May 15, 2009 – 9:02 pm
Co-authored by Aaron Krowne and Robin Medecke
On May 12, 2009, HUD Secretary Shaun Donovan, speaking at an NAR Real Estate Summit, was reported saying that FHA was “going to permit its lenders to allow homeowners to use the $8,000 homebuyer tax credit as a downpayment.” HousingWire said “details on the initiative aren’t scheduled for official release until next week,” but lo and behold a link to FHA Mortgagee Letter 2009-15 (view as pdf) dated May 11, 2009 topped the list of new lender guidance letters on HUD’s web site.
Er, it WAS there. The link has since been removed from HUD’s site (but the one above still appears to be working). The Wall Street Journal on Friday had this teaser for non-subscribers:
“Some analysts wonder if the Federal Housing Administration’s plan to let first-time buyers monetize the federal tax credit early will be a game changer after all.
Industry watchers cheered the idea, announced earlier this week, that qualified buyers could possibly skip saving up for a down payment and sail to the closing table.
The plan is being finalized and details are expected soon, the U.S. Department of Housing and Urban Development said Friday. But in the meantime, there are questions about how much impact it will have and if it too closely resembles the risky lending practices …”
That’s as much as you can see without a subscription to the Journal, but we think we can do a pretty decent job at finishing that sentence:
“… such as low or no downpayment programs and the allowance of seller-funded downpayment assistance (SFDPA) that nearly prompted FHA to request a Congressional appropriation to offset losses against its insurance fund.”
Indeed, over the past few days we’ve had quite the internal debate over this latest initiative to stimulate the housing market. Below are the main points and some Q&A on the matter.
Q: Who needs SFDPA when you’ve got this? Looks like the buyer’s share of the down payment can be raised at a bake sale now.
A: We wouldn’t compare this to SFDPA, unless you’re only going to consider the fees associated with the advance. Technically, the tax credit refund IS the borrower’s money – no different than getting an income tax refund advance from H&R Block. Does it allow for 100% financing in general? Not really. Does it unfairly benefit other parties to the transaction and create a negative equity position for the buyer? No, and not per se.
Q: This just sounds like a way to scam people who can’t afford a home to buy one anyway!
A: No – you have to look at how it works. The tax credit is the homebuyer’s money – not the seller’s. And getting an advance loan against money already owed you is not a “scam.” Borrowers routinely draw on their 401(k)’s, IRA’s and other savings mechanisms to raise downpayment funds, so this is really no different, other than the source of the tax credit is basically a government subsidy. And FHA is limiting the distribution channels and allowable fees — that’ll discourage any outside opportunists from trying to cash in on it.
In fact, we don’t understand why they didn’t allow this sooner. It’s entirely possible they have (on a case-by-case basis), considering under FHA guidelines this would be an acceptable source of funds for the borrower anyhow.
Now, before all the DE Underwriters out there get fired up to argue that last point, we should point out FHA actually has allowed it, in the case of the Memphis Area Homebuilders Association. They announced HUD had approved a similar program to be administered by their non-profit arm, the MAHBA Foundation, Inc. Touted as the “first of its kind in the country,” MAHBA’s initiative differs in that the tax credit does not have to be paid back as long as the homebuyer remains in the property for three years.
FHA’s plan, on the other hand, carries the following stipulations for repayment of the advance:
• The tax credit advance, when combined with the FHA-insured first mortgage may not result in cash back to the borrower. The second lien may not exceed the total needed for the downpayment, closing costs and prepaid expenses.
• The tax credit advance must provide that if the borrower does not repay the amount borrowed by the designated deadline, that principal and interest payments begin automatically.
• If payments on the tax credit advance are required, they must be included in qualifying the borrower and, when combined with the first mortgage, cannot exceed the borrower’s reasonable ability to pay.
• If payments on the tax credit are deferred, the deferment must be for a minimum of 36 months in order for the payment to not be included in the qualifying ratios.
• The tax credit advance second mortgage must not provide for a balloon payment before ten years.
But the real debate here is whether or not this is just another mechanism to facilitate 100% financing utilizing taxpayer dollars. Does it? Yes and no.
Where it compares is that it could induce people to make a purchase when (and perhaps at a higher price) than they otherwise would. The money seems “free” in the sense that there is now a tax credit where there was no tax credit before.
However, there is a natural limiting factor in that the downpayment is not, as in the case of SFDPA, 3.5% (however much that amounts to in dollars), but is limited to $8000. If you are looking at a home that will cost about $230,000 or less, you can swing something akin to 100% financing with this, but that would be the intrinsic limit.
It is theoretically possible that we will see cases like $100,000 foreclosures getting sold at $200,000 because of this, but it likely won’t be as rampant as SFDPA because the borrower is a bit more likely to see the downpayment money as their own:
• The tax credit is limited to 10% or $8000, whichever is LESS, and since it’s technically the borrower’s own money, this is not an inducement to inflate sales price – purchasing power, perhaps, but that’s still subject to the borrower’s ability to repay both the mortgage AND any repayment required on the advance.
We are still seeking clarification from HUD that this meets the 3.5% down requirement. It SHOULD, because (goverment subsidy or no) it is by all definition the borrower’s OWN MONEY. A good processor or LO could argue with any FHA DE Underwriter that this met the standard for allowable sources of funds.
This is the “loophole” in existing FHA guidelines that allows for the tax credit advance to be applied to downpayment, closing costs and prepaid expenses. But that still doesn’t address the issue of 100% financing per se:
• If the house is from $80,000-230,000, you can still get the entire $8000 and cover your whole FHA downpayment.
• This is far less of systemic/criminal issue since it truly is the buyer’s own funds; however —
• It is yet another tax credit has been concocted which the public will become “addicted to.” And they will STILL most likely have to contend with falling home values for years out.
• While there will be far less inducement to inflate on the part of sellers, buyers will have an inducement not to bargain as stringently.
• Based on the ranges calculated below, there might be an intrinsic pressure to “trade up” from a house in the $0-80,000 range to one in the $80,000-230,000 range (there will be no difference in apparent up-front cost if the goal is simply to avoid putting up cash from savings) — unless the buyer is savvy enough to understand that they might be exposed to more severe negative equity.
Note that the whole issue is limited in terms of the market as it is limited to persons who have not owned a home in the past 3 years. In specific, use of the tax credit advance for downpayment/closing costs on an FHA loan is limited to “first-time homebuyers” as defined by HUD, which means they cannot have held ownership (singly or jointly) within the last 3 years.
Q: Will $230,000 become the new $417,000, as the $8000 tax credit roughly covers the 3.5% downpayment for FHA loans?
A: It is possible there will be some convergence on a price of $230,000, as it would be the top end of something like a “privileged subsidy zone”, much like $417k was for years because of the Fannie/Freddie support on the bond-funding side. However, the impact is not likely to be nearly as dramatic, because of the first-time buyer restrictions, the status of the tax credit money as the buyer’s “own” money, and other restrictions.
Q: Doesn’t this open the door to the same fraud and abuse as the seller-funded DPA program, or the rapid refund tax return scams aimed at the earned income tax credit? And why does our public policy continue to push no-money down homeownership right now?
A: Unlike the rapid refund racket which nearly every pay-day lender and tax prep service jumped in on for a quick buck, FHA is limiting the sources who can facilitate the advance of monies under the homebuyer tax credit to Federal, state, and local governmental agencies and nonprofit instrumentalities of government, FHA-approved nonprofits, and FHA-approved mortgagees. Although Mortgagee Letter 2009-15 did not express specific limits, fees that can be charged for the advance would be limited to “a nominal amount necessary for preparing and administering the loan. “ I’d like to think these limitations will discourage any who may look to abuse the process, but it’s inevitable some will find a way to make a profit be it from increased sales or servicing.
And while, as above, the FTHBC may not be terribly good policy or good for the long-term health of the housing market or the number foreclosures, it is not nearly as bad as SFDPA by design. In sum, it differs significantly from SFDPA in that the seller has no specific inducement to inflate the price, nor is there any third party who earns a fee for laundering a “contribution” from the seller. A seller-funded downpayment has no intrinsic limit; no matter what the agreed-upon price of the house, it can include a 3.5% markup which is conveyed to the borrower. Since FHA can now extend up to $700k+, loans to that size can be effected (in fact, in theory, the price of a $350,000 home could be marked up double — why not?) And this could mean up to $25,000k of laundered downpayment benefit, which basically implies a destitute borrower will immediately be underwater by at least that amount. That is a tremendous shortfall for someone with “no money” in general.
By contrast, with the new tax rebate, the maximum you can swing is $8000, which will only let you buy up to a $230k house with “no downpayment” (if you get an FHA loan).
Our verdict: FTHBC is not good, nor is it quite “ugly”, but it certainly ranks as “bad”. If you are a first-time homebuyer considering making use of the FTHBC for your downpayment, make sure not to allow yourself to get into a likely negative equity position. You can do this by making sure to bargain as hard on the house as you would if you had to come up with the downpayment from savings you already had.
Keep the debate going – share your comments on the use of First-Time Homebuyer Tax Credits for FHA loans. Is it facilitating 100% financing? Is it just another flavor of sub-prime being funding by our tax dollars? Sound off!