Robert Pozen does an excellent job in the Wall Street Journal of describing how the home buyer tax credit and the FHA’s low down payment requirement is churning out toxic mortgages.
Here’s how the credit allows buyers to avoid putting their own money at risk. Suppose a couple making $60,000 annually buys a home worth $200,000. They can get an FHA-insured loan if they put down 3.5% of the purchase price, about $7,000. The couple will also need to come up with another $1,000 in closing costs, for a total of $8,000. The couple can either dip into savings or borrow that money from relatives or somewhere else on a temporary basis.
After closing, the couple can quickly obtain the $8,000 refundable tax credit to pay off their temporary loan (or replenish their savings). In effect, they will have bought a home without putting any of their own money at risk. Owners who don’t sink their own money into a house are much more likely to default on the mortgage.
And when the couple defaults, the FHA is on the hook for the loan. And when the FHA goes bust, the taxpayers will be on the hook. Why on earth are will still making and insuring mortgages like this?