downpayment assistance: overview » introduction

Downpayment assistance is one of several forms of assistance commonly provided by state or local governments to help moderate-income families purchase homes. State and local governments typically operate downpayment assistance programs using funds they receive from the U.S. Department of Housing and Urban Development. 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.

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How do downpayment assistance programs work?

The great variation in the structure of downpayment assistance programs from community to community makes it somewhat difficult to generalize about these programs. However, a HUD study of homebuying activity funded with HOME Investment Partnerships funds found that roughly half of downpayment assistance programs provided assistance in the form of a grant or forgivable loan (see below), while the other half offered a deferred second mortgage in which the funds were required to be repaid - usually when the home was resold or refinanced. While anecdotal reports suggest there may be a trend toward requiring repayment through a deferred second mortgage, there are still numerous down payment programs that utilize outright grants or forgivable loans.

A forgivable loan is a second mortgage that is forgiven after families remain in their homes
for a specified period of time. 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. However, assuming beneficiaries remain in their homes long enough for the loan to convert to a grant, forgivable loans are essentially similar to grants because they permanently transfer funds from the government to the home purchaser. Click here to learn more about forgivable loans.

While downpayment 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 much less efficient than programs that require 100 percent of the funds to be repaid so they can be used to help other families.

Improving efficiency through recycling of downpayment assistance

There are a number of different approaches to requiring downpayment assistance to be repaid in full. Some programs provide assistance in the form of a fixed second mortgage with a below-market interest rate and, thus, require 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, however, appears to be to utilize a so-called "silent second" or "due on sale" mortgage that defers all repayment of principal or interest until the home is resold.

Because no monthly payments are required until the home is sold (or in some cases refinanced), a silent second mortgage is 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 will get to keep 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.

Preliminary calculations by the Center for Housing Policy suggest that, due to repayments of silent second mortgages, a jurisdiction that shifted from a grant (or forgivable loan) approach to a silent second mortgage approach could gradually serve more and more families such that, by about the eighth year, they could be serving 50 percent more families per year.

Silent second mortgages can also give jurisdictions a way of keeping pace with hot housing markets. Some jurisdictions require that, in addition to paying back the principal of a silent second mortgage, families repay a portion of home price appreciation. This shared appreciation loan approach -- a form of shared equity homeownership -- helps the jurisdiction keep pace with the rapid rise of housing prices, while ensuring that the participant retains a portion of home price appreciation for investment in future homes or other asset needs.
Solutions in Action
Visalia, California offers two-percent interest, deferred-payment second mortgages of up to $75,000, which must be repaid in full if families sell or move out of their homes within 20 years. Every five years, borrowers' incomes are recertified, and those who are able to start repaying the loans must do so.

Adopting this approach has allowed the HOME-funded program to serve four times more low-income homebuyers. Although the program receives only $300,000 in HOME funds each year, the subsidy recapture strategy made $1.7 million available to serve 23 families in 2006.

The City of Los Angeles - located in a metropolitan area where the median home price is $525,000 and only 17 percent of families are middle-income - recently instituted the Moderate Income Purchase Assistance program to help close its formidable affordability gap. Families with 81 - 120 percent of area median income are eligible for no-interest, deferred-payment second mortgages of $75,000, and families with 120-150 percent of area median income are eligible for no-interest second mortgages of $50,000.

These examples are taken, with permission, from Our Communities, Our Homes, by former HUD Secretaries Henry Cisneros and Jack Kemp, and Kent Colton and Nicolas Retsinas.

Cottages at MattituckLearn about shared equity, a related policy used to achieve affordable homeownership over the long term.

Learn more
about the continuum of homeownership assistance programs in the Building a Strategy section, or by leaving the site to read Preservation of Affordable Homeownership: A Continuum of Strategies [PDF]. 2007. By Rick Jacobus and Jeffrey Lubell. Washington, DC: Center for Housing Policy.