Would increasing the first-time homebuyer credit to $15,000 stimulate homebuying?
The current stimulus package provides an $8,000 first-time homebuyer tax credit. And proposed legislation could increase that credit to $15,000. For the most part, the features of this credit seem to carry over to the newly proposed program with a few additional ones, like not having income restrictions.
Before we get started, it's important to understand that the existing credit is unlike the $7,500 credit that was passed a year ago. That program was really an interest-free loan because the $7,500 had to be paid back. The $8,000 credit does not have to be repaid and neither will the $15,000 credit, should the bill pass.
Most potential first-time homebuyers prepare themselves by saving money for a down payment. They check their credit scores and peruse their credit reports for errors. And I hope they have been getting an education.
After that, buying a home is a marginal game. By that I mean that homebuyers look at marginal differences in the details. For example, if property values come down, a once unaffordable home may become affordable. If interest rates come down a little bit it, the monthly payment will be a little bit lower.
Adding an $8,000 tax credit to the equation changes that equation too. Whatever the economies were before, they are now $8,000 better. Every time values drop, rates drop, or something like this tax credit comes along, a number of homebuyers are better positioned to buy a home. Every marginal improvement helps someone out and makes it more likely that they will buy a home.
This position comes from an academic analysis that may not bear any relation to the real world. But we do have real experience with testing this model. In this decade, Wall Street and the subprime mortgage industry said, "To heck with all these silly rules. We will do a loan for anybody!" That action took a lot of people off the sidelines and into the housing market. Perhaps a million of these homeowners have lost their homes due to foreclosure – so this wasn't a good idea.
That extra demand helped fuel the hyperinflation in housing values that created the bubble that popped and caused our current economic woes. We don't want that again. And with mortgage rules as tight as they are today, we are unlikely to have a recurrence. Rules are pretty tight today.
So the question remains whether an additional tax credit is a motivating factor. I must say that I don't see people saying, "With an $8,000 credit, I wasn't interested, but now that it's $15,000 I am really interested in buying a home." I may be wrong. You would have to go interview 1,000 homebuyers and ask them to what extent the tax credit was a motivating factor. I'd like to know what the results of such a survey would be; I wish someone would do that survey.
Let's step back and look at the economics of a purchase transaction. Let's say a couple was interested in a $300,000 home a while ago. They were going to put $60,000 (20 percent) down and get a $240,000 loan at 6 percent. Now they can buy the home for $250,000 and with their $60,000 down payment they need a $190,000 loan – and the rate is now 5 percent:
Old Deal New Deal
Sales price 300,000 250,000
Loan 240,000 190,000
Rate 6% 5%
Payment 1,899 1,320
Income to qualify 57,000 40,000
As you can see, market forces have dramatically altered the landscape here. For this particular home in this market, a lot more people can qualify. Does a tax credit make it more appealing? Sure it does. Would someone buy this home in these circumstances without the credit? Maybe; maybe not. There are other forces at work.
So we are back to the starting point, the possibility of increasing the tax credit to $15,000. Would that help revive the housing market? It’s hard to say. Again, this is a marginal benefit environment and increasing the benefits would, at least academically, attract more buyers.
In normal times, there are about 1 million homes built every year, although that number will be only 500,000 this year. Right now we don’t need new homes because of the homes that were or will be vacated by foreclosures.
Let's say that 1,500,000 potential homebuying households are created each year. At a cost of $8,000 per home, it costs the government (read: you and me as taxpayers) $12 billion dollars in tax credits if they leave the current program in place. If you increase the credit, you don't have to pay it just to the newest people. You have to pay it to everyone, including the people who were happy with the $8,000 credit and those who don't need the credit at all.
The only reason for doing this is to stimulate EVEN MORE people to buy a home. If we increase the tax credit to $15,000 and assume that adds another 100,000 new homebuyers, then we now have 1,600,000 homes receiving a $15,000 credit at a total cost of $24 billion – double the cost to the government (again, you and me as the taxpayers).
But if you only attract 100,000 more homebuyers but have to pay all 1,600,000 of them, in effect you will have paid $120,000 per marginal household to encourage those 100,000 people to buy a home. That's mathematically equivalent to giving 100,000 people a $120,000 home for free. Isn't there a better way?
For example, when we distribute welfare funds, the money goes only to those who need it. They don't give money to everyone. Why shouldn’t it be the same here? If this is a "marginal game," as I have suggested, why not use stimulus money to attract only those people for whom this credit is the difference between buying and not buying?
I know: The way Washington is throwing money around these days, what's another $12 billion? But I really question if increasing the tax credit to $15,000 is the wisest way to do this. There are certainly a number of vehicles, like down payment assistance – that would have to be paid only to deserving households – that would be more cost effective.
Homebuyers who might
benefit from this tax credit should see IRS form 5405.
If you are a potential homebuyer, I would jump on the current tax credit opportunity. If the new law were to pass, you'd probably get that additional benefit too. And at that point it would be icing on the cake.
Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrowerarticles, Randy is a mortgage broker who has financed over $1 billion
in properties. He writes about home buying and real estate finance
topics for CreditBloggers.com.
Randy Johnson Randy is a Credit.com contributor and seasoned mortgage expert. He writes about home buying, mortgage laws and real estate finance issues. He has financed over $1 billion in properties, is the author of How to Save Thousands of Dollars on your Home Mortgage and he is a feature columnist for Savvy Borrower.
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