Approaches to Creating Homebuyer Units
Approaches to Creating Homebuyer Units
Homebuyer programs can be structured in any number of ways to encourage the acquisition, acquisition and rehabilitation, or the new construction of affordable homes. In general, there are two major types of approaches to creating homebuyer units:
- Development approach: Under this approach the jurisdiction subsidizes the creation (through rehabilitation or new construction) of affordable homebuyer units. These units are then sold to eligible homebuyers.
- Homebuyer subsidy approach: Under this approach, the jurisdiction provides a direct subsidy to the homebuyer to help him or her afford the new home.
These two approaches can also be used together in order to lower the cost of developing homebuyer housing, and to assist individual families to purchase the home.
Under the development approach to homeownership assistance, the jurisdiction funds a nonprofit or for-profit developer of the housing. The developer purchases the site and develops the units. These units are then sold, usually at below market prices, to low-income buyers. In some instances the jurisdiction directly develops the housing, but this is not typical. Options for the development of housing include:
- New construction of units;
- Acquisition with rehabilitation; and
- Development of subdivisions (which may include new construction and/or rehabilitation).
New Construction. Under this option, the developer builds new units and then sells these units to low-income homebuyers. The units may be built scattered site (at infill or other locations) or they may be built as a neighborhood.
For new construction, HOME can be used to pay for costs that are necessary:
- Acquisition of the land;
- Construction costs for the new units;
- Demolition of existing structures; and
- Making utility connections including off-site connections from the property line to the adjacent street.
Every HOME-assisted unit must be occupied by a low-income homebuyer. For the purposes of determining the affordability period, it is important to look at the way in which the homeownership assistance is provided. When HOME provides assistance to a developer for construction and related costs and the property is sold to the buyer at fair market value, the unit is assisted, not the buyer. This is known as a “development subsidy.” When the property is developed using HOME funds and is sold to a buyer at an amount below the fair market value, the buyer is considered assisted and the affordability period is based upon the difference between the fair market value and the sales price, assuming that there was no other assistance provided to the homebuyer. This is known as “direct homebuyer assistance.” The financing structure of the homebuyer’s assistance has further implications for the obligations during the period of affordability, which are discussed in detail the “Ongoing Requirements” section of this section.
CDBG funds, on the other hand, cannot be used to finance the new construction of housing unless it is undertaken by a CBDO as part of a neighborhood revitalization, community economic development, or energy conservation project. CDBG can, however, be used for acquisition of the land, if the acquisition is conducted by the grantee, a public agency or a nonprofit. It can also be used for demolition and clearance.
Acquisition/Rehabilitation. Under this option, the developer acquires existing property and renovates that property. The unit is then sold to an eligible homebuyer, typically at below market prices.
Both HOME and CDBG can be used to acquire existing units, rehabilitate them, and resell them to eligible homebuyers. While this activity is eligible under both programs, it is important to note that acquired units that are rehabilitated with HOME funds must meet the HOME minimum property standard requirements.
Unlike HOME, CDBG does not prescribe a set of property standards that rehabilitated structures must meet when assisted with program funds. HUD recommends that CDBG grantees establish written property standards for units assisted with CDBG funds.
Example: Acquisition and Rehabilitation Turnkey Program
The City of Big Lake wants to encourage homeownership within its community and it wants to see a number of its dilapidated and boarded up homes renovated and occupied.
So, Big Lake funds a CHDO to undertake a turnkey program. The CHDO acquires and rehabilitates substandard units using HOME funds. These units are then sold at $10,000 below market to eligible low-income homebuyers.
Development of Subdivisions and Neighborhoods. Under this option, the developer purchases a large tract of land and uses that land to develop an entire neighborhood or subdivision. The homes that are built in this neighborhood are sold to eligible homebuyers.
CDBG can be used to undertake a wide variety of activities related to targeted neighborhood development. In addition to acquisition, rehabilitation, and infrastructure, CDBG can be used for related activities such as public services or economic development. The CDBG program provides grantees with regulatory flexibility when using program funds to
develop larger-scale neighborhood revitalization activities within areas designated as neighborhood revitalization areas (NRSAs) or community revitalization strategy areas (CRSAs) under the State CDBG Program. Note, however, that this flexibility does not remove the general prohibition on new construction under the CDBG Program.
While the HOME Program does not include special provisions for PJs developing new neighborhoods or subdivisions, costs related to the development of the housing unit(s) are eligible, including on-site infrastructure and off-site utility hook-ups. Note, a subdivision that is developed under common ownership, management, and financing is considered a single project under HOME. Therefore, a substantial amount of infrastructure, including new roads, sidewalks, and utilities, are considered “on-site” in a subdivision that is developed as one project. These costs are eligible, but would be subject to the maximum per unit subsidies. Additional discussion about how HOME and CDBG can be used for neighborhood revitalization activities is provided in Section 5.
Example: Homebuyer Neighborhood Development
Friendsville had a neighborhood that needed to be revitalized. Units were in poor repair and it had a highly transient population. Friendsville wanted to redevelop the neighborhood using a New Urbanism approach with community focused design.
Friendsville owned a large parcel in the middle of this neighborhood. It donated this land to a nonprofit that worked with an architect to layout streets and build homes. These homes were then sold to mixed-income homebuyers. Units that were to be sold to low-income buyers were constructed partially with HOME funds.
Direct Homebuyer Subsidy Approach
There are a number of ways that the HOME and CDBG Programs can be used to directly address homebuyer needs. These include:
- Providing downpayment and closing cost assistance;
- Assisting homebuyers to finance the purchase of the home;
- Establishing individual development accounts to buy a home; and
- Developing lease purchase programs.
The American Dream Downpayment Initiative (ADDI) is a new source of funds to provide direct assistance to low-income homebuyers. Enacted in December, 2003, and administered by the HOME Program, ADDI aims to increase the homeownership rate, especially among lower income and minority households, and to revitalize and stabilize communities. ADDI will help first-time homebuyers with the biggest hurdle to homeownership: downpayment and closing costs. The program was created to assist low-income first-time homebuyers in purchasing single family homes by providing funds for downpayment, closing costs, and rehabilitation carried out in conjunction with the assisted home purchase.
For a comparison of the HOME and ADDI homebuyer assistance requirements, see Appendix 3-1. For more information on ADDI, visit the Office of Affordable Housing Programs’ website at https://www.hud.gov/offices/cpd/affordablehousing/programs/home/ addi/index.cfm. or at www.hud.gov/addi/
Downpayment and Closing Cost Assistance. One of the most common methods for assisting low- and moderate-income households to purchase a home is the provision of downpayment and closing cost assistance. Low- and moderate-income households that are able to afford the monthly cost of homeownership (i.e., mortgage and insurance), are not always able to come up with sufficient funds for the lender’s required downpayment and/or the various up-front fees and charges that are collectively called “closing costs.” Both HOME and CDBG allow for the provision of downpayment and closing cost assistance to eligible homebuyers.
Under the HOME Program, the provision of downpayment and closing cost assistance to qualified low-income buyers is considered an eligible homebuyer activity. This type of assistance is considered direct assistance to acquire a property.
Homebuyer assistance may be conducted under two different CDBG eligible activities: public services and direct homeownership assistance under 570.201(n). If the grantee chooses to fund activities under the public services category, they are subject to the grantee’s overall 15 percent public services cap. Direct homeownership assistance under 570.201(n) is not subject to this cap, but grantees may only pay up to 50 percent of the required downpayment amount. All assisted households must be low- and moderate-income under either eligible activity, if the LMI housing national objective is used.
Homebuyer Financing. Another form of direct assistance to homebuyers is the provision of some or all of the financing that enables them to purchase their home. The jurisdiction can act as a lender or subsidize the financing offered by the private lender. When jurisdictions act as a lender, a number of loan forms are possible including:
- Grants or deferred, forgivable loans;
- Amortizing first position loans;
- Amortizing second position loans (subordinate to a private lender); and
- Deferred payment loans.
Example: Deferred Payment Loans
The City of Spruceville wants to assist low-income homebuyers to purchase units. It studied its waiting lists and found that most low-income buyers simply did not have the income to fully afford a private loan covering the purchase price of a modest unit.
So, Spruceville designed a deferred payment loan program. Under this program, the City lends low-income borrowers up to $20,000 in HOME funds as a second position loan behind the private financing. This means that households can reduce the amount they needed to borrow from the private lender and thereby reducing their monthly payments. The loan is not amortizing and is not due until and unless the homebuyer sells his or her home. At the time of sale a pro-rata share of the funds will be due back, depending upon how long the homebuyer has remained in the unit.
When jurisdictions want to encourage a private lender to make a loan to a low-income family or they want to make that loan more affordable, they may use a tool such as:
- Interest rate write-downs;
- Principal write-downs; and
- Loan guarantees (under HOME).
Both CDBG and HOME can be used for most forms of direct homebuyer assistance, including:
- Subsidizing interest rates and mortgage principal amounts, including making grants to reduce the effective interest rate on the amount needed by the purchaser to an affordable level. (Funds granted would have to be applied to the purchase price.)
- Subordinating direct loans toward the purchase price, at little or no interest, so that the total mortgage will be affordable to the purchaser.
- Under CDBG, paying all or part of the premium (on behalf of the purchaser) for the mortgage insurance required up-front by a private mortgagee. (This would include private mortgage insurance (PMI).) Note, subsequent payments of this premium would not be permitted.
See the section below on development and financing requirements for more detail on methods of structuring financing.
It is important to note a key distinction between the development approach and the homebuyer financing approach when it comes to new construction. In a CDBG rule dated November 21, 2000, HUD clarified that the prohibition on new construction under CDBG does not apply to new units purchased by individual homebuyers. Individuals may use CDBG assistance to buy newly-constructed homes. However, unless they are a CBDO, developers are still prohibited from building new homes with CDBG funds.
Individual Development Account Programs. Individual development accounts (IDAs) are dedicated savings accounts that provide start-up funds to assist low-income residents:
- To start a business; or
- To purchase a home.
IDAs are typically managed by a community organization and savings by the participating household are often matched by foundation grants, employer contributions, or other funds. The participating household is often required to participate in counseling or classes to learn how to manage its finances more effectively.
HOME and CDBG funds can be used to support IDA programs. HOME funds can be used to assist IDAs that are established for the solely for homeownership assistance purposes only, CDBG funds may be used to assist IDAs for both eligible purposes.
Specifically, HOME Program funds may be used as a source of matching funds to an IDA when the objective is purchasing a home and the account holder is income eligible. PJs may choose to use their HOME funds to support IDAs that provide downpayment and/or closing cost assistance. For further guidance on using HOME to support homebuyer IDAs, refer to HOMEfires, Volume 1, Number 8. This is available online at: www.hud.gov/offices/cpd/affordablehousing/library/homefires/volumes/vol1no8.cfm.
The use of grant funds in an IDA program would assist purchasers and be eligible under CDBG as homeownership assistance under 24 CFR 570.201(n) or the statute at 105(a)(24), which makes homeownership assistance eligible. Generally, the activity will need to meet the low- and moderate-income housing national objective, which means that each assisted household must be low- or moderate-income.
CDBG funds may be deposited in an IDA to capitalize the account or as matching deposits over the course of the household’s participation in the program (see notice CPD 01-12). If the individual does not complete the requirements of the IDA program, the CDBG funds must be returned to the grantee and any interest earned returned to the U.S. Treasury.
When HOME funds are used in conjunction with IDA programs, HOME may be committed to the account holder during the course of the household’s participation in the program but may not actually be provided until the participating household is ready to purchase a home. This is due to the statutory requirement that funds drawn down from the U.S. Treasury be invested in affordable housing within 15 days of drawdown.
Example: Individual Development Accounts
The City of Falls Point has a special program designed to assist low-income community members to obtain an education and get a job. As a part of this effort, the City offers life skills classes focused on budgeting and savings.
The City saw a real need to assist program graduates to become homebuyers. While these families usually had jobs upon graduation from the program, they did not have sufficient savings to buy a home.
So, the City started an IDA program where it used HOME funds to match family deposits into an IDA. When the family reached one-half of the amount needed for a downpayment, HOME provided matching funds to cover the other one-half.
Lease Purchase. An alternative to more traditional homebuyer assistance programs is lease-purchase. Lease-purchase programs assist eligible households that currently lease their homes to save for the purchase of the home during the lease period. The lease period and amount vary by program. Housing counseling and homebuyer education are often an integral part of the lease-purchase program requirements.
Lease-purchase is eligible under the HOME Program as a form of homeownership assistance. HOME funds are used to assist a tenant or household currently renting a unit to purchase the unit. In order to qualify for lease-purchase assistance, a household must be income eligible at the time that the HOME lease-purchase agreement is signed.
HOME lease-purchase agreements require that the tenant purchase the unit within three years of signing the agreement. In the event that the rental unit does not revert to a HOME homeowner unit at the end of the 3-year period, the PJ has six additional months to identify an eligible homebuyer to purchase the unit. During this interim period, the HOME affordable rental housing requirements at 24 CFR 92.252 apply to the unit. If an eligible homebuyer has not been identified at the end of this interim period, the unit must revert to a HOME rental unit, governed by all applicable HOME rental housing requirements, including affordability. Tenants receiving HOME TBRA to reside in the lease-purchase unit are eligible to receive HOME lease-purchase homebuyer assistance.
If lease-purchase housing is not conveyed within 36 months of signing the lease purchase agreement or within 42 months of project completion, the project becomes a HOME rental project subject to HOME rental rules.
For further guidance on the use of HOME funds to assist lease-purchase activities, please refer to HOMEfires Vol. 1, No. 10 online at: www.hud.gov/offices/cpd/affordablehousing/library/ homefires/volumes/vol1no10.cfm.
Under CDBG, rental assistance to tenants during the lease period prior to purchase is not generally eligible. However, at such time as the lessee chooses to exercise the option to purchase, homeownership assistance can be provided.
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