Congratulations, you missed the $8,000 tax credit

Thanks for the reblog... I had missed the original one! Great points worth consideration!

This marketing strategy does not include several key, basic financial concepts.  The $8,000 credit has earnings power (even if it "just" reduces the purchase price) and the interest expense is deductible on tax returns.  Factoring these into the scenario can change the conclusion being drawn.

Yes, the interest rate decrease is absolutely going to be a big money saver over time.  The longer they are in the house the more money saved on interest expense. 

However, I believe the example cited is too simplistic.  Reducing the interest amounts paid over the term on the loan by the tax credit 30 years earlier does not factor in the compounded earnings of receiving the $8k thirty years earlier.  Purchase price $180,000, 3.5% down. Loan balance is $173,700 in both the April (month tax credit expired) and Sept (now).

Investing the $8k in tax free 30 year Treasuries on April 30, 2010 would yield a return of 4.53%.  At the end of 30 years that is $22,220 of earnings to offset the interest expense paid. That does not include the $8k.

Interest expense is also deductible on your tax return, subject to limitations (limitations apply only for a small portion of taxpayers).   

Loan in April with $8k tax credit:         Interest costs of $181,350 less $22,220 (earnings on $8k of 30 year Treasuries) plus the tax benefits of $39,783 means a cost of $119,347.  And it is also reduced by the $8k received in 2010 for a real cost of $111,347.

Loan in Sept with lower interest rate:    Interest costs of $133,920 with taxable benefits of $33,480 for a real cost of $100,440.

Conclusion 1:    Over a full term of the loan, in the low down FHA situation, to full 30 year term, the buyer receiving the tax credit is worse off after recognizing the earnings from investing in tax free Treasuries and the interest expense deduction.  Point confirmed - correct? yes, for these very specific, limited circumstances.

In a 20% down payment scenario, the tax credit purchaser is  better off than the Sept purchaser.  I won't go through the calculation again - if you want to see it, email me.

However:  This too is probably overly simplistic as most people do not invest in tax free Treasuries.  A more likely scenario might be investing in the stock market.  Over the long term (30+ years for comparability), the average before tax return from the stock market has been 8-10%.  Assuming an 8% return, there are total earnings of $72,500.  This is taxed at the marginal rate of 25% ($18,125) reducing the after tax earnings to $54,375.  This is an additional benefit of $32,155 over the Treasuries example making the real cost for the person receiving the credit $79,192.  That means the Sept buyer missing the tax credit with the lower interest rate "paid" $21,248 (26.8% more!) more in real costs than the buyer receiving the tax credit.

Not quite the rosy scenario painted above.

Conclusion 2:     I'd rather have the tax credit. And I can refinance at the lower interest rate too. Getting the tax credit and refinancing are not mutually exclusive for the next 30 years.

If you made it through all the numbers and arrived here - all of the above is most likely not going to happen.  Very few people actually keep their 30 year mortgage; most have an earlier time horizon.  It could be interest rates are lower and they refinance, or they move or ....... Life "happens" over 30 years.

The above analysis does not incorporate the present value of money, which brings all of the money streams back to a common point.  No, I won't have you go through that detailed analysis, but here is a simple comparison.

Which would you rather have:  $8,000 now or $8,036.75 in 5 years and one month? I would be glad to borrow $8,000 now and pay the lender $8,036.75 in five years and 1 month.

The earnings on tax free Treasuries in 61 months is over $1,600.  The value of $8000 today is not the same as $8,000 of interest saved over the same 61 months. You have to compare the cash flow stream at a common point in time (the present value) to be meaningful.  Otherwise it is misleading and wrong.

Final conclusion:    Be careful/skeptical of overly general and simplistic scenarios when comparing cash flows and interest rates.  The Denver Post had an overly simplistic article (similar to this scenario) in the business section.  Real life is a lot more complicated than a lowest common denominator news article.

Focus on the low interest rates - not on being better off than someone who got the tax credit - it may not be true.

Mel

Valerie, I didn't see the original post so thanks for the re-blog. Also, seems to me that those that didn't buy initially will still get an additional savings, as prices have come down and some sellers were actually trying to hold value believing that the $8,000 credit should have been savings enough for the buyer. As for Mel & Gretchen, their comment looks like a full blog.

Valerie I love the title of blog ! ... wonder what else will be brought forward for home buyers !

Have a fab...u...lous week !

I am going to a conference next week... I'm going to give the "fabulous" a try!