Numerous creditworthy low- and moderate-income households face barriers to becoming homeowners. Many of these households want to become homeowners but struggle to save a sufficient down payment for a mortgage. To help low- and moderate-income households that are ready for homeownership but do not have a sufficient down payment to secure a mortgage, many state and local governments offer programs that grant or lend down payment funds to eligible households.
State and local governments typically operate down payment assistance programs using funds they receive from the U.S. Department of Housing and Urban Development (HUD). Some communities supplement federal funds with state or local resources in order to offer greater assistance that covers higher purchase costs or reaches families at a broader range of income levels than permitted under federal funding guidelines. These programs typically serve only first-time homebuyers and may be targeted to specific kinds of homebuyers, such as local government employees or veterans. Some communities also target down payment assistance to homebuyers who purchase in neighborhoods suffering from high numbers of foreclosures, vacancies or widespread blight with the goal of helping to stabilize those areas.
Grants and Forgivable Loans
The structure of down payment assistance programs can vary greatly from community to community. Many communities use HUD’s HOME Investment Partnerships funds to provide down payment assistance in the form of grants to low- and moderate-income first-time homebuyers. Down payment assistance can also take the form of a forgivable loan as a second mortgage – a loan in addition to the mortgage secured by the homebuyer. In some cases, the loans are forgiven gradually — for example, 20 percent per year over five years. Forgivable loans are often preferable to outright grants, because they minimize the risk that beneficiaries will quickly “flip” the homes to a new buyer paying market price for a windfall profit. Assuming beneficiaries remain in their homes long enough for the loan to be canceled, forgivable loans are essentially grants because they permanently transfer funds from the government to the home purchaser.
While down payment assistance programs that provide assistance in the form of a grant or a forgivable loan meet the technical requirements of the HOME program (and also of other common sources of funding, such as the CDBG program), they are less efficient than programs that require the loans to be fully repaid so they can be used to issue down payment loans to help other families, recycling the original down payment assistance.
Recycling Down Payment Assistance
In order for a community to help more families within the constraints of a limited amount of funding, some state and local down payment assistance programs require households to repay their down payment loans in order to recycle those funds. Some programs provide assistance in the form of a fixed second mortgage with a below-market interest rate that requires regular monthly payments. Others defer payments for a period of time, such as five years, after which homebuyers begin making regular monthly payments.
The most common approach to recycled down payment assistance, however, is to utilize a “silent second” or “due on sale” mortgage that defers all repayment of principal or interest until the home is resold to avoid adding to a household’s monthly housing costs.
Because no monthly payments are required until the home is sold (or in some cases refinanced), a silent second mortgage can be just as effective as a grant in reducing the first mortgage requirements of home purchasers. Under both approaches, the family’s monthly payment is the same. The difference is what happens when the home is sold. A family that has received assistance in the form of a grant keeps the assistance, while a family that has received assistance in the form of a silent second mortgage will be required to pay it back so the funds can be used to assist other families.
Recycling of down payment assistance is most important in communities with high home prices and limited funds for down payment assistance. Such communities often have large gaps between what entry-level homes cost and what working families can afford. As the amount of down payment assistance a family needs rises, many communities decide that not only do they want the original assistance to be recycled, they want the funds to keep pace with the housing market as well through a shared-equity solution.
Programs aimed at recycling down payment assistance work best in stable and strong housing markets. When home prices remain steady or appreciate, owners are more easily able to repay their loans, which allows these funds to be used to provide assistance to future homebuyers. In housing markets with falling home prices, it may be a challenge for government agencies to recycle down payment assistance. If home values decline and a borrower with a silent second mortgage or other form of down payment assistance owes more on the housing than it is valued at the time of home sale, it may not be possible for the homeowner to repay the loan. In such a case, some communities have few options and choose to forgive the loan, thus losing their subsidy.
While this strategy can be effective in places where home prices rise slowly, it may be challenging to employ it in neighborhoods where home prices rise rapidly, due to scarcity of housing options, and require increasing subsidies. Strategies focused on preservation of existing affordable housing and inclusionary housing policies may be more appropriate in these places.
In general, communities face a trade-off between the value of recycling the funds to help other families and the administrative costs involved in handling the recycled funds. For very small amounts, recycling may not be cost-effective. But for more substantial amounts, recycling can be an efficient use of government funds.
Shared Appreciation Loans
Similar to homeownership programs that recycle down payment assistance by utilizing second mortgages, shared appreciation loans are considered “silent” in that borrowers make no payments until they sell the home (or, in some cases, refinance the first mortgage). However, unlike other down payment assistance loan programs, the homeowner is required to repay the full amount of the loan plus a portion of the home price appreciation at the time of sale or refinance. Including a portion of the home price appreciation in the repayment gives local governments a way of keeping pace with increases in housing prices.
One common approach to designing shared appreciation loan programs is to base the share of appreciation payable upon sale of the home on the share of the original purchase price that was subsidized. For example, if a family received a $50,000 subsidy to buy a $250,000 home (a subsidy of 20 percent), the homeowner would be required to include in their repayment 20 percent of any home price appreciation on top of the original subsidy amount.
The repayment of subsidy plus a share of appreciation helps to fill the gap for the next homebuyers, but it still may not be enough to help a similarly situated family buy a similar home if housing prices rise faster than incomes. Some communities may decide that they are willing to provide additional subsidy to the next buyer to enable greater asset accumulation by the original beneficiary. Communities that wish to ensure the subsidies fully keep pace with the market may wish to select a different resale formula.
Other shared appreciation programs establish the percentage of appreciation that is retained by the homeowner in other ways. For example, some programs offer all sellers a given percentage of appreciation, say, 40 percent, regardless of their contribution to the purchase price or the amount of subsidy they originally received.
When units are created through inclusionary housing—programs that mandate or incentivize the inclusion of a modest share of affordable homes within new developments and sold initially at below-market prices—jurisdictions sometimes impose shared appreciation requirements tied to the homeowner’s purchase price as a percentage of appraised value. So, for example, a homeowner who purchased a home with a 25 percent discount due to an inclusionary housing program could owe the jurisdiction 25 percent of any future appreciation upon sale, in addition to repayment of the subsidy implicit in the discounted price.
Subsidy Retention Strategies
Rather than subsidizing the buyer, subsidy retention programs subsidize the unit, ensuring that the specific home remains affordable for a target income range over the long term. These programs achieve permanent affordability by placing limits on the price at which the assisted home can be sold to the next purchaser. At the same time, well-designed resale restrictions also permit buyers to accumulate some equity in their homes.
By limiting the price at which homeowners can sell their homes, a single investment in a homeownership unit can serve one family after another over time without any new investment of public funds. Subsidy retention programs preserve the buying power of public subsidies, limiting the impact that rises in home prices might have on affordability.