HUD Information Ins and Outs

Contrary to initial expectations, borrowers will not be able to substitute tax credit for a down payment on FHA-backed mortgages.

It was too good to be true: The government will not be offering no-down-payment loans.

Housing and Urban Development Secretary Shaun Donovan announced Friday that the Obama administration's $8,000 first-time home-buyer tax credit could be used toward a mortgage guaranteed by the Federal Housing Administration, but contrary to early understandings of the program, borrowers must still come up with the initial 3.5% down payment on their own.

Letting home buyers immediately "monetize" their tax credit through bridge loans from certain government agencies and nonprofits will help home sales some, but much less than many expected. "We believe the final guidelines are less lucrative than what was originally conveyed by HUD, which will likely limit the benefit to the housing market in terms of incremental home sales," wrote home-building analyst Ivy Zelman of Zelman and Associates in a note to investors.

Many industry participants were disappointed by the final plan because they thought that the credit could be used toward the down payment. When Donovan touched on the subject in a speech to the National Association of Realtors in mid-May, several major media outlets reported that this was the case. This was in part because a preliminary outline of the plan--which indicated that the credit could be used toward a down payment--was inadvertently posted on HUD's Web site.

At the time, HUD spokesman Lamar Wooley would not confirm or deny that the credit could be used as a down payment, writing in an e-mail to Forbes, "The plan's technical details are still being finalized."

While allowing what amounts to no-down-payment government loans would have definitely helped heat up home sales, it never had much of a chance because it would have been in violation of the American Recovery and Reinvestment Act, which requires that borrowers have some skin in the game.

Substituting a tax credit for a down payment would also have bred a host of problems. Issuing taxpayer-guaranteed loans to borrowers who might not have the means--the FHA has no minimum credit score or income--would likely bring about another bout of costly foreclosures down the road. "They are being prudent," said Guy Cecala, publisher of trade publication Inside Mortgage Finance. "It's a tough balancing act. Everything they do to make it easier to buy a home risks causing more foreclosure down the road."

Since the FHA now shoulders more than a third of the market, the agency expects "thousands" of families will be able to buy a government-insured home using their tax credit.

According to HUD, the average FHA-backed mortgage is $182,000. Closing costs--exclusive of the 3.5% down payment and upfront taxes--amount to just over $8,600. The National Association of Home Builders estimates the home-buyer tax credit will fuel 160,000 additional home sales. M.Donavan