Paying for the Payroll Tax Credit

As the final curtain fell on the political circus of 2011, congress managed to eke out one last dramatic performance and renew the payroll tax cut. The media has made much ado about the political gamesmanship and party line bickering that took place during the fiasco, but what the media has yet to explain is that the payroll tax extension will be paid for by American homeowners.

In order to fund the payroll tax cut congress raised the guarantee fee (or “g-fee”) for all loans backed by Fannie Mae, Freddie Mac, and Ginnie Mae bonds. The impact will hit all conventional, FHA and VA loans, which combine for roughly 95% of all loans being produced in today’s housing environment. Banks that produce these loans obtain a type of insurance protection against losses by securitizing those loans through one of these agencies. The banks pay a g-fee to these agencies for every loan securitized in this manner. If and when a loan goes bad, it is the agency absorbs the losses, not the bank.

Currently the g-fee stands at 25 basis points (bps), or 0.25%. As part of the measure passed by congress, the g-fee is going to increase to 35 bps, or 0.35%. The end result is that homebuyers and homeowners looking to refinance will have to pay a higher rate for future loans, roughly by 0.10%.

There are many programs which currently offer 30 year fixed financing at 3.75%, so let’s use this as an example. A $250,000 mortgage at 3.75% would feature a monthly payment of $1,157.79 for thirty years. After applying the 10 bps increase and recalculating for a 3.85% interest rate, this same homeowner would see their mortgage payment increase to $1,172.02 for the same $250,000 mortgage. Our homeowner in this example is going to pay $14.23 more on their mortgage so that the payroll tax cut can pass and the average American will pay $40 less per month in taxes. Sounds like a good deal, right?

Wrong. The difference is that the payroll tax cut was only extended for 2 months. So the average American will save $80 as a result of this bill. The increase in the mortgage payment for our sample homeowner is $170.76 per year. Given that the average lifespan of a loan is 7 years, this translates to an increase of $1,195.32. If the homeowner actually kept the loan for all 30 years, they would end up paying $5,122.80 more over the life of the loan just to fund this $80 savings. That just doesn’t sound like a good deal anymore – at least not for homeowners.

Now congress is talking about how to extend the payroll tax cut for the full year. Undoubtedly they’ll look for another source of funds to pay for it. Hopefully they’ll look elsewhere for those funds rather than tap into a real estate market that’s already struggling to recover.

Arnaud Dufour
Sr. Mortgage Banker
adufour@dljfinancial.com
714-677-4107

CA DRE # 01360217
NMLS # 335758