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Buying a home is when you begin building equity in an investment instead of paying rent. And Uncle Sam is there to help ease the pain of high mortgage payments. The tax deductions now available to you as a homeowner will reduce your tax bill substantially.
For most people, the biggest tax break from owning a home comes from deducting mortgage interest. For tax year prior to 2018, you can deduct interest on up to $1 million of debt used to acquire or improve your home.
For tax years after 2017, the limit is reduced to $750,000 of debt for binding contracts or loans originated after December 16, 2017. For loans prior to this date, the limit is $1 million.Your lender will send you Form 1098 in January listing the mortgage interest you paid during the previous year. That is the amount you deduct on Schedule A. Be sure the 1098 includes any interest you paid from the date you closed on the home to the end of that month. This amount should be listed on your settlement sheet for the home purchase. You can deduct it even if the lender does not include it on the 1098. If you are in the 25% tax bracket, deducting the interest basically means Uncle Sam is paying 25% of it for you.
When you buy a house, you may have to pay “points” to the lender in order to get your mortgage. This charge is usually expressed as a percentage of the loan amount. If the loan is secured by your home and the amount of points you pay is typical for your area, the points are deductible as interest as long as the cash you paid at closing via your down payment equals the points.
For example, if you paid two points (2%) on a $300,000 mortgage—$6,000—you can deduct the points as long as you put at least $6,000 of your own cash into the deal. And believe it or not, you get to deduct the points even if you convinced the seller to pay them for you as part of the deal. The deductible amount should be shown on your 1098 form.
You can deduct the local property taxes you pay each year, too. The amount may be shown on a form you receive from your lender, if you pay your taxes through an escrow account. If you pay them directly to the municipality, though, check your records or your checkbook registry. In the year you purchased your residence, you probably reimbursed the seller for real estate taxes he or she had prepaid for time you actually owned the home.
If so, that amount will be shown on your settlement sheet. Include this amount in your real estate tax deduction. Note that you can’t deduct payments into your escrow account as real estate taxes. Your deposits are simply money put aside to cover future tax payments. You can deduct only the actual real estate tax amounts paid out of the account during the year.
Beginning in 2018, the total amount of state and local taxes, including property taxes, is limited to $10,000 per tax year.
Buyers who make a down payment of less than 20% of a home’s cost usually get stuck paying premiums for Mortgage Insurance, which is an extra fee that protects the lender if the borrower fails to repay the loan. For mortgages issued in 2007 or after, home buyers can deduct premiums. This deduction ended in 2017.
This write-off phases out as adjusted gross income increases above $50,000 on married filing separate returns and above $100,000 on all other returns. (If you’re paying mortgage insurance on a mortgage issued before 2007, you’re out of luck on this one.)
As a further incentive to homebuyers, the normal 10% penalty for pre-age 59½ withdrawals from traditional IRAs does not apply to first-time home buyers who break into their IRAs to come up with the down payment.
However, this exception to the 10% penalty does not apply to withdrawals from 401(k) plans.
At any age you can withdraw up to $10,000 penalty-free from your IRA to help buy or build a first home for yourself, your spouse, your kids, your grandchildren or even your parents.
However, the $10,000 limit is a lifetime cap, not an annual one. (If you are married, you and your spouse each have access to $10,000 of IRA money penalty-free.)
To qualify, the money must be used to buy or build a first home within 120 days of the time it’s withdrawn.
But get this: You don’t really have to be a first-time homebuyer to qualify. You’re considered a first-timer as long as you haven’t owned a home for two years. Sounds great, but there’s a serious downside.
Although the 10% penalty is waived, the money would still be taxed in your top bracket (except to the extent it was attributable to nondeductible contributions).
That means as much as 40% or more of the $10,000 could go to federal and state tax collectors rather than toward a down payment. So you should tap your IRA for a down payment only if it is absolutely necessary.
There’s a Roth IRA corollary to this rule, too. The way the rules work make the Roth IRA a great way to save for a first home.
First of all, you can always withdraw your contributions to a Roth IRA tax-free (and usually penalty-free) at any time for any purpose.
And once the account has been open for at least five years, you can also withdraw up to $10,000 of earnings for a qualifying first home purchase without any tax or penalty.
Save receipts and records for all improvements you make to your home, such as landscaping, storm windows, fences, a new energy-efficient furnace and any additions.
You can’t deduct these expenses now, but when you sell your home the cost of the improvements is added to the purchase price of your home to determine the cost basis in your home for tax purposes. Although most home-sale profit is now tax-free, it’s possible for the IRS to demand part of your profit when you sell. Keeping track of your basis will help limit the potential tax bill.
Some energy-saving home improvements to your principal residence can earn you an additional tax break in the form of an energy tax credit worth up to $500. A tax credit is more valuable than a tax deduction because a credit reduces your tax bill dollar-for-dollar.
You can get a credit for up to 10% of the cost of qualifying energy-efficient skylights, outside doors and windows, insulation systems, and roofs, as well as qualifying central air conditioners, heat pumps, furnaces, water heaters, and water boilers.
There is a completely separate credit equal to 30% of the cost of more expensive and exotic energy-efficient equipment, including qualifying solar-powered generators and water heaters. In most cases there is no dollar cap on this credit.
Another major benefit of owning a home is that the tax law allows you to shelter a large amount of profit from tax if certain conditions are met. If you are single and you owned and lived in the house for at least two of the five years before the sale, then up to $250,000 of profit is tax-free. If you’re married and file a joint return, up to $500,000 of the profit is tax-free if one spouse (or both) owned the house as a primary home for two of the five years before the sale, and both spouses lived there for two of the five years before the sale.
Thus, in most cases, taxpayers don’t owe any tax on the home-sale profit. (If you sell for a loss, you cannot take a deduction for the loss.)
You can use this exclusion more than once. In fact, you can use it every time you sell a primary home, as long as you owned and lived in it for two of the five years leading up to the sale and have not used the exclusion for another home in the last two years. If your profit exceeds the $250,000/$500,000 limit, the excess is reported as a capital gain on Schedule D.
In certain cases, you can treat part or all of your profit as tax-free even if you don’t pass the two-out-of-five-year tests. A partial exclusion is available if you sell your home “early” because of a change of employment, a change of health, or because of other unforeseen circumstances, such as a divorce or multiple births from a single pregnancy.
A partial exclusion means you get part of the $250,000/$500,000 exclusion. If you qualify under one of the exceptions and have lived in the house for one of the five years before the sale, for example, you can exclude up to $125,000 of profit if you’re single or $250,000 if you’re married—50% of the exclusion of those who meet the two-out-of-five-year test.
If your new home will increase the size of your mortgage interest deduction or make you an itemizer for the first time, you don’t have to wait until you file your tax return to see the savings. You can start collecting the savings right away by adjusting your federal income tax withholding at work, which will boost your take-home pay. Get a W-4 form and its instructions from your employer or go to www.irs.gov
Source: intuit | turbotax “Buying Your First Home” (Updated for Tax Year 2018)
Photo by sept commercial on Unsplash
Ah, to be a first-time home buyer again: How easy it was to buy a home when you weren’t carrying another mortgage on your back!
If you’re looking to graduate from first-timer to repeat buyer, you know things are about to get much trickier. Unless you’re a bona fide house collector, you’ll have to sell your home in order to buy anew—adding a whole separate layer of anxiety to what you already know is a stressful home-buying process.
In an ideal world, you’d buy a new home, move, and then, and when all the dust settles, deal with the turmoil of selling. But for most people, that’s totally unrealistic. Not only does it cost significantly more, since you’ll be paying two mortgages, but sellers might be quick to judge if you’re holding on to your current home.
Drew Snyder, a Realtor® with Snyder Sutton Real Estate in Topanga, CA, says one of his clients had difficulty getting sellers to “take them seriously unless the house was on the market or in escrow. As soon as we put it on [the market], they were considered as serious buyers.”
You can do this! If selling and buying simultaneously is the only way to go, here’s what you need to know to make sure both processes go as smoothly as possible.
Before you start seriously searching for a new home—or put your current home on the market—make sure you have a solid understanding of the housing market in your area (and the area where you’re planning to buy). Is the market weighted toward buyers or sellers?
Only then will you be able to fully strategize. As is so often the case, the best plan of action may differ depending on exactly who has the power.
That doesn’t mean to find one house you like and call it a day: Find multiple suitable options. That way, you’re less likely to find yourself in trouble if your purchase falls through—your newly sold home won’t leave you stranded.
Similarly, make sure to hire an appraiser and price your old home fairly. Now is decidedly not the time for delusions of grandeur: Two extra months on the market because you couldn’t humble yourself to lower the price means two months you’ll be paying double mortgages. Two very long months…
Should you buy first, then sell—or vice versa? Both have their risks and rewards. Selling first makes getting a mortgage easier, but it also means you’ll need to find a temporary place to live. Buying first means moving will be easier, but it also skews your debt-to-income ratio, making it harder to qualify for a new mortgage—not to mention the difficulty of juggling two monthly house payments.
“It’s walking a tightrope,” says Gary DiMauro, a Realtor in New York’s Hudson Valley. And he’s not just talking about scheduling: Your finances will be on the highwire, too. When determining whether you should sell or buy first, think beyond “How can I make the move as easy as possible?” Instead ask: “Can I handle two mortgages? What if my home sells for less than its listing?”
Whichever option you choose, make sure you’re prepared to accept the consequences: having to store your stuff and rent temporarily, or undergoing the financial burdens of dual mortgages.
When buying and selling a home simultaneously, “there are so many external circumstances,” says DiMauro. “I’ve yet to see it really work smoothly and efficiently.”
Remember: You’re not the only party in this equation. For every seller there’s a buyer, for every buyer a seller. While things might appear to be working smoothly when viewing your master plan from above, that doesn’t take into account the variabilities of other people. Closings are rife with delays. Your buyers might have difficulty securing their mortgage; your home inspector may bring up issues that need to be fixed before you can move in.
“You’re relying on the seller of the place that you’re buying to be ready to move in concert with the buyer of your house,” DiMauro says.
So even if you’ve planned to sell your home first and are prepared to rent while buying, know that even the best-laid plans go awry—and you might end up juggling both mortgages. Preparing yourself for this (however remote) possibility ahead of time will ensure a smooth transition.
For those who choose to sell first, the process is relatively straightforward other than the additional cost of a rental between homes. However, there is the option of a rent-back agreement, where you negotiate with the lenders and buyers to be able to remain in the property for a maximum of 60 to 90 days—often in exchange for a lower selling price or rent paid to the buyers. This can relieve some of the pressure of finding a new home, giving you additional time to house hunt.
But if you’re buying first, talk to your Realtor about ways to decrease your financial burden and risk. Here are the two most popular options for buyers:
Contract contingency: Buyers can request that their new home purchase be dependent on the successful sale of their old home. If you’re looking in a competitive market, this may not be a good option; however, if the seller of your intended home has had difficulty attracting interest, this may be a good deal for all parties involved—assuming you can convince them that your home will sell quickly.
Bridge loans: Bridge financing allows you to own two homes simultaneously if you don’t have deep pockets for a second down payment. This option is especially attractive if you’d planned to sell your home first and use the proceeds to buy the second. It functions as a short-term loan, intended to be repaid upon the sale of your original house.
If your home has sold but you haven’t found a new place to live, don’t let anxiety push you toward a bad decision. DiMauro usually recommends that his clients pre-emptively plan on a short-term rental “so they don’t feel stressed or pushed into something that they would not normally be interested in,” he says. “They shouldn’t make a purchase because they felt like they were pressured from the time constraints.”
Found the perfect home right on schedule? That’s great. But don’t feel like you have to compromise on things that are important to you just because you need to find a home. Conversely, don’t accept a bid that you feel is too low just because your finances are strained by two mortgages. If you have a temporary apartment set up, you’re less likely to compromise.
Certainly, selling and buying a house simultaneously will be stressful—but carefully considering and planning for the risks and hurdles can mitigate the stress.
Source: Realtor.com – How to Buy and Sell a Home at the Same Time—Without Losing Your Mind, Author: Jamie Wiebe
“Down payment”: It’s amazing that these two little words have such a profound influence on your home ownership process—and your life! Ask most people what is an acceptable down payment on a house, and nine times out 10 they’ll tell you it’s 20% of your home’s selling price. So you do the math, figure you’d have to put down $50,000 on a $250,000 house, and break out in hives when you realize that the chances of your getting out of that tiny one-bedroom apartment are slim.
Well chin up, buckaroo. That 20% figure is common, but it’s not set in stone. Sure, there are many reasons why you should make a 20% down payment on a house, but most banks will allow you to put down less—and yes, you can put down even more if you’re feeling flush.
Let’s take a look at the pros and cons of making a number of different down payments on a house.
It might sound like a huge chunk of change, but you’ll ultimately end up paying less if you make a 20% or higher down payment on a house. That’s because when you put 20% down, you won’t have to pay mortgage insurance, which can add several hundred dollars a month to your house payments.
“Mortgage insurance exists because the lender … assumes additional risk when a homeowner’s equity stake is small,” mortgage banker Craig Berry explains in The Mortgage Reports.
Both private lenders and the Federal Housing Administration have mortgage insurance plans. No matter which you chose, you’ll likely have to pay a one-time fee upfront and then another amount of money that will be tacked onto your monthly mortgage.
The only good thing about mortgage insurance is that it doesn’t last forever. When your loan-to-value ratio is 80% (or you have paid the equivalent of 20% of your home’s value), you can ask your lender to stop charging you for the insurance. Once the loan-to-value ratio reaches 78%, the lender is legally obligated to cancel it.
Another advantage of making a 20% down payment on a house is that that’s often the magic number at which point you’ll get a more favorable interest rate. So you can see the various advantages to saving up for that 20% down payment if it’s possible.
If you are unable to make a 20% down payment, there are many lenders that will allow you to make a smaller down payment on a house. Among them is the FHA, which offers mortgages with as little as 3.5% down, if your annual income is under a certain amount that varies by market. There are even some lenders, like the U.S. Department of Agriculture, that allow you to put 0% down, but eligible homes are usually in rural areas, and your income must meet certain low requirements.
Although you can find decent terms when you put less than 20% down, remember that since you’ll be financing a greater amount, no matter how favorable the terms you negotiate, your payments will be higher and you’ll be paying more interest, so the home will ultimately be more expensive.
People who inherit a windfall sometimes choose to put more than 20% down, so their payments will be lower and they can avoid mortgage insurance payments. But others, with very low credit ratings, are required by the lender to put more than 20% down. According to Robert Berger in U.S. News & World Report, if your credit score is under 620, you’ll probably have to put more than 20% down to get a conventional loan.
There is a surprising amount of down payment and home loan assistance out there for those in need. It comes in the form of low-interest-rate loans, grants, and tax credits. According to Sean Moss of downpaymentresource.com, in some cities you can get as much as $100,000 in assistance for purchasing your first home.
Of course, most of these programs depend on factors like your income, a maximum home price, and even your profession. For example, government employees in the Washington, DC, area may be eligible for $10,000 in down payment assistance, and teachers in Los Angeles and Orange County, CA, can get up to $15,000 to help them with their home purchases. Ask your real estate agent about these types of programs that you are eligible for.
For most people, a home is the biggest financial commitment they’ll make, but don’t let that intimidate you. If you’re serious about owning your own place, there are lots of resources out there to help make this into a reality.
Source: Realtor.com – What Is the Standard Down Payment on a House? Author: Lisa Johnson Mandell
One of the most basic equations you can use to figure out home affordability is your debt-to-income ratio. This is essentially a way for you (and lenders) to compare how much money you make with how much you owe—and how a house can fit into that picture.
As a general rule, your debt-to-income ratio should remain below 36%, says David Feldberg, broker/owner of Coastal Real Estate Group in Newport Beach, CA.
Here’s how to figure it out: Calculate how much you’re paying in debt per month—that’s things like car payments and college loans. Then divide that amount by your monthly income. Let’s say, for instance, that every month you’re paying $500 to debts and pulling in $6,000. Divide $500 by $6,000 and you’ve got a debt-to-income ratio of 0.083 or 8.3%. That’s well below 36%, but then again, you don’t own a home yet.
Once you know your income and debt, you can plug those numbers into a home affordability calculator to see how much home you can afford while still remaining below that 36% debt-to-income threshold. Let’s take the aforementioned example where you make $6,000 a month and pay $500 in debts. Now let’s assume you’ve got around $30,000 for a down payment and can get a 30-year fixed-rate mortgage at a 5% interest rate. So this will put you in the ballpark of affording a home worth $248,800.
So what does this amount to, month to month? To know that, you’ll want to factor in more than just your mortgage. There are other expenses, including property taxes and home insurance. Add those in, and you’ll be paying about $1,573 for the privilege of owning this house.
Of course, these numbers will change with your circumstances. Let’s say you got a raise and now make $8,000 per month. Take those same numbers above (a down payment of $30,000 on a 30-year fixed-rate mortgage at 5%) and you’d be able to afford a home worth $274,600, with a monthly housing payment of $2,073. Or let’s say you make $8,000 per month and are able to whittle your debt in half, down to $250 per month. That would mean “how much home” you can afford is in the area of $313,100, with monthly payments of $2,201 per month.
As you can see, when you’re trying to figure out how much home you can afford, the details matter, so be sure to take all of them into account. In other words, don’t look at just your salary, or just how much your mortgage payments will be. The clearer the picture you have of your financial commitments, the easier it will be to figure out how much home you can afford without getting in over your head.
Source: Realtor.com How Much Home Can I Afford? Find That Magic Number Here by Cathie Ericson
Photo by LinkedIn Sales Navigator on Unsplash
Your mortgage isn’t the only cost that goes along with buying a home. You’ll also be responsible for purchasing a homeowners insurance policy and paying property taxes. Depending on the kind of mortgage you’re getting and your lender’s requirements, these costs may be added on to your monthly loan payment.
With homeowners insurance, it’s common for buyers to pay the first year’s premiums in advance. If you’re not budgeting for these costs ahead of time, that could throw a wrench in your home buying plans.
Source: SmartAsset – Questions First-Time Homebuyers Forget to Ask
Typically, when your offer is accepted, the seller expects you to pony up a deposit as a sign of good faith. This earnest money is usually around 1% to 2% of the purchase price, but the actual amount can vary.
Aside from knowing how much earnest money you’ll need, it’s also important to find out whether you can get your deposit back if the deal falls through. If you don’t include a clause in the contract stating that you have a set amount of time to retrieve your earnest money, you may forfeit the cash if you decide not to purchase the home.
Source: SmartAsset – Questions First Time Homebuyers Forget to Ask
Photo by Nik MacMillan on Unsplash
Once you find a home you love, the next step is to make an offer. If you’re represented by a real estate agent, this is something they can assist you with. In their offer letters, many buyers focus on the deal they can get on the purchase price. But it’s also a good idea to be clear on what concessions, if any, you plan to ask for.
For example, you may want the seller to chip in a certain amount of money toward the closing costs. If the seller agrees, that’ll affect how much money you’ll need to bring to the closing table. Asking about concessions before you have a contract in place can keep you from being caught off guard down the line.
Source: SmartAsset – Questions First Time Homebuyers Forget to Ask
Photo by Jeremy Yap on Unsplash
When buying a home, cash is king, but most folks don’t have hundreds of thousands of dollars lying in the bank. Of course, that’s why obtaining a mortgage is such a crucial part of the process. And securing mortgage pre-qualification and pre-approval are important steps, assuring lenders that you’ll be able to afford payments.
However, pre-qualification and pre-approval are vastly different. How different? Some mortgage professionals believe one is virtually useless.
“I tell most people they can take that pre-qualification letter and throw it in the trash,” says Patty Arvielo, a mortgage banker and president and founder of New American Funding, in Tustin, CA. “It doesn’t mean much.”
Pre-qualification means that a lender has evaluated your creditworthiness and has decided that you probably will be eligible for a loan up to a certain amount.
But here’s the rub: Most often, the pre-qualification letter is an approximation—not a promise—based solely on the information you give the lender and its evaluation of your financial prospects.
“The analysis is based on the information that you have provided,” says David Reiss, a professor at the Brooklyn Law School and a real estate law expert. “It may not take into account your current credit report, and it does not look past the statements you have made about your income, assets, and liabilities.”
A pre-qualification is merely a financial snapshot that gives you an idea of the mortgage you might qualify for.
“It can be helpful if you are completely unaware what your current financial position will support regarding a mortgage amount,” says Kyle Winkfield, managing partner of O’Dell, Winkfield, Roseman, and Shipp, in Washington, DC. “It certainly helps if you are just beginning the process of looking to buy a house.”
A pre-approval letter is the real deal, a statement from a lender that you qualify for a specific mortgage amount based on an underwriter’s review of all of your financial information: credit report, pay stubs, bank statement, salary, assets, and obligations.
Pre-approval should mean your loan is contingent only on the appraisal of the home you choose, providing that nothing changes in your financial picture before closing.
“This makes you as close to a cash buyer as you can be and gives you a huge advantage in a competitive market,” says Lea Lea Brown, a vice president and mortgage banker with Atlanta-based PrivatePlus Mortgage.
In fact, pre-approval letters paired with clean contracts without tons of contingencies have won bidding wars against all-cash offers, Brown says.
“The reliability and simplicity of your offer stand out over other offers,” Brown says. “And pre-approval can give you that reliability edge.”
So take notice, potential home buyers. While pre-qualification can be helpful in determining how much a lender is willing to give you, a pre-approval letter will make a stronger impression on sellers and let them know you have the cash to back up an offer.
Source: Realtor.com – Mortgage Pre-Qualification vs. Pre-Approval: What’s the Difference? – Author: Lisa Gordon
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