Monday, August 18, 2008

Beware the $7,500 'tax credit'

The housing rescue credit may prod some new homebuyers. But the money must be repaid, and the program probably won't be enough to jump start housing market.

By Les Christie, CNNMoney.com staff writer
Last Updated: August 18, 2008: 1:27 PM EDT

NEW YORK (CNNMoney.com) -- Washington policy makers and housing industry insiders hope a new tax credit for first-time home buyers will get the moribund housing market moving again.

But most analysts agree that the program is more of a band-aid than a cure-all for the battered real estate market. What's more, others are quick to point out that the credit must be repaid, which means it's actually an interest-free loan that could get some homeowners in trouble.

"It's one of those things that are more complicated than it seems at first blush, said Allen Fishbein, director of housing and credit policy for the Consumer Federation of America. "Consumers have to make sure they understand the credit thoroughly.

The $7,500 credit is for people buying their first homes, and was passed as part of the Housing and Economic Recovery Act of 2008 and signed into law in July. To qualify for the full $7,500, individuals must earn less than $75,000 annually, while couples may earn up to $150,000. Buyers with income of between $95,000 and $170,000 are eligible for a partial credit.

The Senate Finance Committee estimates that about 1.6 million people will use the credit.

The housing industry pushed for the program. "Breaking the log jam of unsold homes is something we are very much behind," said Richard Dugas, president of builder Pulte Homes, at a news conference to discuss the program. First time home buyers represented about 20% of the market for new homes in 2007.

Realtors are also behind the credit. "[It] will help chip away at inventory levels, stabilize prices and spur [sales] activity," said Richard A. Smith, CEO of Realogy, the parent company of both Coldwell Banker and Century 21.

The industry has had success with tax credits in the past. In 1975, Congress passed a $2,000 credit for home buyers (about $8,200 in today's dollars).

"Buyers flocked to market and cleared out a then-record inventory of homes," said NAHB president Sandy Dunn. But that credit did not have to be repaid.

And the impact should extend beyond first time home buyers, according to Lawrence Yun, chief economist for the National Association of Realtors. A boost in demand for starter homes means that those sellers will be able to trade up to bigger, more expensive places, and so on up the chain.

How it works
Buyers who have not owned a home in the past three years can take a tax credit worth 10% of a home's sale price, up to $7,500, whichever is smaller.

The credit is good for homes closed on after April 9, 2008 and before July 1, 2009, and can be taken on taxes filed during 2008 or 2009. Even buyers who bought a home before the bill passed, but after April 9, can claim the credit.

Unlike tax deductions, which only offset taxes by lowering taxable income, the tax credit is a straight dollar-for-dollar deduction of your tax bill. So a buyer who would ordinarily pay $8,000 in taxes would pay just $500.

It's also "refundable," which means if a buyer's taxes are less than $7,500, the government will send them a check for the difference. For example, if a couple's income generates a tax bill of $5,000, the government will refund all of that plus $2,500.

Buyers must to start paying back the loan within two years, at a rate of no more than $500 a year for 15 years. When the the home is sold, any outstanding balance will be repaid from the profit; if it's sold at a loss and the difference will be forgiven.

And some argue that mortgage lenders will take the credit into consideration, making it easier for buyers to get a loan.

"[The $7,500 reserve] will make borrowers less likely to fall into default," said Ken Goldstein, an economist with the Conference Board, since it gives them a nest egg should they run into trouble. Still, that assumes that buyers will sock the $7,500 away rather than spend it.

No cure
Indeed, the credit comes with plenty of caveats from economists and industry analysts.

"It's not going to provide first-time home buyers with cash up front," said the Consumer Federation of America's Allen Fishbein. "You have to apply to get the credit after the fact. There's a delay before you get the financial advantage."

And there are concerns that borrowers may treat the credit as a windfall, spending it as if it doesn't have to be repaid.

"It may appear to be free money," said Fishbein. "Consumers have to have their eyes open about how this works."

Other economists caution that while the credit may be helpful, it's hardly a solution to the crisis.

"It will not turn things around," said Jared Bernstein, an economist with the Economic Policy Institute. "Given the economy, it will only push a precious few first-time home buyers over the edge right now."

Plummeting home prices will blunt any impact that the credit may have, according to Nicholas Retsinas, director of the Harvard University's Joint Center for Housing Studies. As far as he's concerned, the market is simply too soft right now for a modest measure like this to make a big difference.

"The challenge right now is as much willingness to buy as affordability," he said. "The market still has this psychological barrier because people think prices will be lower tomorrow. I don't think this can overcome that barrier."

First Published: August 18, 2008: 11:08 AM EDT
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Wednesday, August 13, 2008

25% of home sales result in loss

Values have fallen so far in many cities that sale prices don't cover what sellers originally paid. That means more hard times before markets recover.
By Les Christie, CNNMoney.com staff writer
Last Updated: August 13, 2008: 1:38 PM EDT
NEW YORK (CNNMoney.com) -- More homeowners than ever are selling at a loss, propelling the real estate market deeper into crisis.

In the 12 months that ended June 30, nearly 25% of all homes sold nationwide fetched less than sellers originally paid, according to real estate Web site Zillow.com.

While the nation's double-digit decline in home prices has been well documented, the new report underscores the economic force of those price declines. Homeowners are walking away with much less in their pocket when they sell. And that affects more than the real estate market.

"It's stunning what's happening out there," said Stan Humphries, Zillow's vice president of data and analytics, who looked at statistics that date back to 1996. "The numbers are the worst we've seen and it's not just the magnitude of the problem but the scope - so many markets are affected."

In Merced, Calif., 63% of homes sold during the past 12 months brought in less than what the owner paid. Prices there have fallen 40% over the past 12 months and 56% from their 2006 peak.

About 63% of sellers in Stockton, Calif., lost money during the same period, 60% in Modesto, Calif., 55% in Las Vegas and 38% in Phoenix.

And the trend has worsened in recent months. In Merced, 74.9% of sellers took a loss when they sold during the three months ended June 30 compared with just 28.7% during the same period in 2007.

The experience of one would-be seller in Cape Coral, Fla., illustrates the kinds of losses sellers are suffering. The homeowner, who asked not to be named, paid $147,000 in 2003 for a three-bed, two-bath ranch. Prices have dropped there more than 22% in the past 12 months.

He said he made a 10% downpayment spent big on upgrades, including two renovated baths. The house was appraised at $279,000 two years ago. Two months ago: $140,000. He has been trying to sell it for more than a year and has dropped the price to $129,900.

"It's terrible," he said. "I'm taking a major loss. I'll probably have to bring a check to the closing."

The short-sale solution
Many sellers are so underwater that their only solution is a short sale. Elsa Bell, a claims adjuster, bought her Riverside, Calif., house in 2006 for $330,000, using a no-down-payment loan. In April she put the house on the market for $275,000, but it hasn't sold.

"The bank is willing to do a short sale, and we have an offer of $170,000 on the house, but we believe the bank will turn that down," Bell said.

A short sale is when a lender agrees to take less than the amount it is owed on a mortgage and forgives the remaining debt.

For Bell, whatever the sale brings, it's going to be a lot less than what she paid.

The good news is that she should get out of the deal fairly clean. Since she has little invested, she has little to lose. The bad news is that a short sale may mean a hit to her credit score.

Nationwide, nearly a third of all homeowners who bought since 2003 owe more on their homes than the homes are worth. And those that, like Bell, put little or none of their own money into the home purchases, are more likely to try to sell short or simply abandon their homes.

"They hand over their keys and walk away from the homes," says Danielle Babb, a real estate investor, instructor at the University of California Irvine and author of "Finding Foreclosures."

That adds to foreclosure rates. Zillow reported that nearly 15% of U.S. existing home sales during the last 12 months involved foreclosed homes.

That trend will almost surely continue.

In Stockton, Calif., 2006 buyers now owe a median of nearly $171,000 more than their homes are worth. In Salinas, Calif., 2006 buyers now have median negative equity of $161,000, and in Merced, the figure is nearly $160,000.

Broader impact
A plethora of sellers taking losses can have a chilling effect on people's lives, says Dean Baker, co-director of the Center for Economic and Policy Research in Washington.

People don't want to sell at a loss, so they put off their plans, whether it's a move for a better job opportunity elsewhere or trading up to a larger home.

"That will delay the [market correction]," said Baker. "It takes time for people to recognize that [these losses] are real."

A quick turnaround is not likely. More than $200 billion in adjustable rate mortgages are scheduled to reset during the second half of 2008, according to the National Association of Realtors, and loans of all types defaulting at high rates. There is also about 11 months of inventory at the current rate of sales.

"With $3.9 million unsold homes on the market, prices will have to come down even more before the market stabilizes," said Zillow's Humphries.

First Published: August 13, 2008: 1:00 PM EDT

Tuesday, August 12, 2008

The next wave of mortgage defaults

More borrowers with good credit are defaulting on their home loans, and that's going to make it even harder for the staggering housing market to recover.
By Les Christie, CNNMoney.com staff writer
Last Updated: August 12, 2008: 8:06 AM EDT
NEW YORK (CNNMoney.com ) -- Prime mortgages are starting to default at disturbingly high rates - a development that threatens to slow any potential housing recovery.

The delinquency rate for prime mortgages worth less than $417,000 was 2.44% in May, compared with 1.38% a year earlier, according to LoanPerformance, a unit of First American (FAF, Fortune 500) CoreLogicthat compiles and analyzes residential mortgage statistics.

Delinquencies jumped even more for prime loans of more than $417,000, so-called jumbo loans. They rose to 4.03% of outstanding loans in May, compared with 1.11% a year earlier.

And prime loans issued in early 2007 are performing the worst of all, failing at a rate nearly triple that of prime loans issued in 2006, according to LoanPerformance.

"The extent of how bad these loans are doing is very troubling," said Pat Newport, real estate economist with Global Insight, a forecasting firm.

Washington Mutual (WM, Fortune 500) CEO Kerry Killinger said last month that the bank's prime loan delinquencies are on the rise. As of June 30, 2.19% of the prime loans issued by WaMu in 2007 were already delinquent, compared with 1.40% of prime loans issued in 2005.

Also last month, JP Morgan Chase (JPM, Fortune 500) CEO Jaime Dimon called prime mortgage performance "terrible" and suggested that losses connected to prime may triple. For the second quarter, the bank reported net charges of $104 million for prime rate delinquencies, more than double the $50 million recorded three months earlier.

The latest shoe
Prime loans are just the latest class of mortgages to suffer a spike in failure rates. The first lot to go bad was, of course, subprime mortgages, whose problems set the housing meltdown in motion. Next were the Alt-A loans, a class between prime and subprime loans that doesn't require strict documentation of a borrower's assets or income.

Now, as prime loans are added to the mix, the resulting foreclosures could haunt the housing market for a long time, according to Global Insight's Patrick Newport.

"Home prices will drop for quite a while - maybe several years," he said.

Prices are already off nearly 20% from their 2006 highs, according to the S&P/Case-Shiller Home Price index.

And there's a strong inverse correlation between home prices and defaults, according to Lawrence Yun, chief economist for the National Association of Realtors.

"It's a feedback loop," he said. "Price declines lead to more defaults, which leads to more price declines."

More foreclosures will add to an already massive oversupply of homes on the market. Inventories are up to about 11 month's worth of sales at the current rate.

Indeed, about 2.8% of all homes for sale were vacant as of June 30, according to Census Bureau statistics. That's up about 50% from three years ago, and near historic highs.

More foreclosures, fewer loans
The failure of prime mortgages will also make it more difficult for new borrowers to find affordable loans - and that will slow sales even more. Lending standards have been tightening for months, but if prime loans start to look risky, lenders will be even more conservative about who gets a mortgage.

About 60% of the loan officers surveyed reported that they tightened lending standards for prime mortgages during the first three months of 2008, according to the April 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices from the Federal Reserve, which is released quarterly.

That number will likely be even higher for the second quarter, according to Mike Larson, a real estate analyst for Weiss Research. "It's already harder and more expensive to get loans," he said. "Lenders pull in their horns when things go south."

While easy credit fueled the housing boom, restricted credit is certainly contributing to the bust.

"Eventually," said Newport, "time will break the cycle. Pricing will drop enough to attract more buyers, and inventories will decline."

But there will probably more hard times ahead before markets come back into balance and recovery begins.

First Published: August 12, 2008: 4:08 AM EDT