Is Homebuyer Credit Worth An Extension? Critics see default risk, damper on future sales, harm to rental housing

MARILYN ALVA

Political pressure is building to extend and even expand the first-time homebuyer tax credit to all buyers. But a growing chorus of critics says the program is a clunker that should be scrapped.

The $8,000 tax credit ends Nov. 30, but because home sales must close by the deadline to be eligible, the effective cut-off for new deals may be a few days away.

The tax credit doesn't really address housing's fundamental problems -- rising unemployment, a housing glut and heavy foreclosures -- critics say. Nor do they think the billions of dollars in costs can justify the potential outcome: giving a lift to housing.

"It's not like it's a purchase that was never going to be made," said Stan Liebowitz, professor of economics at the University of Texas in Dallas. "It's temporarily moving some sales from the future to today."

It has "a bit of a Cash for Clunkers about it," he said, adding, "It will not have much impact on the price of homes, which is the best justification for having it in the first place."

But proponents estimate that of this year's expected 1.9 million first-time buyers, 350,000-400,000 would not have done so without the tax credit.

To qualify, single applicants must have incomes of no more than $75,000, couples no more than $150,000. A first-time buyer means one who hasn't owned a home in at least three years.

However, thousands of individuals -- including many "children" -- have tried to scam the system, the Treasury's inspector general told Congress Thursday.

Unlike 2008's $7,500 no-interest loan, this year's credit doesn't have to be repaid unless the home ceases to be a taxpayer's main residence within three years. The credit, part of the $787 billion stimulus passed in February, is in effect a cash grant.

"For people who could afford a home anyway, the $8,000 is gravy," said Roberton Williams, senior fellow at the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution.

Both Democratic and Republican lawmakers are batting around proposals to keep the program alive in its current form at the very least.

Sens. Johnny Isakson, R-Ga., and Christopher Dodd, D-Conn., want to extend the $8,000 credit to June 30, raise the income limits and make it available to all qualified buyers.

Congressional tax experts estimate that would cost $16.7 billion.

The Obama administration has yet to take a stand on extending or expanding the program.

Buyer Beware

Opponents fear that many buyers lured by the tax credit, and the low-interest, government-backed Federal Housing Administration loans typically used to finance them, might get in over their heads.

Studies have shown that the less money buyers put down, particularly if it comes from outside assistance, the more likely they will end up in foreclosure. Many new homebuyers are using the tax credit instead of their own equity to handle the down payment.

In recent testimony before a House panel, former Fannie Mae chief credit officer Edward Pinto said a past down payment assistance program resulted in default levels two to three times higher than the norm.

Pinto noted that the annual percentage of FHA loans going into foreclosure has gone from 2.36% in 1998 to an estimated 4.4% in 2009.

FHA and Veterans Affairs loans now account for more than nine in 10 mortgages with loan-to-value ratios that top 90%, he said, and most exceed 96%. The LTV ratio is the first-mortgage lien amount as a share of a home's appraised value. The FHA requires just 3.5% down.

"The heavy use of the $8,000 first-time homebuyers credit may result in price and other distortions that effectively eliminate FHA's protection from its small down payment requirement," Pinto testified.

Besides the FHA, several state programs allow qualified buyers to apply the credit toward their down payment and closing costs. That means buyers using low-interest FHA or other loans would have little or no "skin in the game," similar to the widely criticized zero-down loans made during the boom.

"Do you want to prop up the housing market by incentivizing high-risk people to buy a house?" asked Ted Gayer, co-director of economic studies at Brookings. The government is doing enough without it, he says, citing Federal Reserve efforts to keep mortgage rates low.

Credit Could Be Expanded

Stricter underwriting policies will keep most of the riskiest applicants from buying homes, with or without the tax credit. But Williams of the Tax Policy Center worries about the "borderline" people who would only be able to afford a down payment with the $8,000 tax credit.

"Are they going to be able to handle homeownership? To the extent the credit encourages people on the edge to buy, it might not be the best thing," he said.

But Realtors, homebuilders, mortgage lenders and other industry players are lobbying hard to extend and expand the program. Some want to boost the credit's size to $15,000.

"These tax goodies take on a life of their own and become sacred even though they were supposed to be temporary," said Jim Arbury, senior vice president of government relations for the National Multi Housing Council. "The American Dream of homeownership has been so oversold that I haven't heard any member of Congress say they're willing to take this credit away."

The group -- which has never favored the credit -- represents major owners, developers and financiers of rental apartments.

"If you're switching a renter to a buyer you really haven't helped the overall housing market," Gayer said.

The rental market has been stung by rising vacancies and dropping rents as the supply of housing outstrips demand.

The consumer price index shows that rents fell in September for the first time since 1992. The CPI data include rents and rental equivalence -- what an owner would pay in rent for his or her home.

Gayer, one of the most outspoken critics of the tax credit, says the drop in rental prices could be an unintended consequence.

"Say you're renting a house from me and the tax credit incentivizes you to buy the empty foreclosed house next door," he said. "Now we have one less foreclosed house but my house is empty."

Many owners of underwater condos and single-family houses -- those who now owe more than the homes are worth -- have turned their properties into rentals, boosting rental supply.

Meanwhile, the recession has kept many new households from forming as young people and others who can't find jobs -- would-be renters -- bunk with family or friends.

Renters, seen by many as the have-nots of society, are not given their fair due by policymakers, some say.

"Across administrations and parties everybody has talked abut getting homeownership higher," Gayer said. "There's nothing intrinsically wrong with renting if that's the best outcome for you," and especially if that renter becomes a homeowner at risk of defaulting.

Apartment owners aren't actively fighting an extension of the $8,000 tax credit to first-time buyers because "it would be like jumping in front of a freight train," Arbury said.

But they oppose expanding the program to all buyers or increasing the credit's size.

Weighing Alternatives

A better way to deal with housing woes is to reduce foreclosures so that owners can stay in their homes, some experts say.

"To some degree that's happening," Williams said, citing stimulus efforts to encourage banks to restructure mortgages. "But there are constraints and many hassles seem to be keeping that from happening in big numbers."

While housing is showing a few signs of stabilizing, some fear a "shadow supply" will flood the market as homes backed up in the foreclosure mill hit the market. Another concern is the potential for re-defaults on loans that've been modified.

"Whether or not the credit is extended, the outlook for the market in the near future is almost certain to darken," wrote Dean Baker, co-director of the Center for Economic and Policy Research, in a recent column.

He said extending the credit would have "limited impact" in boosting future sales because it has pulled demand from 2010 and 2011 to 2009.

"The pool of potential first-time buyers is much lower today than it was last February," he wrote.