mortgage

Use first-time homebuyer's credit upfront

A woman holding a miniature house and a form reading "tax credit"
Highlights
  • HUD is allowing the federal housing tax credit to "monetize" it now.
  • Use the tax credit as a down payment or towards closing costs on a home.
  • To be eligible for the housing credit, you must be a first-time buyer.

Some potential homebuyers who have been waiting to get into the market are now taking action, thanks to the new federal housing tax credit.

Passed in February as part of the American Recovery and Reinvestment Act of 2009, also known as "the stimulus package," the credit gives a tax allowance of up to $8,000 to first-time homebuyers who purchase a home before Dec. 1. The credit itself is already well-known, but here's a lesser-known fact: Buyers now don't have to wait until tax time to use it.

On May 29, the Department of Housing and Urban Development announced that it will allow buyers who qualify for the tax credit to "monetize" it by using it as a down payment or toward closing costs on a home. HUD Secretary Shaun Donovan said this new feature is intended to not only ease the costs of homeownership but also boost home sales in areas where properties have been sitting on the markets for months or years.

"What we're doing today will not only help these families to purchase their first home, but will present an enormous benefit for communities struggling to deal with an oversupply of housing," Donovan says.

Figuring out how to use the credit upfront, however, isn't as easy as signing a form and collecting your cash. Check out our step-by-step guide for buying your home without emptying your bank account.

First things first: Are you qualified?

Not everyone is eligible to use the federal housing tax credit. You must be a first-time homebuyer -- meaning that you have not owned a home that is your principal residence for at least three years leading up to your home purchase. Both spouses of a married couple must pass this test to qualify. For example, if you have not owned a home within three years, but your spouse has, neither of you would be considered a first-time homebuyer.

Income limits also apply. To claim the full amount of the credit, your modified adjusted gross income can be no more than $75,000 if you're single, and $150,000 if you're married. If you earn more than that, you can still take advantage of the credit, but at a lesser amount. The credit phases out entirely at $95,000 for unmarried homebuyers and $170,000 for married couples. If you stop using the home as your principal residence before three years are up, you'll have to repay the credit.

If you want to use the tax credit to pay for upfront home-buying costs, you must have a mortgage insured by the Federal Housing Administration. You can find a list of such mortgage programs at www.hud.gov.

Still, Realtors worry that first-time buyers will wait too long to complete the closing process by the Nov. 30 deadline.

2 ways to monetize

If you've met all of the requirements, familiarize yourself with the two options available for monetizing your tax credit.

First, the most common way is accomplished through secondary financing, in which certain government or nonprofit organizations like state housing finance agencies can give you a short-term bridge loan and place a second lien on your home. Then, you would pay it off with the refund you receive after filing for the credit on your 2009 income tax return. If it's not paid off by the deadline, interest begins to accrue. Erik Nore, director of homeownership at the New Mexico Mortgage Finance Authority, says his agency's 2009 monetization program issues loans with a repayment date of June 30, 2010.

"If they don't pay it back by then, it converts to a 30-year fixed-rate mortgage, with an average of 6 percent interest," Nore says.

The other option for monetization is the purchase of the tax credit. In this scenario, the homebuyer assigns the credit to a lender. This option can be used by for-profit, FHA-approved lenders, as well as some government or nonprofit organizations.

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"You sign a form that the lender provides for you that forfeits your right to the credit, and they will file the credit on your behalf for them," says Edward Collins, a wealth adviser at Artisan Wealth Management in Lebanon, N.J. "You won't do anything with the credit after that."

If you choose to sell your tax credit, additional restrictions apply. Homebuyers who take this option can't use the money from the sale of the credit toward the minimum 3.5 percent down payment that is required for FHA loans. However, they can use it to increase their down payment above 3.5 percent.

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