FHA sued for trying to ban some downpayment help

WASHINGTON (Reuters) - Two providers of mortgage assistance to low-income home buyers have in recent days sued the Department of Housing and Urban Development for prohibiting help that the federal agency says is too risky.

On Monday, HUD announced that it would ban some third-party funders from helping prospective borrowers meet a required downpayment test. Since HUD announced its plans, two of the largest such funders, AmeriDream Inc of Maryland and Nehemiah Corp of Sacramento, California have sued the federal agency saying the new rule is capricious.

The rule would affect HUD's Federal Housing Administration, which is the largest homebuyer assistance program run by the U.S. government.

Under current rules, the FHA permits homebuyers from accepting some downpayment help from the seller or private firms that specialize in such assistance. Under the new rules downpayments "cannot be derived from sellers directly or indirectly or any other party that benefits financially," Brian Montgomery, the Federal Housing Administration chief, said on Friday.

Some groups that are ostensibly non-profits give downpayment help to borrowers and then accept donations from the seller in a quid pro quo exchange, Montgomery said.

The donation generally comes from the proceeds of the sale and homeowners who benefit from the exchange are much more likely to default than other borrowers, Montgomery said.

On Tuesday, Nehemiah President Scott Syphax said the downpayment help his firm offers means homeownership for as many as 10,000 borrowers a month and limiting the program could exacerbate the current housing market turmoil.

"This rule could not come at a worse time for the economy," he said in a conference call to reporters. "Many borrowers will have no place else to turn."

Syphax also said HUD was wrong to go ahead with its move while lawmakers are debating a drastic overhaul of the FHA program. While the U.S. Senate Banking Committee has passed legislation that would kill some downpayment assistance, a version passed by the U.S. House of Representatives would preserve the funding program, he said.

Once FHA reform clears the senate, lawmakers will try to smooth out the different versions of the bill.

The FHA, set up in 1934 during the Depression, was designed to help first-time homebuyers win favorable loan terms by guaranteeing mortgage payments to lenders.