The headlines are brimming with good news for first-time homebuyers. They can now purchase with FHA loans and little or nothing down. It sounds great, but is this really a smart idea? Isn’t the lack of down payments one of the reasons we have so many owners being foreclosed?
In the usual situation buying with nothing down is not good public policy, not good for lenders, dangerous for mortgage investors and risky for borrowers. That said, let’s look at some realities.
For decades the VA program has allowed veterans to purchase real estate with nothing down.
We’ve gotten away from requiring meaningful down payments. A 1995 study from the National Association of Realtors shows that a typical first-time buyer purchased with 11.73 percent down — $12,900 up-front for homes then costing $109,900. By 2008 the typical down payment was just 4 percent and 34 percent of all first-timers bought with no money up front.
Today’s real estate market is hardly “usual” by the standards of the past 50 years. Home prices in most areas have declined, according to a NAR study released in May, which shows that 134 metropolitan areas have lower existing home prices than a year ago while just 18 saw price increases.
NAR also reported something else: First-time buyers accounted for half of all purchases during the first quarter.
We are dependent on the entry of first-time buyers to maintain the real estate marketplace. Not only do first-timers represent a huge number of sales, but without them there would be no move-up market. After all, how can current owners move-up if they’re unable to sell their current homes?
HUD now says first-time buyers who qualify for the federal tax credit can apply that money — as much as $8,000 — to the down payment when financing a home with an FHA loan. Since the FHA program requires 3.5 percent down, the HUD announcement means that in some cases buyers can borrow as much as $228,500 and buy with no money down.
The headlines and industry news releases have made a big deal about the no-money-down aspect of the HUD announcement — but do not say much about the details. When you look at the specifics the picture changes.
You can’t participate if you’re not qualified to receive the first-time buyer tax credit. In basic terms you can only qualify if you have not owned a home during the three years before you purchase and if you close before December 1, 2009. In addition, you can only get full benefits if your income is not greater than $75,000 ($150,000 if married).
If you qualify for the tax credit, HUD says you can then get an advance — a “bridge loan” — that can be used to pay all or part of the required 3.5 percent FHA down payment. The catch is that you can’t get a credit against the down payment from just anyone, it must come from state housing agencies or certain non-profits.
Where's The Money?
Some state housing agencies have said they will advance the dollars needed for a down payment, a debt to be repaid once the borrower collects their $8,000 from Uncle Sam. However, funds for state agencies and nonprofits are limited. Many first-time borrowers who qualify for the federal tax credit will never get a bridge loan from any state agency or nonprofit.
The alternative to state agencies and nonprofits is to get a loan from an FHA-approved lender against the tax credit. HUD says first-time FHA borrowers can do this, but the money cannot be applied against the down payment. So what good is a bridge loan from a private lender?
“Lenders,” says HUD, “can now monetize the tax credit for use as additional down payment, or for other closing costs, which can help achieve a lower interest rate.”
What the HUD policy means is that a private-sector lender can give you an advance to be repaid with your money from the tax credit, but you still have bring your own cash to closing for the down payment.
Unlike state governments and nonprofits, private-sector lenders can’t just hand out second liens to help FHA borrowers finance their down payments because it’s illegal. As HUD explains, “current law does not permit approved lenders to monetize the tax credit to meet the required 3.5 percent minimum down payment.”
The $8,000 credit is literally a gift from Uncle Sam. There’s no interest and no need to repay once you get the money. For some borrowers, however, the credit is not so certain. For instance, HUD says that “if the tax credit advance loan has a short term for repayment, it must also provide that if the borrower fails to repay by the designated deadline, principal and interest payments begin automatically or the loan converts to a ‘soft’ second.”
Why would a borrower fail to repay? It may be that some will apply for the credit by completing IRS Form 5405 — but the claim will be rejected because income is too high or someone had title to a property during the past few years. As an example, think of someone who owned a home 30 months ago, got divorced, lost the home and now wants to buy again — they would not qualify for the first-time buyer credit.
The Bottom Line
Should we worry about FHA loans with little or nothing down? Will they reduce the inventory of unsold homes? Yes and no.
Yes, we should worry because buying with nothing down does not suggest we're dealing with purchasers who have great financial capacity. If something goes wrong such buyers can quickly get into trouble and when there’s little or no equity the option of selling without a loss is gone.
But no, overall we shouldn’t worry. While there are estimates that 101,000 first-time buyers will be helped with the credit advance, the final number is likely to be much smaller. Here's why:
There just won’t be that many first-time buyers who will be able to use FHA financing to purchase with little or nothing down. States and nonprofits don’t have the dollars to make large numbers of bridge loans. Many states — if not most — will not advance any money in the form of short-term loans to FHA borrowers. As of this writing only ten states — Colorado, Delaware, Idaho, Kentucky, Missouri, New Jersey, New Mexico, Ohio, Pennsylvania and Tennessee — say they will offer FHA bridge loans.
Seen the other way, 40 states are not now offering bridge loans. The big foreclosure centers, the ones that need the most help, are not in the picture. California, Arizona, Nevada and Florida, according to the Mortgage Brokers Association, “account for about 46 percent of the foreclosure starts in the country, and represented 56 percent of the increase in foreclosure starts, including half of the increase in prime fixed-rate foreclosure starts.”
“The reality is that the HUD policy is reasonable within today’s circumstances,” says James J. Saccacio, chief executive officer of RealtyTrac.com, the leading online marketplace for foreclosure properties. “However, whatever the good intentions of the new HUD policy, many states and nonprofits simply do not have the dollars to make large numbers of down payment advances. The result is that while the HUD policy will help, the impact is likely to be both smaller than estimated and not associated with the major foreclosure centers where it could do the most good.”
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.
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