In a society which has racked up huge sums of consumer debt, it would be far easier to buy homes if credit card balances stood at zero. But that hasn't been the approach of the non-profit Nehemiah Corporation, a non-profit organization that has helped more than 100,000 entry-level buyers attain homeownership, and now HUD is backing the huge gifting organization.

In general terms, the Nehemiah program works like this: An owner donates an amount equal to 4 percent of the sale price to Nehemiah. Nehemiah provides a 3 percent gift to buyers. The purchaser can then purchase with little or no money down, depending on closing costs.

But while the Nehemiah approach impacts the cash required up-front to acquire a property, it does not pay down non-housing obligations such as outstanding credit card bills or judgments.

Unlike Nehemiah, however, other gifting organizations have gone beyond down-payment assistance. Not only do such organizations help with cash at closing, but they also pay off credit card and other debt.

At first this seems like a good idea. With less debt -- or no debt -- mortgages are surely more affordable and it's easier to meet lender qualification guidelines. In fact, someone without consumer debt can surely borrow more and get a larger mortgage than an individual with the same income and big monthly bills.

The catch is this: Paying off credit bills to get into a home does not preclude future debt. Someone can receive a gift sufficient to buy a home and pay off their credit obligations -- and then rack up big credit obligations once again. The result is that mortgage payments which were reasonable at closing with a given level of income and no credit card debt can suddenly become unreasonable -- and unpayable.

Many gifting programs rely on Federal Housing Administration (FHA) financing that requires 3 percent down. HUD has now ruled that it will not provide FHA mortgages for gifting programs which also pay-off installment loans, credit cards, collections, judgments, and similar debts prior to closing.

"When a lender underwrites a mortgage loan, it is responsible for adequately analyzing the probability that the borrower will be able to repay the mortgage obligation in accordance with the terms of the loan," according to a January 16th letter to lenders from FHA Commissioner John C. Weicher.

The FHA, he said, "is concerned that payment of a purchaser's debt by a property seller, or by a nonprofit entity which obtains a contribution from the seller for this purpose, may result in a riskier mortgage loan. Elimination of consumer debt under these circumstances (i.e., prior to obtaining FHA insured mortgage financing in order to have a favorable debt to income ratio), could result in a homebuyer using additional consumer credit which, when added to mortgage loan payments, could exceed a borrower's ability to pay.

"High debt ratios with outstanding judgments, write offs, and collections are indicative of problems that should raise underwriting concerns," said Weicher.

"When a property seller or a nonprofit has paid a homebuyer's consumer debts in order to meet debt to income ratios, the mortgage credit approval of such a borrower would not be considered by FHA to be acceptable underwriting."

FHA rules generally allow "seller contributions" equal to as much as 6 percent of the loan amount. However, since such payments may only be used to pay "a buyer's actual closing costs and financing concessions." Such seller contributions cannot be used to pay credit card debt and other, non-housing, obligations.

"When a gift from other than a family member has been made to pay off debts, the gift must be treated as an inducement to purchase and the sales price must be reduced by a commensurate amount in calculating the maximum insurable mortgage," says Weicher.

"We share HUD's concerns that the use of 'gift' funds to satisfy outstanding consumer debt may have a negative impact on mortgage default rates," said Scott Syphax, president and chief executive of Nehemiah Corporation.

"We are concerned that newcomers to our industry who enable homebuyers to pay off bad or outstanding debt with down payment 'gift' funds are doing the buyers, as well as the entire real estate industry, a real disservice. Not only does this practice prevent lenders from accurately analyzing a borrower's debt to income ratio, but it inevitably leads buyers to assume and accept higher risk and higher interest rate loans that they cannot manage on a monthly basis."

For more articles by Peter G. Miller, please press here.