HUD Details Use of Tax Credit toward Closing Costs

[Update 1 clarifies details about the tax credit.]

New details about the use of the $8,000 first-time home buyer tax credit to obtain a government-insured mortgage reveal the advanced funds may be applied toward the down payment only after the borrower meets the minimum 3.5% of the house’s appraised value.

The US Department of Housing and Urban Development (HUD) secretary Shaun Donovan today announced the official launch of the so-called “monetization” of credit for use toward the purchase costs of a home with a Federal Housing Administration (FHA)-insured mortgage. He first mentioned the monetization at a National Association of Realtors conference in mid-May, although the details remained sketchy at the time.

Today’s announcement clears the air about the use of the credit toward down payments. In addition to down payment purposes in excess of the minimum 3.5%, borrowers may apply the monetized tax credit toward other closing costs, which can in turn lower the interest rate obtained, according to HUD’s announcement.

“Unlike seller-funded down-payment assistance, which was a vehicle for abuse, this program will allow home buyers to shop for the best home price and services using their anticipated tax credit,” HUD officials said in the media statement today.

HUD cites analysis conducted by the National Association of Home Builders that 160,000 home sales will take advantage of the first-time home buyer tax credit. Thousands of families will use the monetized tax credit toward their purchase, HUD estimates.

But that doesn’t mean those thousands of families will receive the full $8,000. Qualifying first-time home buyers only receive a tax credit up to $8,000, depending on the price of the home. And those who apply for an FHA mortgage can only access these funds after filing the year’s tax return.

In the meantime, however, home buyers financing through state Housing Finance Agencies (HFAs) “and certain non-profits” can use the anticipated tax credit amount via secondary financing provided by the HFA or non-profit, according to HUD’s announcement.

Language from HUD’s new mortgagee letter on approved mortgages using first-time home buyer tax credits indicates a credit advance in the form of a second lien may require monthly repayments. Although this provision makes the tax credit monetization sound a lot like a short-term loan or an advance on a borrower’s tax refund, HUD’s statements indicate the department is confident the system will allow for affordable loans.

“The second lien may not exceed the total amount needed for the down payment, closing costs and prepaid expenses,” the new mortgagee letter reads. “…If payments are required, they must be included within the qualifying ratios and, when combined with the first mortgage, cannot exceed the borrower’s reasonable ability to pay.”

Write to Diana Golobay.