This article gives an in-depth report of the recent legislation on FHA equity-sharing loans, the 16-year refund loan, and the death of the “Nehemiah” downpayment programs. This expands upon the brief overview of HR 3221 given in the August issue of the first tuesday journal.
FHA-insured Section 257 cram down of existing loans
The Federal Housing Administration (FHA) will now insure a lender from further loss on a first trust deed loan in default which was originated before 2008 and encumbers the principal residence of a creditworthy owner. In lieu of a discounted loan payoff on a possible short sale arranged by the owner and his agent, the lender accepts a “cram down” of the loan amount and the payment schedule, called refinancing. The owner agrees to share his equity and any appreciation with the FHA. This FHA-insured Section 257 cram-down loan program ends September 30, 2011. What bankruptcy courts can’t easily do to reflect current economic conditions, the homeowner and the lender can.
For the lender to be issued FHA insurance against further loss on the refinancing, both the owner and the lender must voluntarily meet qualifying conditions by cooperating with one another. The controlling factors are the current value of the residence and the monthly payment the homeowner can afford.
First, the homeowner must be in default on the first trust deed loan encumbering his principal residence. The default must be due to his inability to continue to make payments, not an intentional delinquency to place the loan in default to qualify the restructured loan for FHA insurance.
The homeowner’s debt-to-income ratio as of March 1, 2008 must exceed 31% based on all mortgage debts on the property. The owner’s income is subject to a request for verification of income from the Internal Revenue Service (IRS).
The owner cannot hold any type of ownership interest in any other real estate.
Should junior liens encumber the property subordinate to the lender’s first trust deed, these liens must be declared fully satisfied by their holders and be reconveyed as a condition for the lender to obtain the FHA default insurance on the refinancing. Junior lenders who agree to reconvey their trust deed lien and cancel the debt owed them by the homeowner can, in exchange, agree with the FHA to participate in any future appreciation of the property which is due the FHA under appreciation-participation (AP) provisions included in the modified first trust deed note, called refinancing by the FHA.
The lender must agree to reduce the final loan amount to not more than 90% of the property’s value and treat the reduction as a discount. For the homeowner retaining ownership as required by the FHA, a reportable discharge of indebtedness income for the amount of the discount and canceled junior loans will be taxed (unlike a short payoff on a sale of the property). [See April 2008 first tuesday journal article “Short payoffs on loans in foreclosure“]
The mortgage insurance premiums (MIP) due the FHA on a cram-down Section 257 refinancing are paid both upfront and annually. However, the upfront MIP of 3% is paid by the lender and included in the cram-down loan amount. The annual MIP is 1.5% of the loan balance and is paid by the homeowner with loan payments.
The principal amount of the restructured first trust deed note, including advances made by the lender for PMI and brokerage fees, may not exceed the smaller of:
- the principal the borrower can afford to make payments on at current fixed rates over a 30-year amortization period;
- 90% of the current appraised value of the home; or
- 132% of the 2007 loan limitation for the property’s size, an amount generally in the $550,000 loan limit range for a single family unit.
The interest rate on the restructured first trust deed note must be a fixed rate commensurate with market rates for FHA-insured first trust deed loans. Monthly payments must be based on a 30-year amortization period, commencing one month after the close of the loan escrow.
However, the modified note or trust deed must contain an AP provision. Under the AP provision, the FHA will share in the equity created by the cram down of the loan amount (maximum 90% loan-to-value [LTV]) and any future appreciation in value beyond the property’s current market value, payable to the FHA when the property is sold or refinanced.
The FHA’s share of the equity created by the cram-down and modification of the lenders first trust deed, an amount equal to 10% or more of the property’s appraised value at the time of the loan cram down, is payable when the property is sold or refinanced. The FHA’s share in the dollar value of the equity created by the cram down is based on the following formulas:
- 100% share if the sale/refinance occurs during the year following the loan modification;
- 90% share during the second year;
- 80% share during the third year;
- 70% share during the fourth year;
- 60% share during the fifth year; and
- 50% share after the fifth year.
Further, the FHA and the owner will share 50:50 any future appreciation in value when the property is sold by the owner (not a refinance). The appreciation shared will be the difference between the sales price and the appraised value of the property at the time of the cram down.
For more information on this program, please visit the FHA HOPE for Homeowners website.
First-time homebuyer tax credit
Added by HR 3221:
Internal Revenue Code §36
First-time homebuyers who close escrow on the purchase of a principal residence during the period of April 9, 2008 through June 30, 2009 are entitled to an interest-free, tax-credit loan (from the IRS) limited in amount to:
- $7,500 ($3,500 for married individuals filing separately); or
- 10% of the purchase price, if smaller.
Thus, the tax-credit loan serves to replace a portion of the down payment previously made and is funded by a tax refund check or a reduction in taxes due the IRS.
The tax credit loan amount is phased out for married couples reporting an Adjusted Gross Income (AGI) between $150,000 and $170,000, and for single taxpayers with an AGI between $75,000 and $95,000 for the year of purchase.
To qualify as a first-time homebuyer, the buyer may not have owned a principal residence during the three-year period before close of escrow on the newly acquired home. The home cannot be acquired from a related person.
The purchase price for calculating the tax credit loan (refund) limitation of 10% of the price is the adjusted basis of the principal residence on the date of purchase. The home is considered purchased when escrow closes. A home built by the taxpayer is considered purchased on the date the taxpayer first occupies the residence. If the first-time homebuyer closes his purchase escrow during the first six months of 2009, he may report the purchase as made on December 31, 2008. Thus, he receives the $7,500 tax refund or tax payment reduction for the 2008 tax year.
Nonresident aliens are disqualified from taking advantage of the tax-credit loan to purchase a residence.
The first-time homebuyer tax credit refund is an interest-free loan from the government. It must be repaid in 15 equal annual principal installments, commencing the second tax year after the year of purchase. On a resale of the principal residence, the payoff amount of the tax-credit loan cannot exceed the profit taken on the sale (and the cost basis for setting the profit is reduced by the amount of the tax credit loan), unless it is sold to a related person.
A due-on aspect triggers a call of the unpaid principal in the year the home is sold or no longer occupied as the taxpayer’s principal residence.
FHA-insured loan limits increased
Effective January 1, 2009, the FHA purchase-assist loan limit is increased from 95% to 115% of area median home price with a cap at 150% of the Freddie Mac/Fannie Mae loan limit, which is $625,500 for a single-family residence. Down payments of 3.5% will be required for any FHA loan.
Homebuyer’s down payment assistance
Amended by HR 3221:
12 United States Code §1709(b)(9)
The borrower on an FHA-insured loan must pay at least 3.5% of the appraised value of the property toward the price and transactional costs of acquisition.
Money borrowed from a family member is acceptable. However, if the borrowed amount is secured by a lien against the property, it must be a junior lien against the property. Also, the principal amount of the FHA-insured loan and the secured family-member loan may not exceed 100% of the total of the appraised value of the property and all mortgage related fees.
However, the 3.5% payment cannot in any way or at any time be provided by:
- the seller;
- any other person financially benefiting from the transaction (such as a broker); or
- any third party (such as a facilitator for downpayment assistance plans [DAPs]) that is reimbursed in any way by the seller or others financially benefiting from the transaction. [See September 2007 first tuesday journal article “The Scam behind ‘nonprofit’ downpayment assistance charities“]
This only applies to loans approved by the lender beginning October 1, 2008. [See HUD website for more information on DAPs]
MIP increased on FHA-insured loans
FHA MIPs have been increased .75%, from 2.0% and 2.25% to 2.75% and 3%, respectively.
Property tax deduction increased for non-itemizers
Amended by HR 3221:
Internal Revenue Code §63
A married couple who owns real estate and does not itemize their deductibles are allowed to increase their standard deduction by $1,000 ($500 for single reporting) for state and local real property taxes they paid during 2008, limited to the amount of real property taxes paid, if less.
Thus, the standard deduction for joint filers and surviving spouses paying real estate taxes would increase to a maximum of $11,900, an additional tax savings of around $300. The deduction for single individuals would increase to a maximum of $5,950; head-of-household to $8,500.
Note: First-time homebuyers should have their closing statement reflect their payment of taxes (if prorated and charged) or they should actually prepay their April 10th real estate taxes before the end of 2008 to reflect they have paid more than $1,000 ($500 single in 2008).
Maximum possible payment disclosure now required by TILA
Amended by HR 3221:
15 United States Code §1638
Truth in Lending Act (TILA) disclosures must be delivered seven days prior to the origination of a loan. These disclosures must include examples of how much a borrower’s payments would change based on rate adjustments and disclose the maximum possible payment under the terms of the loan.
All TILA disclosures must be given to the borrower prior to payment for anything more than the fee to process a credit report.
The requirement to furnish the borrower with examples of how the borrower’s payments would change based on a variable rate loan and disclose the maximum possible payment under the terms of the loan becomes effective on the earlier of:
- the compliance date established by the Board; or
- January 2011.
City redevelopment of abandoned and foreclosed homes
Added by HR 3221:
Four billion dollars are available for state and local governments to redevelop abandoned and foreclosed homes and residential properties.
The funds are to go to the states and local governments with the greatest need, determined based on:
- the number and percentage of foreclosures;
- the number and percentage of homes financed by a subprime mortgage related loan; and
- the number and percentage of homes in default or delinquency.
Within 18 months of receipt of funds, they must be used to purchase and redevelop abandoned and foreclosed homes and residential properties, giving priority to those metropolitan areas/cities, urban areas, rural areas, low- and moderate-income areas, and other areas:
- with the greatest percentage of foreclosures;
- with the highest percentage of homes financed by a subprime mortgage related loan; and
- identified by the state and local government as likely to face a significant rise in the rate of home foreclosures.
The funds may be used to:
- establish financing mechanisms (soft-seconds, loan loss reserves, shared-equity loans for low- and moderate-income homebuyers, etc.) for purchase and redevelopment of foreclosed homes and residential properties;
- purchase and rehabilitate abandoned or foreclosed homes to sell, rent, or redevelop;
- establish land banks for foreclosed homes; and
- redevelop demolished or vacant properties.
Any purchase of a foreclosed home by the city must be at a discount from the current market appraised value, taking into account its current condition. The discount must ensure the price being paid is a below-market value.
Rehabilitation of a foreclosed home must comply with housing safety, quality, and habitability codes, and may include improvements to increase energy efficiency or conservation, or to provide a renewable energy source for such homes.
If the abandoned or foreclosed home is purchased, redeveloped, or sold by the city to an individual as a primary residence, the sale price cannot exceed the cost to acquire and redevelop the home.
During the five-year period after enactment of this act, any revenue generated from the sale, rental, redevelopment, or rehabilitation in excess of the cost to acquire or fix an abandoned or foreclosed home will be retained for use by the city. After the five-year period, the profits go to the U.S. Treasury.