Last month I wrote about how the expiration of the $8000 and $6500 tax credits for new home buying wouldn’t have much impact on the housing market. Those expired, for the uninitiated, on April 30, and since then sales on new homes have dropped to their lowest levels in history. So that wasn’t one of those really good predictions, and I’m sorry, and I admit I was wrong.

Pundits are saying that the drop is caused by buyers moving their purchases forward to take advantage of the tax credit, so that sales just moved from May to April. That surely took place. But at least here in my shop, there were a good number of people that couldn’t get the deal done in time, and who still are in the process of buying. That should have put some shims under the falling market.

So I have a different explanation for why what happened…happened. See, it wasn’t so much about the money. Markets are really smart. They compensate pretty fast for price-altering events like tax credits and artificial purchase incentives (see “Clunkers, Cash for”). When someone offers $8000 as an incentive for you to purchase a home, then the seller of that home adjusts his price upward to meet the new reality that you have more cash to spend, so most of the $8000 does you no good at all. As an aside, this is what the eggheads call “inflation”.

That did happen in this case, though not by anything like $8000 worth. No, the spike in home buying was not caused by the cash incentive as a dollar amount; rather, it was caused by the application of that dollar amount. As in, the $8000 was not a reduction in the price of the home; it was a boost in cash for down payment and closing costs. Yes, I know the government specifically said that the credit could not be used as a down payment. But, humans being what they are, and being waaaaaaay smarter than the government, they got “gifts” to cover the down payment and closing costs, then repaid those “gifts” with the tax credits. Voila! A temporary reinstatement of the zero-down loan programs the government killed last year.

The reason we’re in the economic mess we’re in is really quite simple: we borrowed too much money, and nobody saved a nickel. Now we can’t make the payments on the things we bought, so they’re being repossessed and foreclosed on. For a business, that means money is drying up and that means firings and layoffs. That exacerbates the personal financial problems, which means people stop spending, which further reduces the money for business, and around and around the mulberry bush.

If you have no cash, you can’t buy a home, because there are no zero-down programs outside of USDA Rural – which, not coincidentally, ran out of money 6 months before the end of the fiscal year – and Veterans’ Administration. But this program made it possible to fudge that, and brought a lot more buyers into the game. Until it ran out.

If you parsed the data, and nobody will actually give it to you so you can do this, but what you would find almost immediately is that the large majority of those tax credits were claimed by people whose down payments were smaller than the $8000 credit. Personally, I would bet that almost half of the loans that closed on which the credit applied were closed with gifts as the means of down payment. That was certainly true in our shop. I have no idea how many of those gifts were legitimate. Perhaps all of them. I hope so. But I doubt it.

Then, of course, the gravy train reached the terminus and everyone had to get off. Immediately, home sales dropped off a cliff. This doesn’t happen in market conditions where nothing hinky is going on. The market simply adjusts – prices fall, in this case – and people move on. Really, folks, the $8000 is not a big deal. It represents a payment increase of only about $40/mo for a borrower at today’s rates. That might have a small depressive effect on the market, but nothing like what we’re seeing.

Conclusion: the $8000 credit had the impact it did because it filled a market niche where there is huge demand, and that is the niche for 100% loans. The loss of the credit has taken out a very large part of the borrowing pool, those people that cannot come up with $7000-10,000 to put down on a house. Until something fills that gap again, don’t expect a huge market rebound.

If you:

1. Have not owned a home in the last 3 years (this means you have not been on the title of a primary residence)
2. Have income less than $250,000 last year
3. Are purchasing a home less than $720,000 in value
4. Have your new home under contract (this means a written agreement signed by both parties) by April 30
5. Close the purchase (this means sign the documents, fund the loan, and transfer the title into our name) by June 30

then you qualify for an $8000 tax credit on your federal taxes.  The credit is fully-refundable, meaning that you get it even if you owe no tax.  You may file it on your 2009 taxes.  You may also file your taxes now, close later, and file an amendment claiming the credit.  The rumor is that the IRS will audit everyone that takes this credit* (seems unlikely, but that’s the rumor), so be forewarned.

For the long-time homeowner tax credit:

If you:

1. Have owned your primary residence for at least 5 years
2. Have occupied that home as your primary residence for four consecutive years of the five
3. Purchase a new home (new to you, it does not have to be new new)
4. Get the new home under contract (see above) by April 30
5. Close the purchase (see above) by June 30

then you qualify for a $6500 federal tax credit.  Same terms apply as those above, except that there is actually a way to document your qualifications, and you should expect to have to.  Ask for a copy of the title report on your current home; your mortgage lender should be happy to provide that.  We are, anyway.

*It being impossible to prove a negative – how, exactly, can you prove that you have NOT been on title on a home in the last three years? – I don’t know how the IRS will be able to dispute this.  They will surely ask for a credit report, and it would be a really good thing if there were no active mortgages on it in the last three years.  But if you own a home outright, it’s going to be complicated for the IRS to prove that, especially if you have some sort of rent that you claim on your taxes.  Not encouraging anyone to cheat, here; I’m just sayin’.

Analysis: strong economic growth is supposed to mean bad things for bonds, because investors take money from fixed-return investments – bonds being chief among them – and put it in stocks.  As bond rates fall, mortgage rates rise, all else being equal.  There are other factors, of course, like inflation, but in the main, good economic news is generally considered bad for mortgage interest rates.  So with rates sitting in the low 5% range on fixed 30-year mortgages and in the low 4% range on 5/1 ARMs and the like, why is the end of the recession not causing a move higher?

Answer: we don’t know.  But the suspicion is that the recession’s end might be oversold just a tad.  Remember, in the last giant downturn, we had a fool’s rally in 1930 that almost got us back to the level before the 1929 crash.  Then the bottom fell out, and we didn’t see those highs again for 20 years.  Not saying here that history is repeating itself, by any means.  But the possibility that history will repeat itself is in the back of every trader’s mind, I assure you.  Caution is warranted.  Therefore I fairly confidently predict that the thing you should worry about, if you’re buying a house, is getting it done before the $8000 federal tax credit vanishes on December 1, rather than the interest rate you’ll get.

My recommendation is that you have your house under contract by Hallowe’en, if you want to have a chance to be closed by Thanksgiving.  And not every mortgage guy can get you done that fast.  Please understand and remember this.

Cj