A New Plan for Homeowners That Protects Taxpayers, Too

First-time home buyers often don't have tens of thousands of dollars sitting around to use as a down payment. Here's a plan to help them.

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Borrowers, lenders, and realtors have begun complaining about new requirements to encourage bigger down payments on homes. Meanwhile, some economists and housing analysts insist that bigger down payments help create a more stable mortgage market. The Money ReportNow that the housing policy discussion has begun, it might be time for some innovative thinking. Is there a way to make the mortgage market stable while providing the government with a way to make home ownership more practical and still limit the risk to taxpayers? Tax-free down payment savings accounts might be a great solution.

First, let's identify the problem: first-time home buyers often don't have tens of thousands of dollars sitting around to use as a down payment. And saving can often be difficult for many Americans who live close to paycheck-to-paycheck. What if the government gave these people the opportunity to save more quickly, by paying less money in taxes, so that they could realize the dream of home ownership sooner?

For example, imagine if the government allowed Americans to contribute a portion of their paycheck each month to a tax-free down payment savings account. They could accumulate those savings as a pre-tax payroll contribution -- much like a 401(k) -- for as long as they like, up to some limit. Perhaps that ceiling could be the 35% of the median home prices in the U.S., which right now would set the cap at around $55,000. Then, once they're ready to make a home purchase, they can tap into that savings, tax-free.

Let's consider a real-life example. Imagine a couple who is just married at the age of 25. They want to save to buy a new home. Their combined income is $60,000. They want to buy a home that costs $250,000, which means that they would need $50,000 to put 20% down. They hope to buy a home in five years, which means they would need to save $10,000 per year, or $833 per month.

That's a lot of money to save. And it's a particularly large sum if we're talking after-tax earnings. After all, they might only make about $3,833 per month after income taxes, health insurance, Social Security, and Medicare are taken out of their paycheck. Putting aside another $833 per month would only leave them with something like $3,000 of disposable income.

But if they were allowed to save for a down payment pre-tax, then this would only result in their take home salary declining to around $3,200 -- including the big savings of $833 per month. Through the pre-tax savings, their net pay would be about $200 higher. That's not a huge difference, but it would certainly make their aggressive savings plan a little more manageable.

Of course, this theory would deprive the government from some taxes -- $200 worth per month in this case. But if you think about it, the government could actually save money through this approach in the long run, by encouraging bigger down payments. In many cases, as incomes rise in time, the government would be losing more tax revenue through higher interest payments that would have been deducted in future years due to a smaller initial down payment.

Tax-free down payment savings plans have already been getting some attention in policy circles. Last week, the American Enterprise Institute published a mortgage finance policy paper that suggested the idea as a tool to expand home ownership to more low- and middle-income Americans. Yesterday, in a hearing on Capitol Hill on housing finance policy, Arnold Kling, a witness from the Mercatus Center's Financial Markets Working Group at George Mason University, suggested the idea as well.

No matter what specific role the government plays going forward in housing finance, it's likely to guarantee a much smaller part of the mortgage market. That, combined with new regulatory goals, will almost certainly increase the down payment rates sought by lenders. Tax-free down payment accounts represent a great way for the government to continue to promote home ownership, but in a way that doesn't put taxpayers at risk by creating the moral hazard that government mortgage guarantees create.