- The Washington Times - Friday, November 27, 2009

The extension - and expansion - of the federal tax credit for homebuyers encourages potential first-time buyers and repeat buyers to buy property before the expiration date of May 1, 2010 (and loans must be closed by July 1, 2010). While consumers want to make the best use of this tax credit, they also need to spend time determining how much they can comfortably spend on housing costs.

Some lenders qualify buyers on strict debt-to-income ratios, which look at both the “front-end” ratio of housing costs compared with gross monthly income and the “back-end” ratio that compares all monthly debt obligations with the gross monthly income.

For some lenders, a desirable range for housing costs is about 30 percent of the gross monthly household income, while other lenders are willing to stretch those limits all the way up to 50 percent if the borrowers have significant assets.

The National Association of Realtors Housing Affordability Index tracks the median price of a single-family home and matches it with the median family income to determine how many homes in a region are affordable to local residents. The qualifying income for a median-priced home of $237,800 in the Northeast was $50,160 based on a 25 percent ratio of monthly housing expenses to gross monthly income, with an expected 20 percent down payment. (It is interesting to note that this qualifying income is the highest for all four regions.)

No matter how much a consumer may be allowed to borrow, the final decision on how much to spend on monthly housing costs should be made according to the borrowers’ comfort level and their understanding of their overall budget. The homebuyer tax credit can be an excellent source of income to replenish a savings account depleted for down payment and closing costs, but most financial experts agree it should not be used to push individuals into buying a home before they are ready.

“The homebuyer tax credit should be viewed as a great opportunity only if all other elements are in place to buy a home,” says Mark Atherton, a certified financial planner with Ticknor, Atherton and Associates in Reston. “In order to decide if you are ready to buy a home, you need to know if you have a big enough cushion in the bank and the financial and job stability to buy. Then you can look at how to best take advantage of the tax credit.”

The basics of the federal tax credit include:

A credit of up to 10 percent of the purchase price for both first-time buyers (buyers who have not owned a home as a principal residence during the previous three years) and repeat buyers (as long as they lived in one residence for five consecutive years of the past eight years). The credit is limited to $8,000 for first-time buyers and $6,500 for repeat buyers.

The price of the home must not exceed $800,000.

The tax credits are phased out for single taxpayers with a modified adjusted gross income between $125,000 and $145,000; and for married couples, a modified adjusted gross income between $225,000 and $245,000.

The home must be the principal residence of the buyers for at least the next three years, or the credit will need to be repaid.

The tax credits are refundable, which means that even if the taxpayers do not owe taxes, they can receive a check from the IRS for the balance of the credit.

“No one should buy a home just because of a tax credit,” says Marv Stanger, a certified mortgage planning specialist with Primary Residential Mortgage in Springfield. “But it can be a good thing that the tax credit gets people to talk about buying a home. The tax credit cannot help anyone qualify for a loan because it cannot be used as money upfront. It is most useful as a way to replenish an account, such as a 401K or an IRA, that the buyers have borrowed from for their down payment.”

Donna Evers, founder and president of Evers & Co. Real Estate Inc. in the District, believes the expanded tax credit may help move-up buyers even more than first-time buyers. Move-up buyers will be able to take advantage of the credit personally as well as benefit from a potential buyer using the credit.

Mr. Stanger says that another way for buyers to use the tax credit is for the inevitable spending, which comes with a new home for improvements or new furniture.

“When I work with buyers to determine how much they can afford to spend on a home, I start by asking them about their goals and then look at their income and job stability,” says Mr. Stanger. “If someone comes in with a lot of debt, they may need to change their spending habits. Even though this isn’t required on a loan application, I think it’s important to go deeper into the household budget and see if they are spending money on child care or tithing, which won’t necessarily show up on the application. They need to be comfortable with their loan now and in a few years.”

Brent Mendelson, a senior loan officer with Choice Finance Corp. in Rockville, says he begins every first encounter with potential borrowers by asking about their comfort zone for a monthly housing payment.

“If they tell me they would be comfortable paying $2,500 per month, I ask them if that includes taxes, insurance and a condo or homeowner association fee,” says Mr. Mendelson. “I can get an accurate idea of taxes and insurance and fees if they have a specific property in mind. I also ask them right away about a down payment, because sometimes people don’t realize they will need to pay mortgage insurance if they make a down payment of less than 20 percent.”

Mr. Mendelson says that the borrowers he sees now are “more conservative than ever.”

At Virginia Heritage Mortgage, a division of Virginia Heritage Bank, chief mortgage officer Richard Hutchison and his loan officers have the ability to provide a $10,000 grant to income-qualified first-time buyers.

“The tax credit and our grant, along with affordable homes and low interest rates, make this a great opportunity for first-time buyers to get into the housing market,” Mr. Hutchison says. “But we are very conservative bankers, and we think it is important that the back ratio, which includes all debt relative to gross monthly income, should not exceed 40 percent. Carrying debt above that range would make it very hard to survive after the house payment each month.”

Mr. Mendelson says that most banks are currently looking for a maximum of 45 percent overall debt to income, but some will go above that if there are strong compensating factors such as a high income, strong pattern of saving money and significant assets.

Mr. Hutchison says that first-time buyers can work with a loan insured by the Federal Housing Administration and pay just 3.5 percent of the home’s value as a down payment, using grant money from state and local programs, if they qualify, and a gift fund from relatives to purchase the home and to buy down the interest rate.

Most state and local programs require buyers to take a homebuyers’ education class, which will teach them about their finances to help them continue to afford their home.

“When we work on a loan, we look at the credit score, the back ratio of debt-to-income and proof of income and assets,” says Mr. Hutchison. “We also check that the buyers have a reserve fund of savings to cover three months of house payments.”

In the past, Mr. Hutchison says, some buyers could qualify for a loan with a credit score of less than 600, but now the minimum is usually 620 to 680 (depending on the loan program).

“Lenders are using credit scores even more than ratios to determine how large a mortgage borrowers can qualify for,” Mrs. Evers says. “Fannie Mae did a study even before the recent housing downturn that showed that individuals with very good credit scores never defaulted on a loan, regardless of the debt-to-income ratio. People with poor credit scores had a higher rate of defaulting. The study showed that the credit score was more overpowering than income or savings to determine whether someone was a good credit risk. The thinking is that people with good credit scores won’t borrow more than they can afford.”

Mr. Atherton stresses that before buying a home, consumers should consider the stability of their jobs and consider attempting to purchase based on one income.

“Realistically, not everyone can afford a mortgage on one income, but it is important to consider what will happen if one spouse is unemployed for six months or longer,” says Mr. Atherton. “I recommend that people keep six months of total expenses in an account, which is both liquid and safe, in case of an emergency.”

Mr. Atherton and other financial experts recommend locking in a 30-year fixed-rate mortgage since rates are low.

“The only reason to do an adjustable-rate mortgage is because you are stretching to qualify for a loan,” says Mr. Atherton. “It would be better to just buy a home you can really afford. It’s also better to make a 20 percent down payment if you can because you will get lower interest rates and have a cushion of equity in the home to avoid owing more than your home is worth. I recommend a 10 percent down payment at the very least to protect yourself from a temporary drop in the home’s value at a time when you might have to move.”

Mr. Stanger agrees that a larger down payment can protect buyers but recognizes that, for many first-time buyers, accumulating a down payment can be a major obstacle to buying a home.

“If everything else is in line and the buyers are sure they will stay in the home for a long time and they have the 3.5 percent down payment needed for an FHA loan, then they should probably go ahead and buy now,” says Mr. Stanger. “Deciding how much to put down depends, too, on how much money you will have left over.”

Mr. Stanger says this is where the tax credit can help buyers, especially if they time their purchase correctly so that their tax refund arrives as quickly as possible after they have borrowed money from their savings or retirement for the down payment.

All the financial experts agree, though, that potential buyers should first concentrate on the household budget rather than on the tax credit.

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