It seems like there is always a steady stream of first time buyers looking to get information about buying their first home. They all have different reasons for wanting to buy a home – settling down and starting a family, tired of dealing with a landlord, want to start growing equity in a home that’s theirs – the list goes on and on.
The one thing that many people forget is that the US Government has a tax policy that encourages homeownership. The policy allows homeowners to write off property taxes, mortgage interest, mortgage insurance, and in some cases mortgage closing costs.
Understanding how you can benefit from owning versus renting requires digging a little into the tax code and understanding how you currently pay taxes.
Most people that do not own will usually take the “Standard Deduction” on their tax return. This is a reduction to the income that you have to pay tax on.
Below is the “Standard Deduction” table that applies to most people:
So depending on which of the categories you fit into above, the corresponding Standard Deduction is on the right. When your income is reduced by the standard deduction you pay tax on the new reduced income amount.
When you are a homeowner and pay enough in mortgage interest, property taxes, and mortgage insurance that the annual amount is greater than the standard deduction, then you should “itemize” your homeownership related expenses. Keep in mind there are very strict rules about what can be itemized and what can’t.
So if you have questions, check out the IRS publication here:
Joe pays $1500 per month in rent and is looking to buy a new home where his mortgage payment is about the same as his current rent. He buys a home and gets a $225,000 mortgage @ 4% interest. He also pays $1700 per year in property taxes and $160 per month in mortgage insurance.
Monthly Payment: $1600 (includes principal, interest, taxes, insurance, and mortgage insurance)
Yearly interest: $9000
Yearly property tax: $1700
Yearly Mortgage Ins: $1920
Joe is single, so his current standard deduction is only $6200. Joe stands to reduce his income by an additional $6400 by owning versus renting. This translates into about $1600 less in taxes paid to Uncle Sam.
So at the end of the year our hypothetical homeowner Joe pays $1600 less in federal tax than he would have had he rented. In addition to that he would’ve paid down about $5500 in principal balance on his loan. Also, as the market appreciates he will begin to grow equity in the home (the difference between the loan and the value of the home).
Outside of the practical reasons you would want to buy your own home there are also some very sound financial incentives to be had. Be sure you take the time to consider the financial benefits of homeownership compared to renting. Reach out to your local mortgage broker to help you see what the options are.