How to Apply “Free Money” Wisely Toward a Home Purchase?

In my previous blog, some prospective homebuyers and comments have expressed that the $8,000 tax credit in the Stimulus Package is “just not enough” to stimulate them to get off the fence. Understandably, the incentive seems too insignificant when we are talking about an average housing price of $500,000 in the Bay Area.

On the flip side of the coin, $8,000 is unarguably a substantial amount of money – don’t we all wish to have an extra $8,000 in our bank account? Since a tax credit is a dollar for dollar reduction in income taxes (e.g. if you have $8,000 tax credit, you will pay $8,000 less tax that year regardless of your tax bracket), it is essentially like “free money”. Therefore, for someone who intends to purchase a home this year, there could be a number of ways in which this money can be wisely applied toward the purchase. Here are a few examples:

1. Down payment – Many buyers have admitted that coming up with enough down payment is the toughest part. Nowadays, in order to get a loan from most conventional lenders, a buyer has to put at least 20% down. For example, a $400,000 home, the down payment would be $80,000. $8,000 would subsidize 10% of the down payments. For FHA loans, when the minimum down payment requirement is 3.5%, $8,000 can cover a large portion of it.

2. Closing costs – There are closing costs associated with every transaction. A buyer’s closing costs may be anywhere from 1%-3% of the purchase price. For a $500,000 home, the costs would be $5,000-$15,000. $8,000 would pay for, if not all, a substantial amount of the closing costs.

3. Points buy-down – Interest rate can be reduced by buying down the points. For example, if the loan amount is $400,000, the mortgage payment is $2,334 per month at 5.75%. Pay 2 points (equivalent of $8,000) to shave off 0.75%-1.25%, a buyer may save about $200 or more a month; that is, a saving of $2,400 per year. If the property is held for 10 years, total saving is $24,000.

4. Property tax – Annual property tax is about 1.2% of the home value. Deriving this mathematically, $8,000 covers one full year of property tax for a $650,000 home or two-years for a $350,000 home.

5. HOA fee – For people who are looking into townhomes or condos, the HOA fee runs about $300 a month on average. By calculation, $8,000 covers over 2 years of HOA fee.

6. Renovations – Most new homeowners would be inclined to update or remodel parts of the house. Depending on the extent of the renovation, $8,000 may serve very well to give a kitchen or a bathroom a good facelift.

In a nutshell, the tax credit in the Stimulus Package may not appear to be as attractive to some prospective Bay Area homebuyers at first. But for those who are willing, able, and ready to become homeowners in 2009, it definitely offers a better financial advantage.

Just a reminder: the $8K no-repayment tax credit applies to those who purchase home between January 1 and December 1, 2009. Carefully planning the timing of the closing could be worth thousands of dollars.

Stimulus Package – What It Means To Bay Area Homebuyers?

The stimulus package is making its way to the President desk as we speak. One of the items that hits home for current and future homebuyers is the tax credit for first-time home buyers. Specifically, the latest version of this plan denotes, as agreed upon by the House and the Senate, "first-time home buyers are eligible for a refundable tax credit equal to 10 percent of the purchase price of their home, up to $8,000, if they made the purchase after Jan. 1, 2009, but before Dec. 1, 2009."

Since I am currently working with a few prospective first-time homebuyers, I thought I'd picked their brain during my follow-up calls this weekend to see how they feel about this incentive.

Interestingly, their answers all seem to boiled down to one thought: if they are ready and want to buy a house now, they will buy no matter what; the tax credit of $8K will NOT be the factor that push them off the fence. On the other hand, if they are "just looking" and don't intend to buy soon, they will not take action because of the $8K tax credit either.

Now, note that all of these people intend to buy a home in San Francisco Bay Area and their target home price is $500,000 on average. Their tax bracket is generally in 25%-30%. One of them is a CPA and he said "free Money is a good way to convince me to buy [but only] around areas where houses are much much cheaper." He also added that the $8K credit works well for house price that is $80K (wait, do they even exist?...), because "if you buy a house around $80K, you already got a 10% discount. Sell the house back out 10% profit in your pocket as long as you hold it for a certain number of years." And that's assuming housing market does not continue to drop.

When asked what will be most helpful to get them into a home now, they unanimously came to the same response -- any program that helps with down payment. Although they have good credit and a reliable income, coming up with 20% of the purchase price (which is the minimum down payment requirement for most conventional loans nowadays) is the toughest part for them.

I think the best way to find out if a stimulus plan works or not is to go directly to the source -- the consumers -- and listen to what they have to say.

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