Thursday, July 24
Posted 4 p.m. EDT
WHO'S ZOOMIN' WHO?: The House has passed a housing bill that is designed to encourage delinquent mortgage borrowers to refinance into FHA-insured mortgages and to stimulate sales of empty houses, among other things.

The Senate is expected to pass the bill, called the Housing and Economic Recovery Act of 2008 (H.R. 3221), and the president is expected to sign it. As a taxpayer, there's some stuff you won't like, and some stuff that you'll appreciate. (That's a pun, one that I'll explain shortly.)

I also recommend that you read Kay Bell's tax blog today, too. She addresses some of these issues.

THE BAD: The law will give first-time homebuyers a tax credit of 10 percent of the purchase price, up to $7,500. (A first-time homebuyer is defined as someone who hasn't owned a principal residence in three years.)

Here's how the tax credit will work. You buy a $200,000 house. The next year, when you file your income tax return, you have a $7,500 credit. Not a deduction -- a credit. Essentially, you get to reduce your income taxes by $7,500. That ought to make for some big refund checks.

But. Yeah, you know there's a "but." But you have to pay the money back over 15 years. Say you buy the house this October. You get the $7,500 tax credit for the 2008 tax year. That's the one with the filing deadline of April 15, 2009. Then you have to start repaying one-fifteenth of that amount, or $500, every year for 15 years, starting with the 2010 tax year.

If you sell the house before then, you have to repay the remaining balance in a lump sum.

What if the home's value doesn't appreciate that much, or you get divorced, or you die and your kids inherit the house? Those issues are addressed in the law, but I'm not going to go into that much detail. If you really want the lowdown, go to Thomas, search for H.R. 3221.EAH, and search for the phrase "first-time homebuyer credit."

What's so bad about this provision? Well, think about it. You buy a house, and get a $7,500 gift. But it's not a gift -- you have to repay it. Where does the money come from? Where does the money go?

(The "Jeopardy" theme plays softly in the background.)

The money comes from you, Dear Taxpayer. It's an interest-free loan, payable over 15 years.

It's a little harder to figure out who the money goes to, isn't it? Does it go to you? Well, it's a loan, right? And a mortgage is a loan, too -- right? Does that mortgage money go to you? No, it goes to the home seller. Does that mean the $7,500 goes to the seller, too? I think it does.

I call this a $7,500-a-house subsidy to homebuilders who made mistakes and overbuilt. These homebuilders will market this tax credit hard, targeting first-time homebuyers with a pitch that says: "Buy a home, get $7,500 cash back." Think about this from the builder's perspective: You can be firm on price. You won't have to cut prices as much because you can tell buyers that they're getting $7,500 cash back from the government.

A previous version of the bill limited the tax credit to buyers of unoccupied houses -- basically, newly built homes and foreclosures. As passed by the House, the bill applies to all arms-length home sales, so anyone selling a house can use this sales pitch. But builders will benefit most, in my opinion.

I interviewed Anthony Sanders, professor of finance and real estate at Arizona State University, when the tax credit applied only to vacant houses. He wondered why it didn't apply to all home sales. Now it does.

"This is a way to try to get the government to step in and clear some of the excess inventory" of houses, Sanders said in that interview. "The good news is, if it's effective, that will help the housing market to rebound sooner, because one of the things that's hurting the comeback is we've put up so much supply, and that has to be absorbed if the housing market is going to turn around."

I told Sanders that I considered this to be a $7,500-a-house subsidy to homebuilders. "I see where you're coming from," he said. "Frankly, I think it's too small." The tax credit won't have much of an effect on builders' bottom lines, Sanders said. "This is one of the cases where, ordinarily, I think government should keep its nose out of the private sector, but for the health of the financial system, we need to get the housing market stabilized as soon as possible."

The main winners, Sanders said, will be first-time homebuyers, particularly if housing prices turn around. "My concern as a taxpayer and citizen is suppose we do induce some first-time homebuyers to jump in and buy these newly built homes. Is this the best thing to do for people who are trying to build up their credit?" That's not a rhetorical question; he doesn't know the answer.

As far as my theory that sellers won't drop their prices because buyers will collect the $7,500 tax credit, Sanders doesn't think it holds water. Builders (and sellers in general) don't have market power, he said. It's a buyer's market, and buyers are setting prices.

Sanders says that if this tax credit works, it will stimulate home sales. That brings up the question of why the credit is only for first-time buyers. Wouldn't it stimulate home sales even more if all buyers got the tax credit? Yes, Sanders says -- but such a tax credit might promote speculation, which is partly what delivered us into this housing mess. "This is a way to ease the entry into the market for first-time homebuyers."

Susan Wachter, professor of real estate at the University of Pennsylvania's Wharton School of Business, isn't bothered by the tax credit, either. There are bigger problems to worry about than whether the tax credit is a subsidy to homebuilders, she said.

"We're in the midst of great financial peril right now, and the leaders have taken action," she said by phone from Singapore, on her way to a professional conference. That underscored her other point -- that the global integration of financial markets forces governments to intervene in crises.

THE GOOD: The law will encourage lenders to let delinquent borrowers refinance into FHA-insured mortgages. If lenders want to participate (it's voluntary), lenders would have to forgive some of the debt. The law says they'll have to forgive enough debt so that the borrower can refinance for 90 percent of the home's assessed value. Actually, it's 87 percent, but we'll get to that in a sec.

An illustration: Let's say you borrowed $110,000 to buy a $125,000 house. The value has declined, and now the house is worth $100,000. You've missed a few payments, and you want to take advantage of this offer to refinance. The lender would have to forgive everything above 90 percent of the home's assessed value. In this case, that would be $90,000. If you still owe roughly $110,000, the lender loses $20,000.

But you'll have to pay a 3 percent upfront premium to the FHA. Actually, the lender will have to forgive everything above $87,000.

The problem is that you're a very risky borrower. You've already been delinquent on a mortgage on this house, and now the FHA is going to insure your new, refinanced mortgage. That 3 percent upfront premium, plus a premium equal to 1.5 percent of the mortgage balance annually, probably isn't enough. So the FHA is going to share in the home's price appreciation.

If you sell the house or refinance the loan less than a year after getting the FHA-insured mortgage, you have to give the FHA all of the price appreciation. In the above scenario, if the house was appraised at $100,000 when you refinanced, and then you sold it nine months later for $105,000, the FHA gets that $5,000.

Over the next five years, the FHA's cut is reduced by 10 percent a year. If you keep the house and the loan for more than five years, the FHA still gets half of the appreciation when you sell the house or refinance the loan, no matter how much time passes. In the above example, let's say you never refinanced the FHA-insured loan, and you sell the house in 2030 for $500,000. You split that equity appreciation 50-50 -- $200,000 to you, and $200,000 to the FHA.

You might not like that as a homeowner who has fallen behind on the monthly payments and is desperate to refinance into an FHA loan. But you gotta like it as a taxpayer.

THE UGLY: Congress listened to the mortgage industry, whose major players said the FHA refinance project had no chance of working unless some provision was made for home equity lenders. If your house has a home equity line of credit or home equity loan, and you owe more than the house is worth, that lender is liable to lose everything if the house ends up in foreclosure.

The equity lender also is going to lose everything (probably) if you refinance into the FHA program. So why should the equity lender play ball? Why should the equity lender lose all of the money it lent to you while the primary mortgage lender loses only some of the money it lent? You can see why your HELOC lender wouldn't like the FHA refinancing plan.

The upcoming law provides a vague answer: The FHA will reimburse the equity lender out of its cut of the shared appreciation after you refinance or sell the house. How much? How will the amount be calculated? It doesn't say.

Posted 2 p.m. EDT
ABRUPT RISE: Mortgage rates reached their highest level in a year in Bankrate's weekly survey, conducted yesterday. The 30-year fixed rose 35 basis points, to 6.77 percent. The last time the 30-year fixed was higher (in Bankrate's survey) was 53 weeks ago, at 6.82 percent.

Lo and behold, since yesterday morning, it looks like mortgage rates have fallen about an eighth of a percentage point. Give the credit to declining home sales and falling stock prices.

Freddie Mac's weekly survey has the 30-year fixed rising 37 basis points from last week, to 6.63 percent.

HOUSING BILL: Tune in later today to find out who's getting an undeserved handout from the federal government, courtesy of the housing bill that passed the House yesterday and will pass the Senate soon.

Wednesday, July 23
Posted 11 a.m. EDT
'SCUSE ME: ... while rates kiss the sky. Mortgage rates have been rocketing upward the past few days, to levels they haven't seen since this time last year.

Bankrate conducts its weekly rate survey every Wednesday. Last week, the 30-year fixed averaged 6.42 percent in our survey; this week, it'll be around 6.8 percent. It's rare for rates to rise this quickly. In February, we had a one-week rise of 41 basis points, the biggest advance since the autumn of 1998.

What's behind this rapid increase in rates? Fears of credit quality. Investors want to be compensated for taking the risk of buying mortgages that eventually could go into delinquency and default in large numbers. Borrowers are seen as riskier than they were before.

Inflation expectations are pushing rates up, too.

Friday, July 18
Posted 2 p.m. EDT
NONSTOP: Mortgage rates just keep rising. To be more precise, the prices of mortgage bonds continue to plunge, for the third day in a row. When mortgage bond prices fall, mortgage rates rise.

All told, we're talking about a rise in mortgage rates of about 40 basis points this week, with most of the damage coming Tuesday and yesterday. Today, we saw a rise of about an eighth of a percentage point -- before noon.

Mortgage rates are rising faster than Treasury yields, which implies that investors are running away from mortgage bonds. Why? It's a bunch of little things, mortgage banker Dick Lepre tells me, but mostly it comes down to concerns about falling house prices and growing numbers of foreclosures. Investors demand higher mortgage rates to compensate for the risks.

CARROTS AND STICKS: This week, I wrote about IndyMac and the FDIC's plan to experiment with short refis. A short refi is when you owe more than the house is worth and you can't afford the monthly payments, so some of the debt is forgiven, and you refinance for a smaller amount, into a loan that you presumably can afford.

I wrote that I was "all for experimenting with short refis for owner-occupants who are in genuine financial hardship."

A reader named Bob replies: "I don't agree with this. What about those of us who did the right thing and can afford our houses? My house has gone down in value at least 15 percent since we purchased last year. Why should I be penalized for purchasing a house that I can afford, while my neighbor gets to refi into smaller loan? I'd like a short refi, too. I could use a couple extra hundred dollars each month."

Despite all the technical potholes in the road to short refis, their future ultimately is a political question. Bob frames one side of this political debate well. I agree with him, and with people on all sides of this issue. I doubt I'm alone in my ambivalence, and that's going to make this issue hard to resolve.

I would like to get away from talking about punishment, though. Bob asks, "Why should I be penalized for purchasing a house that I can afford?" I don't think anyone is penalized for buying a house that they can afford. Bob lives in a house that he can afford, and that seems like its own reward, and not a penalty.

When a neighbor can't afford his mortgage, and he gets a short refi that enables him to stay in the house, I don't see that as a penalty imposed on the other neighbors. I don't think it's any of the neighbors' business. It doesn't affect them, except from the standpoint that they don't have to live next to a house in foreclosure.

Yes, I would like to save a couple hundred extra dollars a month, too. But it's no skin off my nose if my neighbor gets a break like that and I don't.

In large part, I'm playing devil's advocate here -- because I simultaneously agree with the counterargument I just made, and with Bob's argument. If you forced me to jump onto one side of the fence, I suppose I'd hop on my side. I'd say that your neighbor's personal finances are none of your business.

Anyway, the real winner isn't the homeowner who gets a short refi and a lower mortgage payment. The winner is the person who sold that house at an inflated price. Why don't people want to penalize that guy?