Wells Fargo is now peddling down payment assistance crack to potential FHA home buyers in Oakland, Fremont, Hayward, Concord, Antioch, Bay Point, Brentwood, Pittsburg and Richmond – areas that have been hardest-hit by foreclosures.

Similar to the glory days of down payment assistance programs, borrowers could buy homes with zero money out-of-pocket. Back in 2008, the FHA banned these programs because they default rates were much much higher than loans where borrowers had to bring in even 3 percent:

Elimination of Non Profit Down Payment Assistance

On July 30, 2008, President Bush signed H.R. 3221 – Housing and Economic Recovery Act of 2008. Section 2113 of the bill prohibits seller-funded DPA (Down Payment Assistance) for loans backed by the Federal Housing Administration. Prior to this bill, the seller could contribute up to 6% to the buyer to cover either a down payment or closing costs on an FHA loan. The changes took effect on Oct. 1, 2008.

With those previous programs, the money was a free “gift”, most often from the seller and laundered through a third party. The Wells Fargo “gift” has a few strings attached, primarily that it’s only free money after five years of never being late on a payment. I would assume that you couldn’t sell the property for five years without paying the down payment “gift” back either.

The program was developed as part of the a 2012 mortgage settlement with the Civil Rights Division of the U.S. Department of Justice. However, because of the attached strings, many of these “gifts” will end up becoming debt.

The broader problem is a moral one. Simply put, if you can’t save up 3.5% of the purchase price, you probably can’t really afford the house and all of the extra costs associated with ownership. Just like with Nehemiah and the other defunct programs, buyers will be encouraged to get into huge debts that they probably can’t really afford. Some of these stories will have happy endings, but many will end badly.

I am a fan of settlements, but this hardly seems like the best or most moral way for settlement funds to be spent. I am not comfortable with this program being presented as charity or giving back or helping struggling communities. If the guy on the corner was offering free samples of crack, sure some people will be thrilled, but he’s hardly doing a public service.

The Oakland Tribune reports:

Wells Fargo is hoping a new $5 million program will help hundreds of prospective home buyers in the East Bay come up with the thousands of dollars they typically need to make a down payment on a home, the bank said Tuesday.

The banking giant is offering what it calls the CityLIFT program. It intends to help home purchasers in Oakland, Fremont, Hayward, Concord, Antioch, Bay Point, Brentwood, Pittsburg and Richmond, said Jim Foley, regional president for Wells Fargo’s Greater East Bay region, which consists primarily of the East Bay and South Bay.

“This is the first time we are offering the program in the Bay Area,” Foley said.

San Francisco-based Wells Fargo had previously instituted CityLIFT programs in Los Angeles, Atlanta, Chicago, Houston, Las Vegas, Miami, Minneapolis-St. Paul, Orlando, Philadelphia, Phoenix and Tampa.

In the upcoming Bay Area program, Wells will provide qualified buyers with $20,000 for a down payment. The bank also will provide a viewing center so buyers can undertake virtual tours of homes they might seek.

“We are taking a regional approach for the first time by offering CityLIFT in several different cities at the same time,” Foley said. “We will be able to move money out faster. We can touch more buyers.”

The effort could address a financing gap that many consumers face in a tough economy that has chewed up the balance sheets of a number of Bay Area residents.

“People love the 3.5 percent mortgage rates, they love the affordability,” Foley said. “But they may be short when it comes to a down payment.”

We’ve seen this movie before and it usually doesn’t end well for the borrowers. If the FHA is allowing banks to do this, don’t be surprised to see more banks and programs rolling out in 2013.