Who Cares If I Miss Out On The Tax Credit?

Many people who are looking to buy a home now, NEED the Tax Credit to close a gap in their finances.  But not everyone feels that way.

As the days tick away, I have started to hear some buyers already begin rationalizing why they haven’t yet gone to contract.  They say things like, “$8000 isn’t enough money to rush me into buying a home”.  I am not sure they are right (especially as you see interest rates on the rise at the same time), but I do know that for people who “discount” the impact of $8000 need to open up their minds to some “out of the box” thoughts.

Here’s one thought process:  If a customer had sufficient monies to close and cash reserves in the bank after closing such that they didn’t NEED the $8000, as they contend, I would propose to those clients… this strategy.  Pay $8000 in additional  Discount Points on your mortgage!  You see, by doing this our buyers gain two benefits:

First, as I am sure we all know, Discount Points are tax deductible as prepaid interest on the mortgage.  That means our Buyer (assuming a 28% top Income Tax Bracket) will receive a $2240.00 higher tax refund next year…..that’s good!

Second, by paying 2 points on a $400,000 mortgage (cost $8000), our borrower is likely to receive approximately a .50% lower interest rate on their mortgage.  Over the course of the first five years of homeownership, they would save nearly an additional $8000 in monthly mortgage payments…that also is good!

Or, How About This?  By paying the points for a lower rate, you would reduce your Principal & Interest Payment about $132/month on your $400,000 loan.  If you were comfortable with your original payment, you could actually borrow an additional $20-25,000 for the same payment.  That’s $20-25,000 that you could put into a 203K loan to finance home improvements OR it’s buying the bigger house OR buying in a better part of town….for the same payment you were willing to accept without the tax credit.

Here’s another:  $8000 is enough money for a skylight, a living room set, a large Jacuzzi/hot tub, a deck, an awesome barbecue, an above ground pool, a plasma television or one of dozens of other cool things you might want to add to your new home.  Or maybe, it’s the money for a vacation or a top notch House Warming Party.  Whatever you spend it on, it’s basically a FREE GIFT from Uncle Sam.  How many great moments or memories can you “buy” with this gift of $8000?

One more:  $8000 untouched in a conservative investment (like Savings Bonds) at 6% would compound to more than $25,000 in 20 years to help pay for college, a wedding or a car.  In 30 years, when you retire, it would blossom to more than $46,000!  That’s a lot of trinkets for your grandchildren. 

Remember, this is money you didn’t need.  This is money that didn’t provide sufficient incentive to force you to BUY NOW.   Don’t be silly, take the money and enjoy it!  Save monthly, improve your home, improve your lifestyle, or improve your future.  Any way you look at it, $8000 can go a long way.

This past weekend, I saw a decent movie…Hot Tub Time Machine and one of the running themes in the movie reminded me of the shift in the bond market last week (and what our immediate future looks like).   Without giving away the whole movie, I want to explain….

In the movie Crispin Glover plays a bellhop at a ski resort.  When we are introduced to him, it is 2010 and he has lost his right arm.  As the story unfolds, the main characters go back in time to 1986 to the same ski resort.  Here we see our bellhop with both limbs fully functional.  There are numerous episodes with chainsaws and nasty elevators that put the bellhop’s limb in danger.  Because we know the eventual result, each time we have a heightened anticipation (as do the time travelers in the movie) that “this is the moment when it happens”.  Then, it doesn’t happen.  We almost feel disappointed, but then things ease back to normal.

I see that as a metaphor for the bond market today.  We all KNOW rates are going up….and up significantly (just as surely as our bellhop will lose his limb).  This space has given all the WHYs for months (end of the Fed’s MBS Purchase Program and inflation being the main culprits).  The real questions now center around “WHEN will it happen?” and “HOW DRAMATIC will the movements be?”

With the uncertainty of WHEN and HOW DRAMATIC, we enter the world of bond trading.  In their world, every day, every hour, heck every minute is a gamble.  If rates move up OR down with any significance, millions of dollars can be made or lost.  Understand that MBSs have a fixed rate of return (weighing in many factors like interest rates, loan types, length of the loans, insured or not, and so on).   When rates go up, we know future MBSs will have more value because the yield will be higher, right?  That forces the price, that current MBSs can be sold for, lower (because the yields are less attractive).

Back to being a bond trader, in this environment, you are sitting on the trading floor pumped with caffeine (or worse), wondering when will be the exact moment when the market is going to collapse around you.  You stand with your finger on the trigger, looking for any crack in the foundation, any news that can give you an advantage on when to buy or sell.  You live in a state of heightened anxiety.  You wonder what happens on April 1^st (after the Fed exits).  You wonder about every economic report that could hint at inflation rising (jobs, CPI, PPI, PCE, and more).

Then, another trader sells more than normal.  You panic.  “What did I miss?”  But in this microwave world, you know taking the time to figure out what happened can leave you holding the bag.  So, what do you do?  You start selling too.  Then, someone else gets on the bandwagon.  Suddenly, prices are collapsing (rates are climbing dramatically), not based on any real data, but because the momentum of fear has started an avalanche.  Such is the way in a world of heightened anticipation and instantaneous access to information.  But then, the next day, after the dust settles, all the traders see that they overreacted and prices begin to slowly climb back to where they should be.

We saw it all happen last Wednesday afternoon.  With weaker than expected Treasury Auction results (added to the already unstable environment), we saw a selling frenzy (bond prices falling 87.5 basis points).  On Thursday, pricing continued to tumble early, but then recovered and finished flat for the day.  Friday and Monday saw modest gains, gaining back almost 40% of what had been lost.

My friends, as the Fed exits, we return to the frightened landscape that existed when the Fed began their aggressive purchases of MBSs.  In a scared market, rates will shoot up quickly (because of the fear of losing too much) and decline slowly (for fear of it not being sustainable).  We are in a “lock your rate if you like it” mode.  Don’t gamble on getting lower rates because the 1/8% you may gain, isn’t worth the risk of the ½% you could lose.  Volatility is the enemy of predictability because volatility is driven by emotion…..and emotion in business can cost you and arm when you least expect it.

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Nail 1- The end of the First Time Homebuyer Tax Credit.  While there is some debate on how big an impact the Tax Credit has had, there can be no debate on how its elimination (when combined with the other two nails) appears devastating to continuing the momentum.

Nail 2- The slowing, and eventual end, to the Federal Government’s purchase of Mortgage Backed Securities.  In 2008, 99% of all loans sold in the Secondary Market were bought by Uncle Sam.  When he moves to the sidelines on March 31, rates will climb swiftly.  It’s the only way to attract other buyers of MBSs back into the market.  Bottom line mortgage rates 1-1.5% higher than most buyers have become used to……and home sellers reluctant (or financially unable) to reduce prices 10-15% further to compensate.

Can anyone else see the faucet being turned off?

Today, we add the third nail.  Basically to lessen defaults on FHA loans (which have constituted more than 50% of the loans closed in some markets), guidelines are being tightened….even though we don’t have a definitive date for it yet.

1. Lower FICO scores (below 580) will now require a 10% down payment….a significant jump from the current 3.5% down payment.
2. The Up Front Mortgage Insurance Premium is being raised from 1.75% to 2.25%.  While this amount can be financed into the loan, it still raises the cost of home buying.
3. The allowable seller’s concession (by which sellers have been able to pay closing costs on behalf of their purchaser) has been slashed from 6% to 3%.

While I understand requiring more cash in the deal for people who have not demonstrated good credit histories and raising the insurance costs to defray losses, I personally do not believe in reducing the allowable seller’s concession.  I acknowledge that by having more of the buyer’s money in the deal may make them more likely to fight to stay in the home, rather than walk away, I cannot believe that that potential benefit outweighs the number of people who will be forced to continue to rent because they cannot save up an additional 3%.  Taking buyers who would qualify for financing based on their income and credit, and keeping them in apartments when the market so desperately needs them to buy NOW doesn’t make sense to me.

Regardless, we need to adjust to the landscape.  Buyers who were even debating buying need to find a home, get into contract and apply for a mortgage today….waiting even for April 30 could be disastrous.  Home sellers need to price their homes to sell TODAY and not “wait for spring”.  At this point, I can see a first-time buyer who waits until May losing the $8000 tax credit, having to need 3% more cash, and paying a 1% higher rate……my advice, don’t look back with regret.  ACT and celebrate your decisiveness.