Manufacturing Demand

Will home sales fall off a cliff once the latest version of the homebuyer tax credit expires? Experts vary on the precise impact of the credit, and on what will happen when it ends. But most agree the credit created a big wave of sales pulled forward in time to when the housing market really needed a boost.

Mortgage Banking
March 2010


By Robert Stowe England

The homebuyer tax credit--all three versions adopted since its first effective date of April 1, 2008--is widely believed to have boosted overall home sales at a time when the housing market was in a deep slump.

At this point, opinions vary on the extent of the boost, while early data support the view that the credit has had a positive impact. But the big question that remains, is how much of future sales were pulled forward in time, leaving the period after the credits expire badly starved for demand.

"Tax credits like this are designed to essentially pull demand forward," explains Jay Brinkmann, chief economist with the Mortgage Bankers Association (MBA). "So, I don't think anyone thinks that it creates new potential homebuyers out of thin air."

The tax credit is intended to influence people who were prepared to buy next year or the year after, and induce them to buy the home earlier in order to receive the benefit of the credit, according to Brinkmann. One of its goals is to reduce the excess inventory of homes on the market and provide some price stabilization "with the realization that it is a short-term event," he says.

"The trade-off for achieving the short-term benefit is to have lower sales afterward," Brinkmann says. "And we've certainly seen that for the number that came out [for December 2009] after the expiration of the [earlier version of the] tax credit," he says.
Existing-home sales for December 2009 fell 16.7 percent to a seasonally adjusted annual rate of 5.45 million from 6.54 million in November, according to the National Association of Realtors(r) (NAR), Chicago. Earlier in the fall, as the Nov. 30 deadline loomed, potential homebuyers rushed to buy homes to qualify for the soon-to-expire $8,000 first-time homebuyer credit.

However, in early November, Congress extended the $8,000 first-time homebuyer tax credit to April 30 and expanded it to include a $6,500 credit for existing-home buyers buying a new primary home. Buyers must have signed home-purchase contracts in place by April 30 and close on those purchases by June 30 in order to qualify for the credit.

Evidence the credit worked

Providing further proof of the sales boost coming from the credit, NAR's practitioner survey showed a drop in first-time homebuyers in December to 43 percent of homes, compared with 51 percent in November.

Will there be an added boost from the current tax credit? "Yes," says Lawrence Yun, chief economist at NAR. "We'll likely have another surge in the spring as homebuyers take advantage of the extended and expanded tax credit," he says. "By early summer the overall market should benefit from a more balanced inventory, and sales are on track to rise again in 2010."

Persistent high unemployment, however, will continue to dampen the upside potential for home sales, according to Yun. "Job creation is key to a continued recovery in the second half of the year," he says.

Economists at both government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, agree with other industry observers that the tax credit has been a boost to home sales.

"The data are pretty clear that people reacted," says Doug Duncan, vice president and chief economist at Fannie Mae. "The housing starts, new-home sales, existing[-home] sales and the pattern of changes in them [make it] clear that people used the tax credit to make purchases."

Fannie Mae has raised its expectations for economic activity in the first half of the year "as a result of the impetus from the tax credit," Duncan says. "The second half will be somewhat lower than it would have been" if there had not been an expiring tax credit, he adds.

Fannie Mae is forecasting the real gross domestic product (GDP) in the United States will grow at an annual rate of 3.1 percent in the first two quarters, rising to 3.3 percent in the third and 3.6 percent in the fourth quarter. Without the homebuyer tax credit, the forecast for growth would be lower in the first half and higher in the second half than the numbers in the current forecast, Duncan explains.

Duncan is less sure about the impact of the tax credit on current homebuyers buying a new home. That's because such homebuyers have to develop "an exit strategy" for selling the old home before buying a new one, and that may difficult to pull off in the time allotted for the credit.

Good timing

Frank Nothaft, Freddie Mac's chief economist, is also upbeat about the tax credit. "I think it was an important initiative to jump-start home sales once again," he says. "If you take us back to the beginning of 2009, before [the second version of the tax credit] had been enacted, many potential homebuyers were sitting on the sidelines as the news was pretty sour and black--not just the housing market, but the macroeconomic news."

The tax credit provided "additional kick to those who had the wherewithal to buy, but who were hesitant to buy because of all the lousy economic news," Nothaft says. "By putting in a deadline plus an attractive incentive of $8,000 for the first-time homebuyer, that's pretty powerful," he adds.

Nothaft also praises the extended and expanded tax credit and expects it also to have a punch for home sales. "It's important to continue the stabilization we've seen in the housing market and get through the spring," he says.

Nothaft, agreeing with other observers on this point, admits that the tax incentive may "in part" front-load sales for 2010 into the first half. "If we've entered into an economic recovery, which I believe we have, that recovery will be gradually gathering strength over the course of the year," he says.

A turn in consumer psychology will be central to sustaining the housing recovery, according to Nothaft. And that cannot come too soon, he adds, because "there's a lot of damage to repair."

Measuring the impact

It is too early, of course, to have a complete accounting of the impact of the tax credit other than what is available from computer models or derived from home-sales data that measure first-time homebuyer activity.

Ultimately we will know from the Internal Revenue Service (IRS) how many filed claims for the tax credit and were granted the credit. But that authoritative IRS data will not be available until sometime in the latter half of 2011.

Another helpful calculation comes from the Government Accountability Office (GAO), the research arm of Congress. The GAO reviewed the claims filed by taxpayers for 2008 and for 2009 up to Aug. 22, and found that 1.4 million taxpayers had claimed the first-time homebuyer tax credit during the period.

In its third and current version, the credit is now available for both first-time and existing-home buyers. For first-time homebuyers, the credit is provided for 10 percent of the home purchase price up to $8,000. For existing-home buyers, it is available for up to $6,500.

In its original form, the tax credit was authorized in the Housing and Economic Recovery Act of 2008 (HERA) for first-time homebuyers only. It was made available for 10 percent of the purchase price of the home up to $7,500, for a limited time--April 9, 2008, to June 30, 2009. This credit was fully refundable; that is, it would be paid out to taxpayers who were eligible even if they owed no tax, or if the credit was greater than the tax they owed.

The original tax credit had to be paid back by taxpayers who received it over a period of 15 years, in equal payments added on as a surcharge to the annual income tax. Additionally, there were income limits on those who could qualify. Single taxpayers could earn up to $75,000 and married couples up to $150,000 and still qualify for the full credit.

In its second iteration, the credit was amended and extended to apply to purchases made between Jan. 1 and Nov. 30, 2009, and was enacted by Congress on Feb. 17, 2009, as part of the giant $787 billion stimulus legislation dubbed the American Recovery and Reinvestment Act of 2009.

In the Recovery Act, the amount of the tax credit was raised to $8,000 and there was no payback required as long as the homebuyer retained the home for three years. As in the first version passed in 2008, the 2009 version of the credit was a refundable tax credit that qualifying homebuyers could receive even if they have no tax liability or the credit is greater than the amount of tax owed.

On Nov. 6, 2009, Congress enacted the current version of the tax credit as part of the Worker, Homeownership and Business Assistance Act of 2009. The credit was extended and expanded to cover existing-home buyers who want to sell their home and buy another one. This version of the tax credit became effective Dec. 1, 2009, for homes purchased by April 30, with a closing by June 30.

First-time buyers--defined as those who have not owned a home in the past three years--still qualify for the $8,000 rebate. Those who have owned and occupied a residence for at least five years out of the past eight can also claim a $6,500 tax credit for the new purchase of a new primary residence, which could be an existing or newly-constructed home. 
The income limit has been raised, too, for those eligible to claim the credit. Single buyers can now earn up to $125,000 while married couples can earn $225,000 and still get the full credit.

As of Aug. 22, 2009, GAO reported last October that there were 1.43 million taxpayers who claimed they had purchased homes--1,041,361 in 2008 and 385,193 in 2009. The dollar amount of credit claimed was $9.998 billion--$7.108 billion in 2008 and $2.89 billion in 2009.

More first-time homebuyers

One useful proxy to gauge the impact of the tax credit can be found in changes in the share of new homebuyers in the overall mix of homebuyers. Here, the data from 2009 suggest a significant impact for the tax credit.

According to the National Association of Realtors, the share of first-time buyers rose to 47 percent of all home sales made during the period from July 2008 to June 2009.

The survey, conducted in July 2009, was based on a questionnaire sent to 120,038 homebuyers and sellers. It was also the highest yearly level of first-time buyers recorded in the history of the NAR survey, going back to its inception in 1981. The previous high was 44 percent for 1991. The record for 2009 compares with a 41 percent share for new homebuyers in the prior year's survey.

A combination of factors--"tax incentives, record-high affordability conditions, and pent-up demand--brought [about] the record share of first-time homebuyers into the market," says Paul Bishop, vice president of research at NAR.

Interestingly, the NAR survey found that 55 percent financed their new home with a Federal Housing Administration (FHA) loan, with another 8 percent relying on a Department of Veterans Affairs (VA) loan. Thus federal guarantees or insurance backed 63 percent of the purchases made by first-time homebuyers.

While different observers disagree on how much of the gain in share for first-time homebuyers can be attributed to the tax credit, most agree the tax credit contributed to the surge.

Net additional sales

Even if we know the absolute number of people who were granted the tax credit, there is also the question of how many were actually additional new buyers who would not otherwise have bought a house during the time the credit is available.

A number of industry analysts have already tried to estimate the net additional sales attribute to the tax credit--meaning that portion of the total users of tax credits who represent people who would not have bought had there not been a tax credit.

For example, NAR estimates that between 1.8 million and 2 million first-time homebuyers have taken advantage of the second version of the tax credit--the one that does not have to be paid back. That would cover the period from Jan. 1 to Nov. 30, 2009. Of that total, NAR estimates that 400,000 are homebuyers who would not otherwise have bought a home during that time, absent the incentive provide by the tax credit, according to NAR's Bishop.

For the current version of the tax credit, NAR estimates another 1 million first-time homebuyers will claim the $8,000 credit for a home purchase over the period from Dec. 1, 2009, to April 30, 2010. Of that total, NAR estimates that 200,000 will be homebuyers who would not otherwise be buying a home during that time, absent the tax credit.

Thus, for the combined second and third iterations of the tax credit--covering the time from Jan. 1, 2009, to April 30, 2010--NAR's numbers suggest there will be a total of 600,000 first-time homebuyers purchasing a house who might otherwise have waited.

As for the impact of the $6,500 credit for existing-home owners who purchase a new primary residence, NAR estimates there will be 1.5 million homes sold where the credit is claimed. Of the total who purchased a home, probably 200,000 would not have otherwise made a purchase at that time without the tax credit, according to NAR.

It is more complicated for an existing-home buyer who purchases a new residence to obtain the existing-home buyer credit because of the necessity, for most, to sell their prior residence, Bishop notes. The law, however, does not require that the existing home be sold--only that the new home becomes the taxpayer's new primary residence.

In total, then, NAR calculates 3.4 million homebuyers filing a claim for the tax credit, with 600,000 or 18 percent of that total representing a gain in home sales over the period covered than would otherwise have occurred if there had been no tax credit.

Based on total estimated sales, NAR calculates the tax credit program will cost $23.2 billion for first-time homebuyers and $9.75 billion for existing-home owners or $32.95 billion for 2009 and 2010. This does not include any costs associated with the initial $7,500 tax credit program for first-time homebuyers who are required to pay it back over time.

Estimates vary on sales and jobs created

West Chester-, Pennsylvania-based Moody's also sees a significant impact for the tax credit in terms of net additional sales. "We saw that surge in sales in October and November [2009]," strong enough to make 2009 the best [period] for home sales in years, says Celia Chen, an economist who is senior director at Moody's

"Many people bought forward to kick into the tax credit," she adds.

Chen estimates that during 2009, the tax credit added 500,000 to 600,000 to the sales of existing and new homes, which she said was 8 percent to 9 percent of sales. "That's a fairly significant impact," she concludes.

Other estimates of the impact of the tax credit are lower. For example, the National Association of Home Builders (NAHB), Washington, D.C., has calculated that during 2009, there were 200,000 additional homes sold than would otherwise be the case because of the availability of the first-time homebuyer tax credit. That's only about half the level estimated by NAR.

Further, the sales activity associated with the additional home sales produced just over 187,000 jobs, according to Robert Deitz, assistant vice president for tax and policy issues at the National Association of Home Builders. Those jobs were created by the economic activity associated with the home sales.

The extended tax credit will spur an additional 180,000 new- and existing-home sales through April 30 that would likely not occur in the absence of the credit, according to Deitz.

"The reason the number is smaller [than for 2009] is that it is in place in a slower time period" since it covers the winter months from December 2009 through February 2010--a time of year when home sales are typically lower, he says. Yet, Deitz is predicting a bigger impact in terms of jobs, with the activity generating 211,000 jobs. One of the reasons these sales translate into more jobs is that the price of homes affected by the credit is likely to be higher than it was for first-time homebuyers only in 2009, Deitz explains, generating more additional economic activity for higher wage and salary earners, such as furniture sales and economic activity from higher earnings by people in the real estate and mortgage businesses.

Interestingly, new-home sales did not see the big drop-off in December that was registered in December for existing home sales 2009. While new-home sales did fall 7.6 percent in December from November to a seasonally adjusted annual rate of 342,000, according to the Commerce Department, there was already a decline of 9.6 percent in new-home sales in November. Mike Larson, an analyst at Weiss Research LLC, Jupiter, Fla., attributed the drop in new-home sales to the fact the shoppers were flocking to lower-priced existing homes selling at distressed prices.


In assessing the impact of the tax credit in 2009, it's important to take into consideration other major factors that may be driving the sales and, thus, would have boosted the share of first-time homebuyers even absent the tax credit, according to Stuart Feldstein, president and co-founder of SMR Research Corporation, Hackettstown, New Jersey. Improved affordability is probably the most important factor to consider in this regard, he says.

Home prices are now low enough and "people's incomes are high enough to make homes affordable," says Feldstein. "This should cause home sales and mortgage volumes to rise in the future." Further, he adds, improved affordability for houses, which is driving home sales higher, "is probably helping, to some extent, to speed up the recovery."

Housing affordability, after plunging during the housing bubble, has been steadily rising over the last three years. Last year, NAR's Housing Affordability Index(r) reached an all-time high of 178.8 in April 2009 and has declined only modestly since then to 163.8 in December 2009.

"That's the peak over the entire period since the index began in January 1971," says NAR's Bishop. The low point for affordability came in the early 1980s, when mortgage rates were in the double-digits "and the index was in the low to mid-60s," recalls Bishop.

NAR's affordability index is calculated as follows: One takes the median-priced existing single-family home, along with the prevailing mortgage rate, and calculates the monthly principal and interest on a mortgage for a house where the buyer puts down 20 percent on the purchase. One then takes the median family income and calculates the amount of the monthly payment as a percent of income for both fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs). The lower the share of income required to buy the home, the higher the affordability index.

In December 2009, for example, a homeowner with the median family income could buy the median-priced single-family house and spend only 15.3 percent of household income on the mortgage. Typically, lenders prefer that borrowers spend no more than 25 percent of their income on monthly housing expenses.

NAR's affordability data have helped convince Feldstein that affordability in housing is the driving force behind improving home sales. "Even if we didn't have these tax incentives, we should see increased home sales from the bottom," he says. Importantly, homes are now "way more affordable than during the housing boom," he adds. So by contrast, current prices strike would-be buyers as a bargain.


The next factor that could dramatically push home sales forward is a change in the psychology of the American consumer, according to Feldstein.

"We need more American households to believe that home prices are not going to keep falling in order for them to get off the fence and start buying," he says.

Feldstein sees some early signs that the psychology may be turning. "Confidence in the economy seems to be improving a little," he says.

Feldstein notes that during 2008 and 2009, consumer psychology worked to drive down home prices. "Everybody was thinking home prices will keep falling and it was crazy to buy now, when you can wait a few months and get the house cheaper," he says.

"My hope is once people see the reverse--that is, home prices rising--that we will have this rather large inventory of potential buyers leap in," he adds. The new thinking may be this: "You don't want to be foolish and hop in when prices are falling, but you don't want to be foolish and miss the bottom."

If that change in psychology occurs, Feldstein contends, it "could cause a fairly significant turnaround in home sales."

Feldstein is not alone in his expectation that home sales will continue to rise. Moody's, for example, is predicting 6.3 million home sales for 2010, up from 5.5 million last year. Chen at Moody's estimates that the impact of the extended and expanded tax credit will be less than 500,000 home sales out of the 6.3 million.

"We do expect that the improving job market conditions will help to increase sales in the second half of the year" after the tax credit ends, Chen says. "As buyers believe the housing market has come to a bottom, they will be encouraged to come in and purchase homes." 

Moody's is projecting real GDP growth of 2 percent for 2010. "Jobs will be created by the third and fourth quarter," Chen says, "But even then, [the job creation will be] fairly weak." Enough, however, to have "a positive psychological impact on consumers," she adds.

Where are prices headed?

Even though sales are picking up, home prices will continue to fall, according to Moody's Chen explains that "while the numbers have been stable in the last several months, much of this is due to the fact foreclosures sales have declined as a percentage of total sales."

Foreclosures have been kept off the market because many of the loans are in the trial period for loan modifications in the Home Affordable Modification Program (HAMP). Borrowers in the program have temporary modifications that become permanent only if participating homeowners continue to make their mortgage payments on time and provide necessary documentation. "Very few loans are making it through to a permanent modification," Chen notes. "As they go through the program, they will have a tendency to fail," she adds. They will then come onto the market and depress home prices, she predicts.

Moody's is also predicting a double-dip in home prices, partly as a result of loans failing and coming out of the loan-modification program. "We expect more foreclosures to be dumped onto the market, as those distressed loans that are in HAMP trial modifications fail to make it through to a permanent modification," says Chen. "It's likely they will be foreclosed on within the next several quarters. As those loans end up on the market, they will depress the market."

Rising delinquency numbers tend to back up Moody's's views on future higher foreclosures. For example, FHA, previously boasting better delinquency rates, reported in February that the share of borrowers who are delinquent on loans backed by FHA insurance rose from 6.5 percent in 2008 to 9.1 percent in 2009.

The Fed's exit from TALF

At the end of March, the Federal Reserve's $1.2 trillion program to purchase mortgage-backed securities (MBS) under the Term Asset-Backed Securities Loan Facility (TALF) comes to an end. The worry is that with the end of the Fed's very active role in the market, mortgage interest rates will rise, putting a damper on home sales.

Fannie Mae's Duncan thinks, however, that any impact from the end of TALF should be modest. "The general consensus--and our view from a forecast perspective--is that there may well be an incremental but not dramatic increase in [mortgage interest] rates," Duncan says. Any increase in rates will curtail refinance activity, he adds.

Before the mortgage meltdown in 2007, 30-year mortgage paper tended to trade between 100 to 125 basis points above the 10-year Treasury note. Recently, the mortgage rate has traded at 75 basis points above the 10-year note. Roger Lehman, a mortgage analyst at Bank of America Merrill Lynch, expects that spread to widen by another 20 to 30 basis points to somewhere between 95 and 105 basis points.

Currently Fannie Mae is forecasting that mortgage refinancings, will account for 60 percent of its forecast $347 billion in mortgage originations in the first quarter of 2010. In the second quarter, refis will fall to 38 percent of a forecast $369 billion in originations. A rise in home purchase mortgages in the second quarter to $228 billion from $138 billion in the first quarter will more than offset the decline in refis.

Fannie Mae forecasts that overall mortgage originations will fall modestly in the second half of 2010. In the third quarter, the agency forecasts $332 billion in total originations, with $214 billion in home purchase mortgages and $118 billion in refis. In the fourth quarter, origination volume will slow to $305 billion, according to Fannie projections, with $188 billion in home purchase mortgages and $117 billion in refis.

With any luck, 2010 could a strong year for the home purchase market--one where the need for a homebuyer tax credit will, by midyear, no longer be necessary. 



Rooting Out Fraud

A review of some of the tax returns for taxpayers filing claims for the first version of the tax credit turned up a number of cases of fraud, according to J. Russell George, Treasury Inspector General for Tax Administration (TIGTA). George's office was mandated to oversee the Internal Revenue Service's (IRS') efforts in monitoring the claims to prevent fraud, waste, error and abuse. The credit is claimed using IRS Form 5405, First-Time Homebuyer Credit.

George revealed the existence of the fraud in his testimony before the House Subcommittee on Oversight on Oct. 9, 2009, when he reported that the IRS had, as of Oct. 9, 2009, processed 1.2 million tax returns claiming $8.5 billion in the first-time homebuyer credits for the 2008 tax year.

The total in processed claims falls short of the $13.6 billion allocated for the credit in the original 2008 legislation. The Joint Committee on Taxation has estimated that an additional $4.3 billion (above and beyond the $8.5 billion reported by George) will be paid to first-time homebuyers for additional claims. Thus, the projected overall claims were estimated to be $12.8 billion before the tax credit was extended and expanded into its current version.

The inspector general's finding of the existence of fraudulent claims clouds any analysis of the economic impact of the tax credit on the housing market. In its review of 2008 filings, for example, the inspector general found 19,300 electronically filed returns in which taxpayers claimed the credit for a home which had not yet been purchased--"but allegedly would be in the future," George stated in his prepared testimony last October. This represented $139 million in claims.

Following up on this initial problem, the IRS took steps to reject claims electronically that were filed with a future purchase date on Form 5405. George reported that the IRS has not decided what to do about the earlier 19,300 claims with a future home purchase date or whether or not the IRS would review the paper filings for the same period for claims involving future home purchase dates.

The inspector general also developed a computer program to identify taxpayers who did, in fact, claim homeownership in the prior three years, which would make them ineligible for the first-time homebuyer credit. In this review, the inspector general found nearly 74,000 claims by June 25, 2009, that were claimed by taxpayers for whom there were indications of prior homeownership within the past three years. This represents more than $500 million in questionable claims, including some filed by IRS employees, according to George. The evidence of prior homeownership came from prior federal income tax filings by those claiming the credit.

The IRS has taken steps to weed out recent prior homeowners from those who filed claims for the credit. Under a new approach, once the program identifies a claim, payment is frozen until the IRS can review each individual case. The IRS reported that by May 24, 2009, it had prevented payment of $75 million in claims from 10,000 filers who had evidence of prior homeownership.

The inspector general, however, identified 70,000 questionable claims totaling $480 million before the IRS initiated its new claims review system. Of those suspicious claims, 12,000 had claimed the Residential Energy Credit on at least one of their prior three annual tax returns. The inspector general recommended that the IRS take steps to recover the homebuyer credit from taxpayers who previously had claimed the energy credit, plus those who had claimed the District of Columbia's First-Time Homebuyer Credit or the Mortgage Interest Credit.

Other findings of the inspector general generated embarrassing headlines and press stories for the IRS. For instance, there were 580 taxpayers younger than 18, including one 4-year-old, who claimed nearly $4 million in credits. The inspector general recommended the IRS add age as a screener to claims for the credit, and the IRS complied with the request.

The inspector general also identified 3,200 taxpayers who used Individual Taxpayer Identification Numbers (ITIN) instead of Social Security numbers (SSNs), representing $20.8 million in claims for the homebuyer tax credit. Filers with ITINs are not authorized to live or work in the United States and, according to the inspector general, resident aliens account for 93 percent the total number of ITINs issued.

If one totals all the known fraudulent claims identified by the inspector general, they represent $1.14 billion and may be only a portion of the actual fraud that has occurred. Thus, at a minimum, 13 percent represents potential fraud--enough to affect any assessment of the economic impact of the tax credit.

To deter fraud, Congress, when it extended and expanded the tax credit in November, added documentation requirements to those who file for the claim. The IRS has a new revised Form 5405 and will require that those who file for the homebuyer tax credit file a paper return (and not file electronically), and include specific documents tailored to certain kinds of purchases.

The IRS has set out the filing instruction for existing-home owners who purchase a new principal residence. To qualify, taxpayers must show they lived in their old homes for five consecutive years during an eight-year period prior to the purchase date of the new home. To avoid refund delays, the IRS is encouraging filers to attach one or more of the following:

* Form 1098 Mortgage Interest Statement, or substitute mortgage interest statements;
* Property tax records; or
* Homeowner's insurance records.

The IRS has estimated it will take four to eight weeks for those who file for the refund to receive payment.




Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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