Taking Advantage of the 2009 First-Home Buyer Credit

The $787 billion stimulus bill that President Barack Obama signed into law in February 2009 includes an $8,000 first-time home buyer tax credit. This is an expansion of a 2008 incentive that was essentially an interest-free loan.

This subsidy is just one of many steps the government is taking to revive the housing market, with the most important being its attempt to lower mortgage interest rates. The government is also refinancing mortgages held by Fannie Mae and Freddie Mac that are under water (the outstanding balances exceeds the value of the home). And the FHA (Federal Housing Administration) is guaranteeing mortgages of low-income home purchasers who meet certain criteria. The FHA, which was established in 1934 to rescue the housing industry, details these opportunities on its website).

Is the $8,000 tax credit a big deal for those eligible to receive it? Well, lets run Anna, whose characteristics are outlined below, through ESPlanner and find out.

Basic Profile:

  • Age: 30 years old
  • No children
  • Location: Illinois
  • Housing: Currently 1200.00 per month rent; she wants to put 6% down on a 125K purchase.
  • Income: $70,000
  • Retirement Assets: 10K in 401(k)
  • 401(k) contributions: 8K, plus 4K from employer
  • Annual Roth Contribution: $1,900
  • Inflation: 3%
  • Nominal return on regular assets: 5%
  • Nominal return on retirement assets: 6%
  • Illinois Tax Tables

All questions of personal finance boil down to the impact of choices on one's living standard. ESPlanner calculates users' lifetime living standards, which is defined as discretionary spending per household member adjusted for economies in shared living (two can live more cheaply than one) and the fact that children require less spending to achieve a given living standard than do adults.

In Anna's case, her current sustainable annual living standard is $30,310. This is the amount she can spend each year, measured in today's dollars, over and above paying rent, paying taxes, contributing to her retirement account, and paying premiums to Medicare Part B during retirement. This living standard is steady throughout her life because of ESPlanner's "consumption smoothing" approach.

If Anna purchases a $125,000 home with a 6 percent downpayment (FHA backs a 30-year fixed loan for as low as 3.5% down) she'll end up with an annual living standard increase of 11.5 percent in the first year and that living standard would rise several percentage points each year until it finally levels off at a 35 percent annual advantage over renting when the loan is paid off at age 60.

This terrific increase in Anna's living standard is due only in small part to the one time $8,000 home purchase tax credit. The real magic comes from Anna buying a modest home and being able, thereby, to lower her lifetime housing costs. There are also tax advantages from owning one's own home. The main advantage is not, however, what everyone thinks, namely the deductibility of mortgage interest, but rather it's not having to include as taxable income the housing services from one's home. Indeed, if you can swing it, it's generally a good move to pay down or pay off your mortgage.

So what's been stopping Anna from buying a home? Well, the days of "no money down" loans and other forms of irresponsible lending are over. Even using an FHA insured loan, Anna needs money for a downpayment. Six percent down on a $125,000 purchase is $7,500. If she had to reduce her current spending to come up with $7,500, she'd experience a 26.6 percent one-year drop in her living standard. In other words, $7,500 down is no small sum for Anna. If, however, she uses the stimulus money, she covers her down payment and experiences no drop in living standard in the first year.

By the way, Anna is allowed to file an amended return and receive her $8K as soon as the IRS processes her return. She can also solve the short-term cash flow problem by borrowing $8K from her 401(k) until the IRS processes her amended return. Of course she'll want to return this money to her 401(k) as soon as she receives her stimulus money six weeks after she files the return.

The chart below compares the three living standards: renting, purchase with the stimulus money, and purchase without the stimulus money.

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