Too good to be true? The truth behind the housing tax "credit"

The Housing and Economic Recovery Act of 2008 announced a new tax "credit" allowing qualified first-time home buyers purchasing homes on or after April 9, 2008 and before July 1, 2009 to claim up to $7,500 on their taxes. The credit is a dollar for dollar reduction for taxes paid (rather than a deduction from your taxable income) but the term credit may be a bit deceptive.

You see, unlike any other tax "credit" that I can think of, this one has to be repaid. The credit truly acts like a zero interest loan that is repaid over the next 15 years, or when the house is sold if there is sufficient gains. So if a family claimed (ie borrowed) $7,500 they would repay that by owing an additional $500 on their taxes each year for the next 15 years.


An interest free loan is a good thing though, right? It can be, if used constructively. My beef lies in calling it a tax "credit". You don't have to repay your earned income tax credit, or child and dependent care tax credit. In fact, I can't seem to find a single "credit" that you have to repay.....except this one, which makes the name all the more galling. It seems that it sets the stage for an expectation, free money because it is a tax credit, when in fact it is nothing of the sort.

Won't borrowers take the time to learn the rules and read the fine print so they won't be surprised when they owe $500 more on their 2010 taxes? If we have learned anything from the market meltdown we shouldn't even have to ask this question. So lets look at the possibilities of how this "credit" could impact families now.

Lets start with the good. We will assume a family actually owes $7,500 in taxes and will therefore be able to claim the whole credit. In our current economy this could be a fantastic boon for a household in distress. If they are struggling to make ends meet they could use this to make up the difference rather than turning to a high interest credit card or insane interest payday loan. They could use it to pay down existing debts and bills, leveraging the no interest loan in a smart way to wipe out high interest payments and freeing up cash reserves. It could even act as emergency savings for the family, they could sock it away for a rainy day to help cover medical expenses or vehicular distress. This is a great tool for families.

If they spend it that way. Remember, part of the reason the government is providing the money in the first place is to stimulate the economy. They want them to spend it. If they spend it to make ends meet, the family is helped, and the government gets what they want. If it is used to pay down debt, it has little impact on the economy (unless it frees up money for the family to spend in the future by reducing payments). It could however be used for our favorite past time, increased consumption. Increased consumption implies we are spending more than what is required to meet our needs, and all too often in a world of instant gratification this is the way of most financial windfalls. Many households have developed the habit of spending the tax return frivolously, why should we expect them to approach this larger windfall any differently? If the money is spent on increased consumption then the family has not "gained" anything, they are simply spending today what they could have spent tomorrow...for the next 15 years.

Regardless what the initial $7,500 is spent on, lets look at the other end. For the next 15 years the family will owe $500 more on their taxes. Will families even remember to take this into account in 2010? What impact will this have on our spending for the next 15 years in and around tax time?

What about the other option? What if I sell my home and the government wants their money back? Profit from the sale is subject to recapture up to the amount claimed. My concern here is the fact that many homeowners put little to nothing down in the first place, and as such when they go to sell one or two years later, especially with the current home appreciation rates ;) there may not be much, if any, profit from the sale. When you pay off the $7,500 on top of that (or whatever is left over based on how long you have been shelling out $500 a year for)....I suspect many homeowners will have little to nothing to show for their time in the home unless they stay for five years or more. This means no down payment for the next home, meaning if they want to keep being a home owner they will have to look at another low to no down payment loan....haven't we been down this road once before? Or they could go back to the renting. Either way the family has made no progress.

It all comes back to how it is sold. The US government gets grumpy with businesses for false or deceptive advertising. How is this any different? It could have been called many things, a tax refund advance (implying a loss of future refunds) or most appropriately, a no interest first time home buyer loan. What it never should have been called, is a credit. They are not freebie bailout bucks. Do you think the Better Business Bureau accepts complaints against the US government? No matter what we say on the side of the package, its the contents that matter most.

The most confusing part of all? The proposed new housing tax credit doesn't look like it will have to be repaid at all. But we will call both of them credits, just to make things clear ;) .

Riding the waves till they break

As mentioned in my last post the Washington Post presented an excellent article highlighting some of the difficulties faced by families in the current market.

The article shares the story of Robin Bohnen, who purchased a 1.16 million dollar home in Riverside County, CA. The home came with a $6,400 monthly payment (thats right, she was paying $76,800 annually!), and Robin's income came primarily from her furniture store which rode the boom selling to new homeowners. With climbing equity in her home and great sales what could go wrong?

Now her sales have dried up and her family can no longer afford to make payments on the home. She can't sell it either though, since falling prices mean the mortgage loan is higher than the value of the home. When the wave broke on the housing market Robin and her family found themselves first swamped, and now thoroughly under water.

The article noted that one family in five is now upside down on their loan. Considering that our home ownership rate is in the high 60's percentage wise, that is a great many families who may have to find other accommodations.

It is important to point out that she was not a subprime borrower, but she certainly should never have obtained the loan she did. Robin and her husband opted for an interest only loan for the first five years and used a Stated Income (meaning they did not have to prove what they actually made) loan (known as as Alt A mortgage). While they had a hefty down payment (more than 200K, money pulled from their first home that never sold and is now also in foreclosure) with the loss of Robins furniture income and fewer sales commissions from her husbands job the payment became unaffordable. Now that the property has lost value as well, they cant sell it without taking 200K in losses.

In the meantime they have maxed out their credit cards trying to make ends meet and in Robin's county unemployment has soared to 10%, hampering her ability to obtain employment that will save her home.

The article pointed out that beginning in last October more prime loans were in default then subprime.

This doesn't mean that the prime loans were good, many families acquired regular loans that were unsustainable, but many of the loans we will see in default over the next year and a half will be Alt A, Interest only, and prime ARMs. The Washington Post was quick to point out that many of the loans issued were only appropriate for high asset high credit borrowers and were instead issued to mediocre credit asset poor borrowers in an effort to keep sales high. Robin and her husband acquired an

The article gave a couple more great examples of other families who got in over their heads and indicated that some opt for keeping their car over their home, thinking they can take a ding on their credit and buy again a few years later.

What do we do about it? Is if fair to force mortgage companies to refinance existing loans for the current value of the home (forcing them to take a huge loss)? Forget about fair, do we really think the banks can afford to do that?

Is it the governments responsibility to tell families what they can and cannot afford?

Take a look at the last couple of paragraphs in the article that share an exchange of views between Robin and Shane (her husband). What kind of impact are we seeing on the family? Should the government be looking into an increase in funding to family counseling agencies/providers or do you think these problems will go away when the hard times are over?

How do we help those who may have lost their home, maxed all of their lines of credit, lost their job (or have truncated employment), and now can't even afford a deposit on an apartment?

Give that home a snorkel.

I want to play a little game called spot the swimmers. Take a gander at this. Look at the average listing price, then look at the average home sales price. Some of the states really shine..... do you see it yet? Look at Wyoming, for example.

Avg List price: $610,035 Avg Sales Price $130,702

So, the average listing price is 4.67 times higher than the average sales price?!

Utah: Average List $486,538 Average Sale $129,000 3.77 times.

Idaho: Average List $357,490 Average Sale $85,000 4.2 times.

Anyone see a pattern?

Why is the average list price so high when the average sale price is so low?
What does this tell us about the type of homes that are having "problems" right now?

Well, there are a couple of possibilities here, so lets toss some around. Perhaps there are more homes for sale in big cities that had higher prices and are experiencing the largest decline in home values. With a few exceptions this seems to hold true.

There is another possibility here: that there is a higher concentration of expensive homes on the market across the state. I used a fairly crude method to test this. I jumped back to the trulia.com website and pulled up the data on Cache county , and compared this to the data on population pulled from this site on area codes and inputting those at the and the census bureau fact finder.

Then I put the numbers in a little chart so I could see the population of each zip code (this information is dated, last census was 9 years ago but no other data by zip code is available)compared to the average list price and number of homes that are on the market. One quick thing I want to point out, the LOWER the per person number, the more homes are being sold in the area per person.

The zip code with the most homes for sale per person is 84325 with just over 1 home being sold for every 32 people compared to the overall average of one home per every 103 people in the zip code! It also has the third highest average sales price. The two zip codes with the highest average sales prices are just above and below the average per capita. The next 3 are all well below average (meaning more homes on the market than you would expect for their population). This is interesting to me, since it seems to imply that the wealthiest families (those in the 2 zip codes with the highest average home price)seem to have an average number of homes for sale. Just below that, in what could be termed wannabe wealthy zip codes we have a disproportionate number of homes for sale (especially in that number three slot). I have to wonder if this might hint at a group of people who got in over their heads. People who perhaps wanted to appear well to do, and are now reaping the consequences.

One thing is for sure, being upside down or "underwater" on their loans is something we are sure to see more of. The washington post indicated that 1 in every 5 homeowners now owes more on their loan than the home is actually worth . I plan on taking a closer look at that article more indepth on my next post. In the mean time I plan on waiting a month and then doing this little exercise again to see how home sales are doing for each zip code. (Note, this does not include homes that are for sale by owner, or by a builder who has not posted them on the MLS.)

While we wait, maybe we should invest in some fins and a snorkel?

Home sweet home

It used to be that the American Dream meant being able to come to America, from anywhere, and through hard work achieve your dream, what ever that may be. You could work as whatever, believe whatever, and achieve whatever. Somehow, part of that dream has been redefined to include the house and picket fence.

What does it mean for homeowners now? How have families used their homes (besides for shelter) during the time that lead up to the current crisis? Demos has provided some insight on what is happening with homeowners and why we should be concerned in:

A House of Cards: Refinancing the American Dream. Borrowing to Make Ends Meet

I want to look at a couple of the highlights and share why I think there may be some concerns.

From 1973 to 2004 homeowner equity fell from 68.3% to 55%. The number of people in homes was up, but they owned less as a whole. The real scary thing is the market had not bottomed out yet. Where is our equity at now?

Where did the equity go when times were good? From 2001 to 2005 alone households cashed out $715 billion dollars in home equity. 51% of who pulled money used some/all of it to pay for other debts, and 25% used it to pay for consumer purchases.

So what? People pulled money out of their homes to pay off credit card debt or buy a car. Thats a good thing, right? They pay less in interest on a home equity loan than they would with a credit card or car loan, so what is the big deal?

Well, its not just falling equity.....from 1998 to 2004 the average credit card debt held by households increased from $2,768 to $5,129. Our savings rate decreased, to near nothing, and is at the lowest it has been since the great depression.

Surely these numbers reflect young people who bought into home when they couldn't really afford it and had to put money on a credit card to make ends meet. But the older generation, those getting ready to retire or already retired, they are not in the same boat. Right? Well, on average people over 65 only have $4,906 in credit card debt, a bit below our overall average noted above. The real concern? While the overall average increased roughly 85%, the average for elderly increased 194% over the same time frame.

Dropping property values may be a boon to elderly trying to pay rising taxes, but it certainly does them no favors if they were hoping to use a reverse mortgage to make ends meet. Higher health care costs, more debt (as evidenced by rising credit balances), and likely depleted retirement funds from the tanking market may be placing our elderly at greater risks to make ends meet.

The elderly to be are at risk as well. Baby boomers lead the pack in refinancing their homes and undercutting their equity. As they near retirement not only will they face high health care costs and depleted retirement accounts, they will probably still have a house payment. If they truly retire, and their income goes down accordingly, how exactly do they plan to make ends meet?

While the government discusses bailing companies out and dithers over what to do with homes in foreclosure there is little discussion over the only slightly more distant future. Give the economy a couple of years to recover (and time for Alt A, interest only, and ARM loans to default) and they seem to think we will see the silver lining on the clouds. Maybe. If we don't prepare households to utilize their homes wisely and manage their debt payments we may find storm still going strong.

Demos isn't quiet about what they think should be done. I am not saying I completely agree with all of their suggestions, but here is the gist:

Enact a Borrower’s Security Act: limiting interest rates and fees on credit cards. (Still very relevant, could have a big impact on struggling families)

Maintain Existing Bankruptcy Laws: They were up for review. The new legislation is a bit tighter, and better (in my opinion). Demos would have liked to have seen it remain the same.

Address Real Estate Practices: Fight appraisal fraud (Better late than never, though two years ago would have been a good start)

It will be interesting to see what the new administration does. Hopefully Obama will at least consider some of these issues. Whether we help families now, or let them default/declare bankruptcy later, one thing is for sure: taxpayers will continue to foot the bill. Stronger polices for families in financial distress may be the order of the day.