Despite record-low interest rates bringing homeownership within reach for many first-time homebuyers, the down payment remains a major barrier.

Policymakers have floated the idea of down payment assistance for first-time homebuyers through a $15,000 refundable and advanceable tax credit at the time of purchase. For the typical low-tier, entry-level home, this amount is sufficient to cover a Federal Housing Administration (FHA)-insured 3.5% minimum down payment.

This solution has its perceived merits. For one, it makes the hurdle to homeownership less daunting for first-time homebuyers, many of whom are paying more for rent than is paid for a similar home’s mortgage.

According to Zillow, the share of renters in California metros that qualify for a mortgage payment at 30% of their monthly income with a 3.5% down payment are:

  • 21% in Riverside;
  • 17% in Sacramento;
  • 16% in San Francisco;
  • 13% in San Diego;
  • 12% in San Jose; and
  • 10% in Los Angeles.

Although roughly one-in-six rental households in these California metros qualify for mortgage payments, saving up for a down payment is no easy task. In fact, since renters continue to spend more on their rents than is recommended — 31% of their monthly income — saving is made more difficult, and renters continue to be stuck in a vicious cycle.

Lucky for some, at least 18% of first-time homebuyers receive some form of down payment gift from family or friends. For those without access to wealthy relatives, Zillow estimates it will take 14 years for the average U.S. renter to save $15,000. But with a $15,000 credit available towards the purchase of a first home, renters will receive a boost to their savings, putting those willing to make the leap years ahead in homeownership.

The drawbacks of down payment stimulus

The first-time homebuyer tax credit is an attractive incentive towards increasing home sales, but we have seen the disadvantages of a similar plan in action already.

Take the 2009-2010 homebuyer tax credit for example.

Under this program, first-time homebuyers were given an $8,000 tax credit toward purchasing a home, and existing homebuyers were allotted a $6,500 tax credit. The result was that homes experienced artificially inflated prices and home sales volume rose — briefly. Further, since home prices later dropped, many of the buyers who took part of this program ended up owing more than their homes were later worth, a situation called negative equity.

While the tax credits did boost sales temporarily, the demand was artificial. Sales volume became concentrated, and the real estate market was booming for a short time. However, after the tax credit’s expiration in May 2010, sales and prices plummeted once again.

Prospective buyers on the cusp of purchasing but not quite there yet took advantage of the stimulus. But the stimulus merely cannibalized from demand that was to be spent in the following year or two. Thus, qualified homebuyers all concentrated their purchasing power during the 2009-2010 tax incentive years, leaving sales volume to plummet in 2011.

Another drawback to the homebuyer tax credit is that it is unnecessary to drive demand here in California, especially in the current market where inventory is low.

The problem is not demand for housing. The demand has already been met, with prices at new highs due to low inventory and historically low interest rates. The problem is the lack of housing available, especially low- and mid-tier housing that first-time homebuyers gravitate towards.

New single family residential (SFR) construction was 24% below a year earlier in the latter half of 2020, while multi-family SFRs were down 41% from a year earlier, maintaining a downward dip that began in 2019.

Rather than investing in tax credits, which briefly inject the market with artificially inflated prices and levels of demand, the government ought to focus on:

  • increasing residential construction by loosening zoning restrictions and increasing building incentives; and
  • job creation for demographics typically making up potential first-time homebuyers.

By investing in job creation, potential homebuyers have a chance to stabilize their financial situations independently and organically. Local jobs are the fuel that keeps the real estate market burning strong and bright.

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