FHA is not a bad (nor obscure) word!
Last month I had a couple of posts that talked about the effects & opportunities that the Economic Stimulus package presented to the real estate marketplace. I saw bits of press and some Realtor and NAR advertising about the $8000 first time home buyer credit. There were lots of blog posts about its benefits. But is it really understood? Are people really aware of how powerful the benefit is when combined with available FHA mortgage programs?
What brought this back to the front of my mind (no wasteland jokes, please) was a visit to my accountant. We were catching up on family news and she mentioned her daughter – a recent college grad – who had just leased an apartment in Chicago. I asked if they had looked at buying, especially with the new credit. Her answer that it would take a while to save the 20% down payment necessary in today’s market was surprising to me. I asked her if she was aware that with an FHA loan she could put down 3.5%, get a great rate and qualify for the $8000 tax credit. Her answer, obviously was no. (ok, should I have been quicker to get this scenario in front of my clients? Yes.)
So, presented here, is a purchase scenario for a first time buyer in the Chicago area market. Note that differences in property taxes will affect the potential tax savings. As always, check with your personal tax adviser for details and implications for you.
This scenario estimates the potential tax savings to a first time home buyer purchasing a home under an FHA program that calls for 3.5% down payment. Assuming the buyer(s) eligibility for the new 1st time buyers credit of $8000 and deductible mortgage interest and property taxes, the first year tax savings could be significant. The 2 views below look at a full year tax savings (12 months) or optionally a mid year close which would yield a reduced, but still significant itemized deduction.
| ITEM |
|
AMOUNT |
Mid Year Close |
|
| Purchase Price |
|
$200,000 |
$200,000 |
|
| FHA Down Payment |
3.5% |
$(7,000) |
$(7,000) |
|
| Mortgage Amount |
|
$193,000 |
$193,000 |
|
| Loan Term |
30 years |
|
|
|
| Interest Rate |
5.50% |
|
|
|
| First 12 months interest |
$10,550 |
$5,257 |
||
| Property Taxes 1 yr |
|
$5,000 |
$2,500 |
|
| First year itemized deduction |
$15,550 |
$7,757 |
||
| Projected Tax Bracket |
|
25.0% |
25.0% |
|
| Projected Addl Tax Savings |
$3,888 |
$1,939 |
||
| 1st Time Buyers Credit |
|
$8,000 |
$8,000 |
|
| Est 1st Year Tax Savings* |
|
$11,888 |
$9,939 |
|
*These projections/estimates are not intended to replace the advice of a tax professional. Each case is different and should be reviewed by the appropriate professional. As always, I am available to discuss your plans. Please contact me at your convenience.
This combination of FHA financing and first time buyers credit is only available (as of this writing) until December 1, 2009. Is there someone in your family who could take advantage of this? Pass this on and let them see what the savings could be. And oh, by the way, any unused portion of the credit is refunded to you by the government at tax time.)
[...] tonylazz placed an interesting blog post on FHA is not a bad (nor obscure) word! « NAPERVILLE HOMES BLOGHere’s a brief overviewI saw bits of press and some realtor and NAR advertising about the $8000 first time home buyer credit. There were lots of blog posts about its benefits. But is it really understood? Are people really aware of how powerful the benefit is … [...]
I guess it doesn’t surprise that a realtor is in favor of someone putting down 3.5% instead of 20%, but the 0%-5% down is what got us into this mess (among other things).
For your example, while you are saving $11,888 in taxes, we don’t seem to highlight that the buyer is paying $15,550 in Property Taxes +Interest and probably paid $6K in closing costs, so they’re out $21K. If we want to get picky, we can discuss the $7K of opportunity cost that they sunk into the downpayment, but real estate always goes up, right?
Justin: Thanks for taking the time to comment and offer your observations, I appreciate it. And you are right, I am a Realtor and I do help people buy and sell homes. As a Realtor I believe it is my responsibility make my clients aware of what opportunities exist to acquire a home. One alternative that exists and is not well understood is the combination of a FHA mortgage program and the first time homebuyer credit. That is what this post attempts to explain.
Are 3.5% mortgages “what got us into this mess”? The answer is no. Is one of the factors that many loans were issued to borrowers with poor credit scores, no reserves, and often for more than the value of the property? Yes. Is the fact that owners, once in the home, overdrew their equity and became upside down in their mortgage? Yes. Lending practices and approvals probably have much more to do with “this mess” than the down payment percentage required. As a Realtor, I am pleased to see that tighter, more stringent guidelines are being implemented for new loans.
I am going to answer your next series of points in reverse order.
1. Real Estate always goes up: Real estate, is cyclical as are opportunities for investment such as markets, precious metals etc. Markets have their ups and downs – historical fact. The following statistics come from USA Today, Dennis Cauchon (12/12/2008): “Appreciation. Existing home values rose 0.5 percent annually, adjusted for inflation, from 1950 to 2000. From 2000 to 2006, they rose at the annual rate of 8.2 percent above inflation and peaked with a 12.3 percent rise in 2005.” There have been peaks before and declines also. There will be more in the future. Market fact. Period. The more pertinent question one may ask is what is the reason someone is putting money into a house? Are they purchasing shelter for themselves or are they making an investment in real property. Those are 2 fundamentally different choices that people make with different sets of evaluation criteria.
2. Opportunity cost of $7k sunk into a downpayment: You nailed this one. A home buyer in this scenario would choose to spend $7000 to purchase a tangible piece of property with a stated market value. The opportunity cost would in fact be what could they have made by investing that $7000 in some other vehicle – stock market, munis, precious metals, collectibles, etc? To the buyer it would seem that they believe this is the way they choose to spend their money.
3. Is the buyer out $21k in this scenario? It seems to me that the net out of pocket, first year, would be the difference in the downpayment and interest less the tax savings or $3,662 plus any closing costs. Your $6,000 in closing costs seems a bit on the high side. I checked with a lender, and in the market area where I work, HUD-1 Closing Costs on a loan package like this would be around $2300. (does not include prepaid reserves required by lender). So the net out of pocket, first year is more like $6,000, not $21,000.
Thanks again Justin for asking the questions and providing the opportunity to flesh this out a bit more.