The opinion of the court was delivered by: Paul L. Friedman United States District Judge
This matter is before the Court on cross-motions for summary judgment filed by plaintiffs in Civil Action No. 07-1282, plaintiff and plaintiff-intervenors in Civil Action No. 07-1752, and the United States Department of Housing and Urban Development ("HUD"), which is the defendant in both cases.*fn1 While are not technically consolidated, the Court addresses the cross-motions in the two cases simultaneously because plaintiffs in both cases challenge the same HUD regulation on similar grounds.
The regulation at issue establishes that the Federal Housing Administration ("FHA"), a unit of HUD, will no longer insure mortgages originated with certain kinds of downpayment assistance. See Standards for Mortgagor's Investment in Mortgaged Property, 72 Fed. Reg. 56,002 (Oct. 1, 2007) (codified at 24 C.F.R. § 203.19) ("Final Rule"). The Court concludes that HUD's promulgation of the Final Rule violated the Administrative Procedure Act.
A. The FHA Mortgage Insurance Program
FHA insures mortgages, meaning that it agrees to protect mortgage lenders against the risk of loss caused by borrowers' non-payment, as authorized by the National Housing Act, 12 U.S.C. § 1701 et seq. ("NHA" or "the Act").*fn2 As an insurer, FHA sets conditions on the types of mortgages it will insure, subject to certain statutory requirements and conditions. See NHA § 1709(b)(9). One condition imposed by the NHA requires a home buyer to make a cash investment, or "downpayment," of at least 3% of the total cost of acquisition. See id.*fn3
HUD's longstanding policy -- not challenged in these cases -- has been to allow certain parties to assist home buyers with this downpayment, but not to allow such assistance to come directly from home sellers or other parties with an interest in the transaction:
An outright gift of the cash investment is acceptable if the donor is the borrower's relative, the borrower's employer or labor union, a charitable organization, a governmental agency or public entity that has a program to provide homeownership assistance to low- and moderate-income families or first-time homebuyers, or a close friend with a clearly defined and documented interest in the borrower. The gift donor may not be a person or entity with an interest in the sale of the property, such as the seller, real estate agent or broker, builder, or any entity associated with them.
HUD Handbook 4155.1, Rev. 5, at 2-24 (Oct. 2003) (emphasis added). HUD's view has always been that to permit home sellers to provide downpayment assistance would "create an obvious circularity and distort the fundamental economics of a home purchase." HUD Mot. at 6. According to HUD:
A home seller who has to pay the buyer's downpayment in order to make the transaction happen will often demand a higher sale price for that transaction than he would have required in an otherwise equivalent transaction where such down payment assistance was not necessary (or will refrain from discounting the sales price when he otherwise would have done so). Thus, seller-funded down payment assistance tends to push sales prices upwards, because it can be generally expected that the seller will attempt to recoup at least some, if not all, of the down payment assistance through a higher sales price. Higher prices, in turn, result in larger mortgage loans, with the buyer essentially paying the amount of the down payment assistance through a higher sales price and mortgage. Larger mortgage loans mean larger monthly payments, making it more difficult for the purchaser/borrower to make those payments. Thus, while the seller and lender both walk away from closing with immediate benefits, the home purchaser/borrower and FHA bear the long-term risks of default and foreclosure that are associated with less sound mortgages.
Id. In other words, HUD believes that loans originated with downpayment assistance from home sellers are bad for borrowers (because they tend to increase the sales price) and bad for FHA (because increased sales prices tend to result in larger, riskier loans).
B. The Emergence of Seller-Funded Downpayment Assistance
Beginning in the late 1990s, several Section 501(c)(3) tax-exempt organizations began providing what has come to be called seller-funded downpayment assistance ("SFDPA"). HUD Mot. at 6. Typically, an SFDPA provider will give a charitable gift to a home buyer which allows the buyer to make the 3% downpayment required to obtain an FHA-insured mortgage. Then the home seller will make a charitable donation to the SFDPA provider and/or pay the SFDPA provider a processing or enrollment fee. Thus, in form at least, the home buyer receives downpayment assistance from a charitable organization (which is permissible under HUD policies), and not from a home seller (which is not permissible under HUD policies). See HUD Handbook 4155.1, Rev. 5, at 2-24 (Oct. 2003).
According to HUD, the agency "had concerns about the propriety of this form of transaction" from the beginning. HUD Mot. at 7. But because the practice "initially did not affect a material number of FHA-insured loans," HUD elected not to ban SFDPA immediately and instead "resolved to study and monitor [such] programs over a period of years." Id.
HUD now contends that it must cease insuring SFDPA loans because the number of FHA-insured SFDPA loans has exploded. See HUD Mot. at 2.*fn4 The problem with that, says HUD, is that SFDPA loans experience a much higher rate of default, foreclosure, and resultant claims on the FHA insurance fund. Indeed, HUD contends that SFDPA loans are so risky that, if FHA continues to insure them, they will threaten the fund's solvency. See id. at 9.
HUD therefore has promulgated a new regulation which provides that FHA will no longer insure loans originated with SFDPA. In pertinent part, the Final Rule provides that FHA will not insure a mortgage if the funds for the buyer's downpayment consist, in whole or in part, of funds provided by any of ...