Q I just finished filling out my federal income tax return for 2004. We don’t own a home, so we don’t have a mortgage deduction and therefore we don’t have enough deductions to itemize our return. We’d like to save money on taxes, but we don’t want to increase our monthly rent expense. Is it really worth it to buy a home for the tax savings?
C.P., Edmonds
AI wouldn’t recommend buying a home just for the tax benefits. However, the savings are significant, so you are missing out on the last great tax break available to the average American if you don’t own a home. But let’s turn your question around. Rather than looking at how much you’d save in taxes by purchasing a home, let’s see how the tax savings might allow you to buy a home without blowing your household budget.
For example, let’s assume that you’re paying $1,200 a month to rent a nice home in a good neighborhood. How much home could you afford if you keep your housing expense at $1,200 a month?
First, you have to subtract a monthly amount for property taxes and homeowner’s insurance. Property taxes vary from home to home. You can obtain the amount of the actual property tax bill on a given home from the listing agent. However, if this information is not readily available, you can use this simple rule of thumb to estimate the property tax bill: Multiply the sales price of the home by 1 percent. For example, $200,000 times 1 percent equals $200. That means the property tax bill on a $200,000 home would be approximately $200 a month. This is a very rough calculation, but it’s close enough for our purposes in this illustration. Homeowner’s insurance costs can easily be determined by obtaining a quote from your insurance agent.
Using the $200,000 home as an example, if we assume the property taxes are approximately $200 a month and homeowners insurance costs approximately $40 a month, you would subtract $240 from your $1,200 monthly payment, leaving you with $960 a month for the loan payment.
You can get a lower interest rate by selecting an adjustable rate mortgage or a buy-down loan program of some kind, but let’s say you’re conservative and you want to stick with a 30-year fixed rate mortgage because you like the certainty of knowing exactly what your payment will be each and every month for the life of the loan.
At today’s interest rates, you could get a 30-year fixed rate mortgage of about 5.5 percent without paying points to get a lower interest rate. At 5.5 percent, a $960 monthly payment would allow you to borrow $169,000. With today’s zero-down loan programs, it is possible to buy a home with as little as $500 out of pocket, so lack of a large savings account is no longer a roadblock to homeownership.
Should you limit yourself to a home that costs $169,000 or less? Let’s see what impact the tax deduction has on your home buying decision.
Let’s say you decide to extend yourself a bit and buy a $200,000 home. The payment on a $200,000 mortgage at 5.5 percent would be $1,135 a month. Adding $240 for taxes and insurance, your total monthly housing expense would be $1,375 – $175 a month more than your rent payment. But after one year of payments on this loan, you will have paid $10,932 in interest plus $2,400 in property taxes, for a total tax deduction of $13,332. If you are in the 15 percent income tax bracket, that deduction would save you $2,000 in taxes, which is $167 a month. After deducting the tax savings, your true cost of owning a $200,000 home would be only $1,208 a month, which is about the same amount as your rent in this example.
Now, I should point out that I simplified the example above by leaving out factors such as the standard deduction available to taxpayers who do not itemize. But as you can see, the primary benefit of the home mortgage tax deduction is that it allows you to buy a more expensive home with a given amount of income by reducing the true cost of your monthly loan payments.
Mail your real estate questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206. Fax questions to Tytler at 425-339-3435, or e-mail him at economy@heraldnet.com
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