Read Nolo's Essential Guide to Buying Your First Home Online
Authors: Ilona Bray,Alayna Schroeder,Marcia Stewart
Tags: #Law, #Business & Economics, #House buying, #Property, #Real Estate
Nolo's Essential Guide to Buying Your First Home (5 page)
BOOK: Nolo's Essential Guide to Buying Your First Home
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icking up a book on homebuying for some light reading? We’re guessing not. If you’re reading this, you’re probably seriously interested in buying a house. But before we launch into how, let’s explore why—just in case you’ve got any lingering doubts about whether it’s a good idea. This chapter will preview some of the primary financial and personal benefits to buying a home (and you’ll find details on many of the subjects covered, such as tax benefits, in later chapters). Then we’ll talk about some common myths and fears, and how to get over them.
icking up a book on homebuying for some light reading? We’re guessing not. If you’re reading this, you’re probably seriously interested in buying a house. But before we launch into how, let’s explore why—just in case you’ve got any lingering doubts about whether it’s a good idea. This chapter will preview some of the primary financial and personal benefits to buying a home (and you’ll find details on many of the subjects covered, such as tax benefits, in later chapters). Then we’ll talk about some common myths and fears, and how to get over them.
Buy my first home.
Although Leah was happy with her rental place, she says, “I wanted a place that I could call my own, with a backyard for my cats, and space for an office so I could work at home full time. After three weeks of looking, I found it! And after a year, some of the best parts of homeownership are things I wasn’t even expecting—like having already gotten to know more neighbors than I did during a whole six years in my apartment. Plus, although I’ve never thought of myself as domestic, I’ve had a surge of interest in decorating—I put up Roman blinds, have been picking out paint colors, and just bought my first Christmas tree!”
Investment Value: Get What You Pay For … And Then SomeAlthough Leah was happy with her rental place, she says, “I wanted a place that I could call my own, with a backyard for my cats, and space for an office so I could work at home full time. After three weeks of looking, I found it! And after a year, some of the best parts of homeownership are things I wasn’t even expecting—like having already gotten to know more neighbors than I did during a whole six years in my apartment. Plus, although I’ve never thought of myself as domestic, I’ve had a surge of interest in decorating—I put up Roman blinds, have been picking out paint colors, and just bought my first Christmas tree!”
You’ve probably heard people talk about real estate as a great investment. But what exactly do you get out of the deal? Well, a few things: You’ll build equity instead of spending cash on rent, you gain immediate benefits (a place to live!), and you’ll eventually have full ownership of an appreciating asset.
Equity, BabyOver time, as you patiently pay your mortgage, two things may start happening—your principal loan balance will go down, and the house’s market value may go up. Both of these mean that you’re accruing
equity
. Equity is the difference between the market value of a house (what it’s currently worth) and the claims against it (what you have left to pay on any mortgages or loans you’ve taken out against it). You’d be hard-pressed to find another investment where you can borrow a large amount of money, pay a modest interest rate, and reap every bit of the gain yourself.
equity
. Equity is the difference between the market value of a house (what it’s currently worth) and the claims against it (what you have left to pay on any mortgages or loans you’ve taken out against it). You’d be hard-pressed to find another investment where you can borrow a large amount of money, pay a modest interest rate, and reap every bit of the gain yourself.
EXAMPLE:
Hugo buys a home for $300,000 with a $30,000 down payment and a $270,000 mortgage. If the market value of the house is $300,000, Hugo’s current equity in the home is $30,000 (market value minus mortgage debt). A few years later, Hugo has reduced the principal on the mortgage by $5,000, to $265,000. Meanwhile, the house’s value has risen to $310,000. Hugo now has $45,000 in equity: ($310,000 minus $265,000). That’s $15,000 more than he originally invested.
Hugo buys a home for $300,000 with a $30,000 down payment and a $270,000 mortgage. If the market value of the house is $300,000, Hugo’s current equity in the home is $30,000 (market value minus mortgage debt). A few years later, Hugo has reduced the principal on the mortgage by $5,000, to $265,000. Meanwhile, the house’s value has risen to $310,000. Hugo now has $45,000 in equity: ($310,000 minus $265,000). That’s $15,000 more than he originally invested.
Of course, sometimes the value of a property doesn’t increase: It can even decrease. Fortunately, history shows that houses rarely drop in value permanently. In fact, median existing U.S. home prices increased an average of 6.5% every year between 1972 and 2005, according to the National Association of Realtors®.
It Beats Paying RentA good chunk of the money you’ll use to finance your home is money you’re already spending anyway, on rent. When you buy a house, that cash is actually going into your investment.
You Can Live in Your InvestmentSome people like to call a mortgage a forced savings plan, because it makes you sock a little cash away every month in the form of a mortgage payment—money you’ll probably get back when you sell the place. On the other hand, we like to call it a smart investment plan, because it gives you both a roof over your head
and
a way to convert your cash into a potentially appreciating asset.
That House Isand
a way to convert your cash into a potentially appreciating asset.
Yours
One benefit to buying a house is kind of obvious ... you’re becoming a home
owner
, and when the loan is paid off, you won’t have to pay for a place to live. You could keep renting the same place you’re in now for 50 years, and at the end of that time you’ll still have to pay monthly rent checks to your landlord.
Tax Breaks: Benefits From Uncle Samowner
, and when the loan is paid off, you won’t have to pay for a place to live. You could keep renting the same place you’re in now for 50 years, and at the end of that time you’ll still have to pay monthly rent checks to your landlord.
As if buying a home weren’t already financially beneficial, you’ll get to claim various federal tax deductions and credits for home-related expenses. These can add up to some serious savings.
Tax Deductions Versus Tax CreditsBe careful not to confuse a tax deduction with its more valuable cousin, a tax credit. A tax deduction is an amount you subtract from your gross income (all the money you earned during the year) to figure out how much of your income is subject to tax. For example, if your gross income is $80,000, and you have a $2,000 tax deduction, your taxable income is reduced to $78,000.A tax credit, by contrast, is a dollar-for-dollar reduction in your tax liability. If your taxable income is $80,000, and you qualify for a $2,000 tax credit, your taxable income is still $80,000, but you get to reduce the amount of tax you ultimately owe by $2,000.
As a new homeowner, you may be entitled to certain tax credits.
•
Tax credit for first-time homebuyers.
If you purchase your first home before July 1, 2009, you may be eligible for a tax credit of 10% of the purchase price of the home, up to a maximum of $7,500, in the year you make your purchase. If you make $75,000 or less ($150,000 if married filing jointly), you’re eligible for the full credit; the credit phases out at higher income levels and is eliminated entirely when your income reaches $95,000 ($170,000 if married filing jointly). The downside of the credit is that you must pay it back over 15 years, so it functions more like an interest-free loan. Still, it can put a little extra cash in your pocket the year of purchase.
•
Tax credits for energy-efficiency.
In 2009, if you make your home more energy-efficient by putting in insulation, replacement windows, water heaters, or certain high-efficiency heating and cooling equipment, you may be eligible for a tax credit of up to $500. For more information, visit
www.energystar.gov
(search for “tax credit”).
One of the biggest deductions will be the interest you pay on your home mortgage (available for mortgages up to $1 million for individuals and married couples filing jointly and $500,000 for marrieds filing separately). This one’s particularly advantageous during the first few years of a fixed rate mortgage, when most of your payment will be put toward interest.
Other Tax-Deductible ExpensesYou can also deduct certain other expenses, such as:
Itemizing Your Deductions•
Property taxes.
While the amount varies between states, most people pay around 2%-4% of the home’s value each year in state property tax, which is deductible from your federal taxes.
•
Points.
Points are additional and usually optional fees paid when you buy your mortgage (you get a reduced interest rate in return). They’re tax-deductible in the year you pay them.
•
Private mortgage insurance (PMI).
If you get a mortgage for more than 20% of your home’s purchase price, the lender will probably require you to buy PMI. (Though you pay the premiums, PMI protects the lender from loss if you don’t make your payments.) Through 2010, PMI is tax-deductible, though the amount of the deduction decreases as the taxpayer’s income increases.
•
Interest on a home improvement loan.
If you take out a loan to make improvements that increase your home’s value, prolong its life, or adapt its use—for example, by adding a deck or a new bathroom—you can deduct the interest on that loan, with no limit. But you can’t deduct interest on loans used to make normal repairs, such as repainting the kitchen or fixing a broken window.
•
Interest on home equity debt.
Sometimes you can deduct interest on a home equity loan even if the money isn’t used to buy, build, or improve your home, for example, if you use it toward a child’s college tuition or family medical bills. The deduction is limited to a maximum loan amount or the total fair market value of the home less other mortgages. The maximum loan amount is $100,000 for an individual or married couple filing jointly and $50,000 if married but filing separately.
•
Home office expenses.
If you use part of your home exclusively for a home-based business, you may be able to deduct a portion of the related expenses—including the costs of some home repairs.
•
Moving costs.
If you move because of a new job that’s more than 50 miles from your current residence, you may be able to deduct your moving expenses.
•
Prepayment penalties.
Although we advise against getting a mortgage with a prepayment penalty (as discussed in Chapter 6), if you do, and then you make a prepayment, the penalty you pay will be tax-deductible.
To take advantage of house-related tax deductions, you’ll need to
itemize
your tax deductions, rather than take the standard deduction (for 2008 tax returns, $5,450 for individuals and $10,900 for marrieds filing jointly). The true tax savings comes in the difference between your tax liability when you take the standard deduction and your tax liability when you itemize. Itemizing involves a step up from the good old 1040EZ, but it’s not all that complicated. To make it worthwhile, your itemized deductions should exceed the standard deduction. With the high price of real estate these days, it’s not usually too hard to outpace the standard deduction with deductible homeowner costs, not to mention other deductible expenses like donations to your favorite charity.
itemize
your tax deductions, rather than take the standard deduction (for 2008 tax returns, $5,450 for individuals and $10,900 for marrieds filing jointly). The true tax savings comes in the difference between your tax liability when you take the standard deduction and your tax liability when you itemize. Itemizing involves a step up from the good old 1040EZ, but it’s not all that complicated. To make it worthwhile, your itemized deductions should exceed the standard deduction. With the high price of real estate these days, it’s not usually too hard to outpace the standard deduction with deductible homeowner costs, not to mention other deductible expenses like donations to your favorite charity.
EXAMPLE:
Let’s say you get a $200,000 fixed rate loan at 6% interest. You’re looking at paying around $12,000 the first year in interest alone. That doesn’t count property taxes, points on the mortgage, or any other tax-deductible expenses.
Let’s say you get a $200,000 fixed rate loan at 6% interest. You’re looking at paying around $12,000 the first year in interest alone. That doesn’t count property taxes, points on the mortgage, or any other tax-deductible expenses.
If you’re single, the standard deduction is $5,450. But if you itemize your deductions, you could deduct the $12,000 in interest payments instead. By itemizing even this one deduction, almost $7,000 less of your income will be taxed.
TIPKeep good records.
You’ll be able to reap the benefits of itemizing your deductions only if you know about them and are prepared to prove them to the IRS—all of them, not just the house-related ones. Keep a file of receipts for the more common deductions, such as unreimbursed business expenses (office equipment and travel); educational expenses (tuition and books); charitable contributions; and unreimbursed medical expenses. Consider getting help from a tax professional—even your meeting might be tax-deductible!
CHECK IT OUTGo straight to the source.
See IRS Publication 530,
Tax Information for First-Time Homeowners
, available at
www.irs.gov
. This publication will give you more detailed information about the tax benefits of buying a home.
BOOK: Nolo's Essential Guide to Buying Your First Home
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