Tax credit can be used for down payment

The Federal Housing Administration has issued formal guidelines allowing first-time homebuyers to apply a federal tax credit of up to $8,000 toward the purchase of a home with an FHA-backed mortgage.

The bad news, for those hoping that the initiative would allow homebuyers to buy a home with nothing down, is that the tax credit can’t be used to meet the FHA’s 3.5 percent minimum down-payment requirement.

But the tax credit can be used as an additional down payment and for other closing costs, which can help borrowers obtain a lower interest rate. For the average FHA-insured mortgage of $182,000, buyers must bring to the closing table or finance about $8,600 in costs on top of their down payment — about $5,460 in closing costs (typically around 3 percent of the sales price) and $3,185 for FHA’s initial 1.75 percent mortgage-insurance premium.

In announcing  the release of the guidelines, Secretary of Housing Shaun Donovan called them “another important step toward accelerating the recovery of the nation’s housing market.”

The ability to “monetize” the tax credit and apply it to a home purchase will not only help families purchase their first home, Donovan said, but “present an enormous benefit for communities struggling to deal with an oversupply of housing.”

The National Association of Home Builders has estimated that the tax credit will generate 160,000 home sales — 101,000 purchases by first-time buyers and 59,000 purchases by existing homeowners who will be able to sell their home and trade up. FHA’s market share has grown from 1.9 percent in the fourth quarter of 2006 to 23.7 percent in the last three months of 2008.

The guidelines for monetizing the first-time homebuyer tax credit have been anxiously awaited for more than two weeks. After Donovan announced the initiative in a May 12 speech to members of the National Association of Realtors, HUD released and abruptly withdrew a set of guidelines that were later described as a draft version.

The final guidelines for lenders, spelled out in Mortgagee Letter 2009-15 RS/2009_MORTGAGEE_LETTERS/09-ML USING FIRST-TIME HOMEBUYER CREDITS. ,

explain the conditions under which FHA-approved lenders and nonprofits, and federal, state and local government agencies may purchase the tax credits anticipated by homebuyers.

Those offering tax-credit advances with second liens can’t charge more than 2.5 percent of the anticipated credit, which works out to $200 in fees and costs for the maximum $8,000 tax credit.The second lien can’t exceed the total amount needed for the down payment, closing costs and prepaid expenses, and can’t result in cash back from the borrower.

The homebuyer’s 3.5 percent minimum down payment can’t come from the lender, the seller, or any other third party or person benefiting from the transaction.

But FHA does allow parents, employers and other governmental entities to contribute towards the 3.5 percent minimum down payment.  A number of state housing finance agencies offer down-payment assistance loans that can be used to meet FHA minimum down-payment requirements, some of which already incorporate the first-time homebuyer tax credit.

“This guidance will enable more housing finance agencies to go forward with programs they’ve been waiting to launch until the guidance came out,” said Garth Rieman, director of housing advocacy and strategic initiatives for the National Council of State Housing Agencies.

Rieman said that the mortgagee letter appears to allow housing finance agencies to continue to offer second loans that incorporate the tax credit as one of many underwriting factors, and those loans can still be used to meet the FHA’s 3.5 percent down-payment requirement.

But the letter does appear to prohibit borrowers who obtain second loans based solely on their eligibility for the first-time homebuyer tax credit from using those funds to meet FHA’s minimum down-payment requirement, Rieman said.

“We think the guidelines are flexible enough to allow housing finance agencies that already have (down-payment assistance) programs to continue to use them, and to allow them to use them with FHA loans,” Rieman said.

The process described as “purchases” of tax credits in the FHA’s letter to mortgagees is a new approach, Rieman said.

“You want to make sure it’s done responsibly,” and HUD has done an “artful” job balancing the need to stimulate homebuying against risk to the FHA insurance fund, he said. “When you consider all the fees and costs homebuyers must come up with, this will be very valuable in helping them raise the funds to close.”

The first-time homebuyer tax credit is equal to 10 percent of the purchase price of the home, up to $8,000, for first-time homebuyers purchasing a home before Dec. 1. A first-time homebuyer is anyone who hasn’t owned a primary residence in the last three years.

Individuals making $95,000 or more and married couples earning $170,000 or more can’t claim the credit. Lesser tax credits are available for individuals with a modified adjusted gross income of $75,000 or more but less than $95,000, and for married couples earning $150,000 or more but less than $170,000, and filing jointly.

The IRS has created a landing page with links to a Q&A and Form 5405, the form used to claim the credit after closing on a home
purchase.

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