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September 14th, 2010

Homebuyer tax credit: Third time’s the charm?

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According to the most recent numbers, since it was first introduced in 2008, the homebuyer tax credit helped 3.3 million homeowners and cost the country $23.5 billion.

After President Obama extended the closing deadline to the second portion of the homebuyer tax credit back on July 2, 2010, most of us thought that was it for the credit. However, the homebuyer tax credit has been back in the news ever since HUD Secretary Shaun Donovan failed to give a reporter a straight answer when asked whether the administration was considering a third tax credit.

Yet while the tax credit may be in the news again, the general consensus — coming from sources as diverse as writers to home builders and realtors — is that it shouldn’t come back.

There can be no doubt that the on-again, off-again nature of the various homebuyer tax incentives has created tremendous distortions in the housing and mortgage markets. These offers have caused spikes in sales activity which has distorted the true level of demand in the market. Without the tax credits, the home sales activity — while much less pronounced — would have produced a smoother, more wave-like pattern as opposed to the surges and drop offs that the tax credits produced.

Maybe we need another tax credit

So while even those who championed the hardest for these homebuying incentives to begin with no longer think they have a place in the market, we wonder the opposite — maybe we need another tax credit.

Given the fact that the credits have disturbed the market to such a great degree, and twice nonetheless, would a third credit produce better results than the first two?

If we hadn’t already distorted the natural function of the market so greatly (and twice), the answer would probably be no. While there is little doubt that there have been some benefits, the resounding criticism is that the tax credits probably only incentivized borrowers who would have bought anyway, tax credit or not. Still, having gone to this well twice already, and with the market still in such difficult shape, the answer is probably a reluctant “yes”.

Why the first two credits failed

If the objective of the tax credit was to spur demand and help smooth out weak and rough spots in the market, it failed. We suspect that this “failure” was due more to the structure of the offers than anything else. Each homebuyer tax credit had a “hard expiry” date — a date at some point in the future when then the credit would definitively end. Each go round, this caused a mad rush of borrowers to take advantage before these arbitrary deadlines came and went. The pattern of demand both times was slight at the beginning and strongest towards the expiration.

While the tax incentives have been beneficial, it is the way they have been structured which has produced this mini “boom and bust cycle” for sales… and isn’t that what we’re trying to overcome? Because of the nature of the programs, the market is again in a very precarious position, where sales have collapsed, inventories are again rising fast and downward pressures on home prices are forming anew.

Time for something different

If the tax credit does get resurrected for a third time, we’re proposing that it be structured quite differently. Furthermore, we believe that if all the prior tax credits were structured in this fashion that the pattern of demand would have been more even and promoted more predictable behavior by homebuyers.

We think the tax credit should be structured so as to prompt more immediate demand but fade over time as the natural forces of economic recovery take hold. As this occurs, the market will need less support to become self-sustaining, and there won’t be a mad rush of demand, thus distortion, at the end of the offer, leaving a “market hangover” in its wake.

A newly constructed tax credit concept

A newly constructed credit which seeks to foster immediate market support — producing more sales early in the offer, rather than at the deadline — would arguably have greater benefit for the market as a whole.

A concept might work like this: A year-long tax credit offer, which starts at $12,000 and falls by $1,000 per month until it naturally ends a year down the road. Given the extraordinarily weak sales environment at present, it is likely that some — but relatively few — borrowers will want or be able to take immediate advantage, so the actual cost to the government might be minimal. By the time month 11 is reached, the credit is only worth $2,000, so to the advantage of rushing to get a deal in under the deadline would be slight, and the program would come to a soft end without the huge distortion in demand we have seen from the past two credit expiries.

We believe that it would have been better if Congress had never messed with the housing market in the first place, but since they’ve already gone down this road, the dynamics of housing demand remain distorted. Despite the first two offers, the market remains a mess, and the economy has not yet recovered to a point where natural forces produce demand for homes. Do we need another homebuyer tax credit? Unfortunately, yes, but perhaps one which produces less distortion and damage to future housing demand.

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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