Can $8000 Homebuyer Tax Credit Be Used For Down Payments? (Not Yet)

There’s been a lot of chatter about whether the $8000 homebuyer tax credit can be used toward down payments. Most recently, HUD said the tax credit can go for down payments and here’s a press report on it:

First-time homebuyers will now have access to quick cash to help them with their down payments.

On Friday, the U.S. Department of Housing and Urban Development (HUD) announced that first-time homebuyers using FHA-approved lenders can now get an advance on the $8,000 tax credit created by the stimulus package and apply it toward their down payments or closing costs.

“We believe this is a real win for everyone,” said HUD secretary Shaun Donovan in a speech before the National Association of Homebuilders (NAHB). “Families will now be able to apply their anticipated tax credit toward their home purchase right away. What we’re doing today will not only help these families to purchase their first home but will present an enormous benefit for communities struggling to deal with an oversupply of housing.”

As part of the stimulus package, Congress created a refundable first-time homebuyers tax credit in hopes of helping on-the-fence buyers to take the home-purchase plunge. But buyers couldn’t collect the $8,000 credit until tax time, rather than at closing time — when it’s needed.

The delay created an obstacle to reigniting the housing market because most first-time buyers — the ones who would buy much of the available inventory — have only saved enough to cover 4% of the purchase price, according to the National Association of Realtors.

The mechanics of the new program, according to NAHB economist Robert Dietz, allow lenders to purchase tax credits from the buyers and then collect the rebate from the IRS. Homebuyers must still come up with FHA’s mandatory downpayment of 3.5% on their own, but they can use the tax credit to lower their principal balance and save on monthly payments.

Besides the press and HUD propaganda, here’s the current status: it will take time (1-3 months in my estimates) for lenders to implement this—it’s not a deal on the table today. The reason is because homebuyers must live in the property and prove it’s owner-occupied for 3 tax filing years following purchase. So lenders assume significant risk (default, foreclosure, and sale-before-3-years risk) buying out tax credits in order for borrower to apply it to closing. So to use the credit at closing, borrowers will pay for the privilege, fees likely to be deducted from the credit. Below are some additional notes on how this IRS credit situation is evolving. Items 8-9 pertain to the FHA-lender credit purchases. Bottom line: Realtors should not tell clients that they can get a full $8k credit at closing because, FHA or not, borrowers won’t net $8k if they want an advance (from lender or government agency 2nd lien) on the credit. It’s a developing issue, but this is where we are today.

1. The IRS tax credit refund can be made only to the taxpayer and not a third party.
2. Government agencies may offer tax credit advances with second liens.
3. The buyer cannot get cash back through the tax credit advance.
4. The 2nd lien may not exceed the down payment, closing costs, and prepaid expenses.
5. The 2nd lien may be “soft” or require payments.
6. Payments on 2nd liens must be included in ratios unless deferred for at least 36 months.
7. Balloon payments on 2nd liens may not be before 10 years.
8. FHA approved lenders and FHA approved non-profits may purchase the tax credit.
9. Tax credit purchaser may not charge more than 2.5% of the tax credit as a fee.
10. IRS may deduct from the tax credit: unpaid student loans, tax liens and garnishments.