February 23, 2009

By Danielle Hale, Research Economist

On February 17, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (ARRA 2009). This law did many things, but one item of key importance to Realtors® and the housing industry was the modification it made to the first-time home buyer tax credit that was enacted as part of the Housing and Economic Recovery Act of 2008.

The major changes that are applicable to primary residences purchased on or after January 1, 2009 include: increasing the credit to $8,000 from $7,500, dropping the repayment provision, decreasing the period for recapture from 15 years to 3 years (i.e. if you sell your home less than 3 years after taking the credit, the government recaptures the value of the credit), expanding eligibility so that the credit can be used in conjunction with state/local bond financing, and extending the closing period for eligible purchases from before July 1 to before December 1, 2009. A chart summarizing the changes can be found here.

Impact on Existing Home Sales

The changes to the tax credit are great news for buyers, sellers, and Realtors® alike. How much will modified tax credit boost home sales? We estimate that an additional two to three hundred thousand first-time home buyers will be moved by the tax incentive to purchase a home. This estimate is based on the number of buyers on the cusp of eligibility for a home purchase. Using a house price of $175,400 (the December median price) and assuming a 10 percent down payment, the mortgage payment on a regular 30-year fixed rate mortgage at 5.5 percent would be $896. Since housing payments comprise around 25 percent of income, a household would need to earn $43,023 annually to meet the threshold for purchasing the home.

What would happen if a first-time home buyer who is eligible for the $8,000 credit put it entirely towards the mortgage? The monthly mortgage payment could be reduced $45. This small reduction in monthly payments translates to a reduction in qualifying income of $2,180 making $40,843 the new threshold. How many families would now be eligible based on lower income requirements? Using American Housing Survey data, we know that there are 5.9 million renter households in the $35,000 - $49,999 income bracket, or just under 400 renter households per dollar. Therefore, a $2,180 reduction in required income expands the pool of eligible first-time buyers by 862,722 households.

Obviously, not every one of these eligible households will go on to purchase a home. However, if one in four of these households make a purchase, that would be 216,000 additional first-time buyers. If one in three households subsequently make a purchase, that would translate into 285,000 additional first-time buyers.

But Wait, There's More…

The analysis above focuses solely on first-time buyers directly motivated by the tax incentive. Common sense tells us that changes generally have indirect effects as well. In this case, the additional first-time home buyers in the market are buying two types of properties: vacant or occupied. To the extent that first-time buyers are purchasing vacant property, they are helping to clear inventory which will help stabilize home prices and may bring repeat buyers back into the market. If first-time buyers are purchasing occupied property, the sellers, who may have been waiting for a buyer to come along, are likely to make a repeat purchase.

We can't know exactly how many repeat buyers will come back into the market or make a repeat purchase, but we can use a "back of the envelope" calculation as our guide. If 216,000 first-time buyers enter the market next year (the low end of our estimates), first-time buyers could comprise 44 percent of total existing home sales. According to the 2008 Home Buyers and Sellers Survey published by the National Association of Realtors®, the share of home sales purchased by first-time buyers has ranged between 36 and 42 percent from 2001 and 2008 falling exactly at 40 percent in 2003 through 2005. While first-time buyers will most certainly make more than 36 percent of home purchases in 2009, 44 percent also seems high. What if they comprise a 41 percent share of the market like they did in 2008? Evaluating this question we find that, depending on our assumptions, we have an additional 77,000 to 436,000 repeat buyers making purchases leading to a total impact between 300,000 and 650,000 additional home sales in 2009.

Each home sale has associated economic activity from fees and services associated with the sale transaction, to moving expenses, to remodeling, renovating, or new furniture purchase. The National Association of Realtors® estimates that each home sale currently leads to $61,760 in additional economic activity. At 300,000 additional home sales, that's an $18.5 billion boost to the economy. At 650,000 additional home sales, that boost is $40 billion.

Foreclosure Prevention

On Wednesday, February 18, President Obama outlined the broad goals and ideas behind his plan to prevent additional foreclosures. The primary tool of the plan is to enable refinancing even for homeowners who have little to no equity in their homes. The administration estimates that the plan will help as many as 9 million homeowners. Noting that foreclosures are associated with externalities, namely causing price declines in nearby homes, the administration also suggested that the plan could stop price declines by as much as $6,000 per property. Taking the administration's estimates at face value, the declines could mean preventing the loss of $453 billion in housing equity for the nation's 75.5 million home owners. Preventing that destruction of wealth could also translate into $27 - $36 million in consumer spending saved if the traditionally observed housing wealth effect holds on the downside as well as the upside¹.

 

^{1. The housing wealth effect refers to the propensity for households to increase consumer spending for every dollar increase in housing wealth. Traditional estimates of the size of the spending increase are $0.06 to $0.08.}

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

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