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UPDATE: FHA Policy On Tax Credit More Limited Than Expected

(Updates with comment from National Council of State Housing Agencies in 19th and 20th paragraphs.)

By Jessica Holzer and Dawn Wotapka

Of DOW JONES NEWSWIRES

WASHINGTON -(Dow Jones)- U.S. housing officials rolled out the details of a plan to allow borrowers who use Federal Housing Administration financing to apply a federal home buyer tax credit toward a home purchase.

The new policy is the latest in a string of moves by the administration to spur demand in the housing market. But the details announced Friday suggest it won't have the impact that realtors, home builders and housing analysts had first anticipated.

Under the guidelines, most borrowers won't be able to use the funds from the tax credit to meet the minimum 3.5% down payment required for an FHA loan. Rather, they can apply the money toward closing costs, other upfront charges or increasing the size of their down payment above 3.5%.

"One of the primary hindrances for a lot of would-be buyers, especially if they're entry-level buyers that are looking to be home owners, is coming up with a down payment. It doesn't erase that," Brent Anderson, vice president of investor relations for home builder Meritage Homes Corp. (MTH), said.

Anderson pointed out that closing costs can often be paid by the seller. "The down payment is a bigger assistance," he said.

Through Dec. 1, qualified first-time home buyers are entitled to a federal tax credit under economic-stimulus legislation passed into law earlier this year. The credit amounts to 10% of the purchase price of the dwelling, or $8,000, whichever is smaller.

But the tax credit can only be claimed by filing a form with the IRS once the home has been purchased. A slew of states - including Colorado, Idaho, Missouri, New Jersey and Ohio - quickly launched programs to allow people to "monetize" the tax credit, by advancing money to qualified borrowers so that they can apply the funds from the tax credit toward a home purchase.

HUD's announcement earlier this month that it intended to allow FHA borrowers to do something similar was met with great fanfare from the home-building and real-estate industries. But some analysts argued the policy could harm borrowers and taxpayers, citing the higher default rates of no-money-down loans popularized during the housing boom.

Buyers Will Have Skin In The Game

HUD on Friday said amounts advanced by FHA lenders cannot be used to meet FHA's minimum 3.5% down payment due to a law barring such lenders from assisting borrowers with their down payments. FHA borrowers may use the money to increase the size of their down payment above the 3.5% minimum, to pay closing costs, any upfront interest charges or FHA's upfront premium.

This could help reduce monthly payments for borrowers by reducing the amount of principal and interest on the loan, a senior HUD official argued.

By contrast, state and local housing finance agencies as well as certain nonprofits aren't barred from assisting FHA borrowers with their down payment. They will be allowed to provide short-term loans to borrowers for that purpose under FHA's new policy. But most FHA borrowers obtain financing through a lender.

A senior HUD official said it was important that FHA borrowers funded their own minimum down payment "because we want the home buyer always to have skin in the game."

Some housing analysts agreed that it would have been unwise to change the rules so that a flood of FHA borrowers could rely on the tax-credit funds to meet FHA's requirements. As of Oct. 1, sellers were barred from funding a borrower's down payment because high default rates on such loans were taking a toll on the FHA's insurance fund.

"A hundred percent financing with no skin in the game is probably not a good solution either in the near term or the long term," Michael R. Widner, a home building industry analyst for Stifel Nicolaus, said.

New Program Draws Praise

Housing Secretary Shaun Donovan touted the new program before a conference of the National Association of Home Builders Friday, saying it would allow tens of thousands of people to purchase a home with an FHA loan. FHA loans accounted for roughly a quarter of all U.S. mortgage originations at the end of the first quarter.

"This should help make home purchase more affordable," Donovan said.

NAHB Chairman Joe Robson offered praise for the new policy in a press release. "With the spring home-buying season in full bloom, Secretary Donovan's move to enable buyers to access the tax credit at the time of closing could not have come at a better time," he said.

Mary Trupo, director of policy issues for the National Association of Realtors, also applauded the announcement. "We of course think the less restrictions, the more advantageous for a home buyer. However, keeping a 3.5% down payment does, as they're saying, give the buyer skin in the game," she said.

The FHA's new policy could spur more states to action, said Garth Rieman, director of housing advocacy and strategic initiatives for the National Council of State Housing Agencies.

"We think the FHA has gone forward with an approach that will allow low-down- payment lending by responsible state and local governmental entities, but will avoid the risks of opening up no-down-payment lending too widely," he said.

HUD unveiled several requirements to ensure lenders and borrowers don't abuse the program. For example, any fees and costs charged by the lender to advance funds from the tax credit must be reasonable. The FHA would consider fees and costs amounting to more than 2.5% of the credit amount excessive, HUD said.

FHA lenders are also required to contact the borrower's employer to confirm there are no garnishments to their wages and review tax returns to determine whether the borrower has any outstanding obligations to the IRS.

-By Jessica Holzer and Dawn Wotapka, Dow Jones Newswires; 202-862-9228; jessica.holzer@dowjones.com

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  05-29-091517ET
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