President Obama’s Recovery Act implemented a tax credit for first time home buyers. The tax credit amounts to 10% of the home’s purchase price, and up to a maximum of $8,000.

This was widely welcomed by home buyers, sellers, and realtors alike. But at the same time, it has been a frustration to some home-buyers that they could not use this tax credit as part of their down payment for FHA loans.* The tax credit could not be used for any purposes in obtaining a loan, including a minimum down payment of 3.5% from other sources.

Recent changes have been announced by the Secretary of the Housing and Urban Development (HUD), which are intended to help with this situation. This new FHA rule allows the tax credit to be used as an additional down payment for other closing costs incurred in the process of purchasing a FHA loan. It still does not include the 3.5% down payment, but the contribution towards closing cost could help secure a lower the interest rate.

Furthermore, there are still other issues to be worked out with the scenario of using the tax credit towards any down payment or closing costs. Tax credit would normally be claimed by tax payers “after the fact” of home purchase on their income tax returns. IRS is not intending to pay out any money to anyone ahead of time. It has been proposed that buyers obtain a short term second loan for the amount of the tax credit and pay off this second loan with the income tax refund check. However, IRS is not willing to send the refund check to anyone other than the tax payer. That is a catch 22 situation because buyers could very well spend the refund money going on a vacation and not pay off this loan. There are no lenders at this time willing to fund this second loan without being assured that it will be paid off.

* The FHA is an institution, set up in 1934, which insures the lender’s loans, allowing the buyer to receive lower down payments, lower closing costs, and easier credit qualification. The process of purchasing an FHA insured loan includes rigorous background checks of your income, employment, and credit. Buyers who do not meet the qualifications would have to resort to seller-funded down payment assurance programs, which have been a questionable necessity in the past.