Tax Credit

Tax Credit

Originally Published November 11, 2008

For those who haven’t seen the tax credit that is currently available, a quick review: If you have not owned a house in the last three years, and you make below a pretty hefty threshold you qualify for a $7,500 tax “credit” if you buy a home this year. Well, the tax credit has not done a lick of good in spurring on a buying spree of homes this year. Somehow a $7,500 credit isn’t appealing to people when they realize that actually, it isn’t a credit at all, but rather a loan. Well, there may be some changes on the horizon to the credit.

It was reported this morning that the National Association of Home Builders Association is lobbying for changes in the tax credit. The argument is that the credit has not had the intended effect, and thus needs to be improved until it has the effect needed.
I wrote earlier this year about the credit / loan program and stated that it is a poorly presented program, but no matter how you look at it, it is a great deal, and buyers should want to be a part of the loan. That doesn’t mean that I think the loan is enough reason to buy a home, but if you are going to buy a home, you should not snub the opportunity for some free cash.
But here come the lobbyists and the new proposal. Gone would be the first time home buyer provision, gone would be the repayment plan, and gone would be the $7,500 limit. In its place would be a 10% credit up to $22,500 with no repayment at all.

So lets get this straight: Since the lenders are no longer willing or able to lend to 100%, let’s let the IRS be responsible for ensuring that buyers who have no ability to save for a down payment still get the 10% the banks want to see.

Instead, lets take the money that would cost and provide some real relief that would end the foreclosure crisis. That alone would take homes off the market and thus bring inventory levels into line, and thus stabilize the prices, and entice non-homeowners to jump back into the market.

JP Morgan and Chase have both announced plans to try and do this WITHOUT government intervention. They understand what is really driving the crisis, and we’ll see if other banks will follow suit. Why write off bad debt if you can salvage the underlying security? Chase is trying a real tactic of readjusting the payments and keeping people in their homes. JP is simply not going to foreclose on more homes until after the New Year. I hope more banks jump on board, and I hope the government will support them in protecting their actions with guarantees akin to my Davis Plan.

The Davis Plan

Originally Posted October 9, 2008

Seeing as we as taxpayers now have access to $700 Billion of federal money to play with in the mortgage market, I thought it would be irresponsible of me if I did not put forth a legitimate plan for what to do with this money. Yes it involves restructuring debt loads, but I think it does more to solidify the real estate market more than anything I have seen thus far from our friend Sec. Paulson.

This post began, as did the preceding post, as a reaction I had when listening to the debate on Tuesday. Sen McCain offered that as part of our helping the middle class, we should use the $700 billion to buy back the mortgages of sub-prime and Alt-A debt that are having difficulty paying back the debt. Once purchased, we would re-set the principal to the new value of the home, so that people are not underwater in equity.

In all fairness to both parties, Obama has said he wishes to do the same, although I did not hear him say it on Tuesday.
This is a horrible idea. A miserable idea of massive proportions.

Let’s dissect the value of this proposition and why it is being bantered about. The goal is that if we don’t have foreclosures, we won’t have diminishing property values. If we halt the fall in prices, it will restore confidence, and thus the world will be all good. Well, the other obvious thing is that people love getting something for nothing, and that’s just what this does. It rewards people who borrowed too much and are now unable to pay for it. Further, if we remove the burden of being underwater, what is to stop people from dropping the sales price of their house dramatically to get out from under the loan.

So, what is The Davis Plan?
Rather than adjusting the principal, adjust the interest. This has multiple purposes. If a borrower qualified for the teaser rate in the beginning, he (theoretically) should still be able to do so in most cases. So, the borrower should be able to make the monthly payments. Because he can make the payments, he won’t get foreclosed. However, because his mortgage is still underwater, he can’t sell. This is a GOOD thing. Because he can’t sell, he stays. This reduces inventory on the market. This produces a stable market. This provides for liquidity to those persons who can sell and wish to sell.

How does this really play out? Well, if a person bought a $400,000 home with 100% financing at 5.5% teaser, his original payment (assuming no negative amortization) would have been $2,271 + Taxes and Insurance. With interest rates resetting, that rate could be 8.5 or 9.5%. If we assume 8.5%, then the borrower is now paying $3,075 +T&I. Under the current plan touted on Tuesday night, the principal would be reduced to the market value. Let’s say it’s dropped 25% in Ohio, that borrower now owes $300,000 at 8.5% interest and the payment is all the way down to $2,306 + T&I. And the cost to the taxpayer is an instant $100,000. With no chance of ever seeing that money again.

Now, under The Davis Plan, the borrower returns to paying $2,271 (less than the proposed plan). The borrower stays in his home. He doesn’t sell because he can’t afford to; remember, he still owes $400,000 on a home that has dropped in value. But he still has his home which is really what he wanted anyway.

Now, I know what you are thinking: what if the borrower needs to move because of work or family. Well, I have that covered.
Remember how I said people like getting something for nothing. That doesn’t exist in The Davis Plan. People will have the option of putting their house into The Plan or not. If they choose not to, they can be foreclosed upon, face bankruptcy, and see what the court allows them. That’s fine. I don’t think most people will take that route. I think they’ll opt for The Plan.

Upon agreeing to this workdown of debt, the borrower agrees to one simple change in their mortgage. Just like government insured student debt, you won’t be able to bankrupt your way out of this one. It is with you to your death.

So, if in five years you need to sell your home and you only get $350,000 for it, you still have a $50,000 – 30 year note with the Government. You can take it to your next home. You can prepay it if you would like. It will be tax deductible to the same degree that any other mortgage is – provided that loophole remains.

We now have a method for helping out the middle class, keeping them in their homes, removing excess inventory from the market, stabilizing the housing market, restoring confidence to the markets, and all of this without giving away something for nothing.

How much would all this cost? I have no idea. But I don’t think anyone really knows if $700 billion is enough to do what little they want to do anyway.

Uncle Sam to the Rescue

Originally Published on August 12, 2008

On June 9, I wrote about a proposal that was floating through Congress to provide some real incentives to first time home buyers. I wasn’t a big fan of what I was reading at the time, but it appears that what congress has come up with is actually a pretty good idea for the economy and a really good idea for the borrower / buyer. Don’t be fooled by the name of Tax Credit. This is not really a tax credit. But it does provide some great incentives to any first time buyer.

While I hope to give you a good picture of the new Federal Housing Tax Credit of 2008, there is no substitute for reading the original source if you fall into the category of first time home buyer. Also, here are my thoughts from June.

The terms of this credit are very simple. If you have not owned a home during the past 36 months, and you make less than $75,000 for a single person or $150,000 for a married couple, you likely qualify for the new tax credit. Homes must be purchased between April 9, 2008 and July 1, 2009. The law was not passed until July 30, 2008, so there are some folks out there who did not buy with the intent of reaping this tax benefit but who will receive the credit retroactively. I have contacted each of my clients who fall into this category, not one of whom had heard of the credit before my call.

So a first time home buyer now buys their first primary residence (sorry, no investment property) and can claim on their 2008 taxes the credit. If the taxes due are not $7,500, a refund will be sent to the home owner, even if the refund is greater than the full tax liability before the credit.

For two years, nothing happens… but on April 15, 2010 the IRS wants some of their money back, just $500. For the next 15 years in fact, they will want $500. So, this really is nothing more than a 17 year, interest only loan of $7,500.

I like this a lot. It’s not a bail out, it is an incentive. And most importantly, one that the buyer will be paying back. If they sell the house, the full amount of the loan is due at closing — Provided the value has gone up enough to cover the note. So, if Joe Taxpayer buys a $400,000 home and sells it for $415,000 three years later, but pays $15,000 in commissions to a realtor, they don’t owe anything back to the IRS. So now, we are able to offer our first time buyers:
1) A short term incentive to buy now and stimulate the market.
2) The ability to buy when the buyers don’t have a huge amount of equity, in a market that is no longer friendly to 100% borrowers.
3) A safeguard against fears of a falling market.
4) A program that allows for a full $7,500 credit for any home over $75,000. Therefore, there is no incentive to buy bigger than you can afford just to get the credit.

What does this really mean in terms of dollar value to a borrower? Well, let’s assume that the buyer would need to borrow the $7,500 to make the purchase happen. ( I think assuming that it is a real stretch to believe that a buyer could find this $7,500 anywhere other than a credit card, but let’s not go there.) I am seeing 80% loans for homes still under 6.500%, but the second mortgages can be 8.500% up to 9.875% and higher based on final loan to value. Let’s pick the 8.500% for conservative sake. This loans tend to be 10 year, but we’ll stretch this assumption to make the first two years, payment free, and then 15 even payments.

Before the first payment would even be made in two years, the borrower would already have incurred $1,829 worth of interest. At year two and every year thereafter, the buyer would owe $979.92. That is a $479 difference every year, or a total of more than $7,150 should the home buyer stay in the home for the whole 15 years.

Even for people not NEEDING this money to close on the home, they should absolutely be taking advantage of the opportunity.

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