A popular downpayment assistance program that has helped nearly 25,000 families become home owners -- 3,000 of them in August alone -- would be cut off at the knees under a federal directive eliminating sellers as a source of funds for closing on government-insured mortgages.

Sellers don't give their purchasers money directly under the subsidy program operated by the five-year-old Nehemiah Foundation, a Sacramento-based charitable organization. Rather, they agree to pay a service fee equal to 4 percent of the purchase price to Nehemiah, which keeps 25 percent of the fee to administer the program and support its other housing endeavors and gives the other 75 percent to the buyer as a grant.

The grant coincides with the amount of cash Uncle Sam requires borrowers to invest when they finance their purchases with loans insured by the Federal Housing Administration. And since the balance of closing costs can be in the form of a direct credit from the seller, lender or practically anyone else, the net result is that someone can buy a home with an FHA loan without putting any of his own money into the deal.

That worries officials at the Department of Housing and Urban Development, which has proposed a rule intended to end quid-pro-quo downpayment assistance programs by no longer permitting FHA borrowers to take cash gifts, either directly or indirectly, from the seller of the property.

HUD has several concerns about Nehemiah and other programs like it that have surfaced around the country. For one thing, the government feels borrowers who make little or no cash investment in their properties pose "significantly greater risk" to the FHA insurance fund. For another, it believes that sales prices are inflated to cover the seller's contribution so his net proceeds are not reduced.

If the buyer of a house whose value has been overstated should default on his loan, it is highly unlikely the lender will recover the full amount owed when it forecloses and resells the property. And that, too, puts added pressure on the insurance fund, because the government would have to pay the difference.

The proposed rule, which could take effect by the spring, is aimed at all charitable organizations that have established gift funds, not just Nehemiah, says FHA Commissioner William Apgar. "We've received a substantial amount of complaints about schemes leading to inflated prices and appraisal fraud," he says, "so many" that HUD's inspector general has launched a major investigation. "In one case, the house was listed for two prices," one without assistance and a higher one with assistance.

Nehemiah operates the largest and most successful downpayment fund in the country, and Executive Director Don Harris is hopping mad about HUD's proposal. "We were completely blindsided," he says.

Harris is particularly puzzled by HUD's apparent change of heart over what he views as the agency's approval of the Nehemiah program just 18 months ago and its participation in it. Since HUD said in April 1998 that the program "complies" the government's regulations and guidance pertaining to the source of funds for borrowers' downpayment, the former minister points out, the department has worked with Nehemiah on several community projects and even provided a link from its website to Nehemiah's under the heading of "help with your downpayment."

The Nehemiah Progressive Housing Development Corp., which takes its name from the Old Testament figure who governed Jerusalem after rebuilding its walls, section by section, was founded in 1994 as a charitable organization. "We started out with an interest in providing affordable housing," says Harris, "and we still are involved in community redevelopment."

At last count, Nehemiah has assisted 25,000 buyers in 47 states and the District of Columbia. After helping a record 3,000 in August with a total of $9.7 million in gifts funds, Harris expects the tally to reach 30,000 by year's end.

Those numbers notwithstanding, HUD's Apgar is bothered by any "pass-through program" that leads to artificially high housing prices. "Sure we want to help, but if we start off with inflated values, that worries us," he says.

When sellers jump their prices to cover their contribution, he explains, the buyer has only "what looks like a downpayment," and the FHA insures a house "for more than it's worth. If there is a default, the seller doesn't lose a dime, but the buyer pays, the FHA pays and ultimately the neighborhood pays."

Nehemiah, on the other hand, says properties are not overpriced. Rather, it says that sellers who participate in the program simply insist on full-price contracts that are confirmed by an FHA appraisal.

Nehemiah has submitted to HUD a number of recommendations Harris believes will allow his organization to keep operating while shutting down abusive programs "not as carefully constructed" as his. But even though the number of people Nehemiah could assist would "drop dramatically" if the FHA decides to rule out all forms of seller assistance, he vows to "continue to advance the interests of minorities with or without" the government's participation.