\ The addition of a statutory provision on prohibited 
sources of cash investment funds, as part of the amendments to section 
203(b)(9) of the NHA enacted in HERA, was intended to preclude the 
abuse of the program where a seller (or other interested or related 
party) funded the homebuyer's cash investment after the closing by 
reimbursing third-party entities and added the cost of this 
reimbursement to the sales price of the home, thus inflating the price 
of the home beyond its market value. It is HUD's interpretation that 
the amended section 203(b)(9) does not exclude as a permissible source 
of cash investment, funds provided directly by Federal, State, or local 
governments, or their agencies or instrumentalities as part of their 
respective homeownership programs.

    \25\ In Mortgagee Letter 94-2, FHA defined a government agency 
or instrumentality for purposes of section 528 of the NHA. See 
This definition applies here. That definition provides that the 
entity must have been established by a governmental body or with 
governmental approval or under special law to serve a particular 
public purpose or designated as an instrumentality by law (statute 
or court opinion) and the majority of governing board and/or 
principal officers named or approved by governmental body/officials, 
or the government body approves all major decisions and/or 
expenditures, or the government body provides funds through direct 
appropriations/grants/loans, with related controls applicable to all 
activities of entity.

    HUD finds support for this interpretation in the surrounding 
provisions in HERA and in the legislative history of the amendment to 
section 203(b)(9). First, HERA itself authorized governmental 
homeownership programs that include a cash investment component, and 
interpreting section 203(b)(9)(C) to deny FHA insurance to mortgages 
resulting from such programs would frustrate their statutory purpose. 
In section 2301 of HERA, Congress authorized the first increment of 
funding for the Neighborhood Stabilization Program (NSP). NSP provides 
funds to low- and moderate-income homebuyers for the cash investment on 
purchasing lender-foreclosed single family properties when the property 
will be the buyer's primary residence and is located in an eligible 
target area. NSP funds are distributed through State and local 
government agencies and instrumentalities. NSP funds are also used to 
purchase vacant or distressed properties, which may then be resold by 
the purchasing agency or instrumentality to low- or moderate-income 
buyers with funds toward the minimum cash investment. Access to FHA 
mortgage insurance is often essential to making such programs work.\26\ 
Thus, an interpretation of section 203(b)(9)(C) that precludes 
governments and their agencies and instrumentalities government 
agencies from providing funding toward the minimum cash investment for 
an FHA-insured mortgage would undercut a central purpose of NSP and 
similar Federal, State, and local government programs.\27\

    \26\ HERA was enacted in 2008. FHA data shows that in that year, 
there was a dramatic increase in FHA's market share. From 2005 
through 2007, FHA's market share ranged from 2.6 to 3.9% of the 
national mortgage market. In 2008, it rose to almost 20% of the 
market share. See ``FHA-Insured Single Family Mortgage Originations 
and Market Share Report, 2009-Q4, http://portal.hud.gov/hudportal/documents/huddoc?id=DOC_16681.pdf (last visited 7-3-2012). See also 
FHA's Annual Report to Congress on the Fiscal Year 2012 Financial 
Status of the FHA Mutual Mortgage Insurance Fund, issued November 
16, 2012, which has updated information on FHA's market share, at 
    \27\ See United Savings Ass'n v. Timbers of Inwood Forest 
Assocs., Ltd., 484 U.S. 365, 371 (1988) (statutory provisions should 
be interpreted to avoid interpreting inconsistencies between 
provisions); see also Babitt v. Sweet Home Chapter of Communities 
for a Great Oregon, 515 U.S. 687 (1995); Gade v. Nat'l Solid Waste 
Management Ass'n, 505 U.S. 88, 100-01 (1992).

    Second, the legislative history of the amendment to section 
203(b)(9)(C) also supports HUD's interpretation that it does not 
exclude State and local government home ownership programs from FHA 
insurance eligibility. In a statement supporting the amendment to 
section 203(b)(9)(C), Senator Dodd explained that ``this bill 
eliminates the seller-funded downpayment assistance program.'' \28\ 
There is no indication that State and local governments or their 
agencies or instrumentalities were to be within the scope of the 
amendment. The Senate Committee Report accompanying a 2007 bill 
containing statutory language \29\ identical to what was eventually 
enacted in HERA further support this interpretation. The report 
explained that the ``section also prohibits seller-funded downpayment 
entities from providing any of this required cash investment.'' \30\ It 
noted that ``[s]ince this legislation was passed by the Committee, HUD 
has promulgated a regulation that also prohibits these entities from 
providing downpayment assistance funds.'' \31\ As discussed above, the 
2007 HUD rule to which the Senate Report refers expressly excluded 
State and local government agencies and instrumentalities from the 
category prohibited sources for the minimum cash investment. The 
report's identification of ``seller-funded downpayment entities'' as 
the targets of both HUD's proposed rule and of the bill indicates that 
the provision, which is identical to what was enacted in HERA, does not 
include State and local governments or their agencies or 

    \28\ See 154 Cong. Rec. S6354-S6356 (July 7, 2008) available at 
    \29\ See FHA Modernization Act of 2007, S. 2338, (2007) Sec.  
    \30\ S. Rep. No. 110-227, at 6 (Nov.13, 2007), available at 
    \31\ Id. (emphasis added).

B. Scope of Interpretive Rule

    Under section 203(b)(9)(A) of the NHA, the homebuyer's investment 
in the property must be at least 3.5 percent of its appraised value. So 
long as the homebuyer makes this minimum required investment from his 
or her own (or other approved) funds, any person, even one associated 
with the transaction, may contribute additional funds towards the 
borrower's costs without violating section 203(b)(9)(C). This 
interpretive rule only applies to funds that constitute all or part of 

[[Page 72223]]

3.5 percent minimum investment requirement.

C. Conclusion

    Accordingly, HUD interprets NHA section 203(b)(9)'s ``prohibited 
sources'' provision in subsection (C) as not including funds provided 
directly by Federal, State, or local governments, or their agencies and 
instrumentalities in connection with their respective homeownership 

D. Solicitation of Comment

    This interpretive rule represents HUD's interpretation of section 
203(b)(9)(C) and is exempt from the notice and comment requirements of 
the Administrative Procedure Act. See 5 U.S.C. 553(b)(3)(A). 
Nevertheless, HUD is interested in receiving feedback from the public 
on this interpretation, specifically with respect to clarity and scope.

    Dated: November 29, 2012.
Helen R. Kanovsky,
General Counsel.
[FR Doc. 2012-29361 Filed 12-4-12; 8:45 am]