Will Homebuyer Tax Credit Bankrupt the FHA?

The Federal Housing Administration (FHA) is on shaky ground as it is. The actions of President Obama and congressional Democrats aren’t going to help matters. Robert Pozen explains in The Wall Street Journal.

A few weeks ago, President Barack Obama signed legislation extending an $8,000 tax credit for first-time home buyers. The refundable tax credit, available even if a family has no taxable income, will enable many more buyers to close on a home. But it also could bankrupt the Federal Housing Administration (FHA) and, by doing so, damage an already weak housing market.

The tax credit was put in place as part of the stimulus package signed into law earlier this year. Initially, it was available only to first-time buyers with a combined income of $150,000 or less ($75,000 for individuals). Approximately 40% of all first-time buyers used the credit in 2009, so extending it was strongly supported by real estate brokers, home builders and their congressional allies.

The extension the president signed makes the credit available to first-time buyers, but also to people who have owned a home for at least five years. In addition, it raises the maximum income for a qualified buyer to $225,000 a year for couples and makes the credit available until mid-2010. (It had been set to expire at the end of this month.)

The problem is that the FHA insures mortgages of homes below certain price levels with such a low down payment that it can be funded solely by the refundable tax credit. And, as we’ve seen in the recent housing crisis, buyers with no skin in the game are more likely than others to default on their mortgages when the value of their home falls below their mortgage balance.

Here’s how the credit allows buyers to avoid putting their own money at risk. Suppose a couple making $60,000 annually buys a home worth $200,000. They can get an FHA-insured loan if they put down 3.5% of the purchase price, about $7,000. The couple will also need to come up with another $1,000 in closing costs, for a total of $8,000. The couple can either dip into savings or borrow that money from relatives or somewhere else on a temporary basis.

After closing, the couple can quickly obtain the $8,000 refundable tax credit to pay off their temporary loan (or replenish their savings). In effect, they will have bought a home without putting any of their own money at risk. Owners who don’t sink their own money into a house are much more likely to default on the mortgage. ….

Everything they do just makes things worse. Not only will this hurt the housing market in the long run, but you and I are on the hook for these mortgages, as well as the rest of the debt they’re racking up.