Caution: First Time Homebuyer Tax Credit

Practice: Advances on the First-Time Homebuyer Tax credit
The First-Time Homebuyer Tax Credit, which offers up to $8,000 to qualifying buyers who purchase a home through Nov. 30, is a generous perk worth taking advantage of. But it can also get some home buyers into deep trouble.

In late May, the Department of Housing and Urban Development (HUD) said it would permit FHA-approved mortgage lenders to offer eligible borrowers an advance based on the tax credit. Borrowers, in most cases, are still required to make the standard 3.5% down payment required for FHA-insured mortgages, but they can add the value of the credit to the down payment or they can use it to pay for closing costs, says Cummings.

Repayment rules vary, but depending on the lender, borrowers will have to pay the loan each month, pay a lump sum when they receive their tax credit or make payments
over several years. And, in most cases, they'll be paying interest, too. (HUD recommends that lenders refrain from charging fees that surpass 2.5% of the tax credit.)

Bottom line for the borrower: If a borrower needs to rely on an advance of their tax credit to afford the purchase, then they'll probably have a hard time affording both their loan payments on the advance and the mortgage payments, says Cummings.

Risk for the economy: “We’re building a house of cards like we did before,” says Cummings. “We’re getting people into homes that they can’t necessarily afford with no equity, which is artificially propping up the market.” A new ripple effect of foreclosures could occur in the next two years as a result of this practice, he says.