Buying your first home is always a special thing, and for most people it’s an eye opening event to the inner workings of real estate. Most people don’t realize how involved purchasing a house actually is, and how many problems and delays can occur. So we’d like to offer some advice for all of you first time home buyers who are not familiar with the process of buying a house.
Get pre-approved before you do anything
The obvious reason to get pre-approved for a loan is so you know how much you can afford and you don’t waste any time looking at houses you can’t qualify for. But the more important reason to get pre-approved for a loan is so that when you present an offer to a seller, you can use you pre-approval status to strengthen your offer.
Expect hiccups along the way
Very rarely does a real estate transaction go perfectly. Minor to major things can happen that can make or break a deal. Property inspections, appraisals, loans, title searches, liens, etc. are all things that can result in a property being unsellable.
Don’t doubt yourself
First time buyers typically get filled with many emotions, but the most common emotion is fear. “Am I rushing into this house? What if there’s something better out on the market that I overlooked? How can I be sure this house is right for me?” etc. etc… Don’t worry, having doubts like these are normal, especially when the excitement of purchasing your first home wears off some. Remind yourself that buying a house is one of most secure ways to build long term wealth. If you’re afraid that there might be something better out there, ask yourself “Is this house everything I’m looking for in a home?”; If the answer is “yes”, you know that there probably isn’t much better out there. And by that point in time you’ll probably be too emotionally attached to the house to care much about comparable homes.
Don’t get too attached
I know know, how can you not get attached when you are finally purchasing a house of your own? Many first time buyers start furnishing their desired homes in their head before they even receive the title to the house, and sometimes it can lead to heartbreak. As I said previously, real estate transactions are a complicated process and requires effort on everyone’s part to complete, and sometimes deals will just fall through for one reason or the other, leaving the first time home buyers crushed. Often these discouraged first time buyers lose their interest in purchasing a house, which leads to them going back to throwing away money in rent. Remember that there are lots of houses out there, and once you settle down and detach yourself from your previously interest house, you’ll begin a new search with more experience and know how then before!
Buying your first home is a huge step. When you leave the world of renting behind, you begin building equity in an investment. And Uncle Sam is there to help ease the pain of high mortgage payments.
The deductions now available to you as a homeowner will reduce your tax bill substantially. And, if you have been claiming the standard deduction up until now, the extra write-offs from owning a home almost certainly will make you an itemizer. Suddenly, the state taxes you pay and your charitable gifts will earn you tax-saving deductions, too.
Mortgage interest. For most people, the biggest tax break from owning a home comes from deducting mortgage interest. You can deduct interest on up to $1 million of debt used to acquire your home. 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 is listed on your settlement sheet for the home purchase. You can deduct it even if the lender does not include it on the Form 1098. If you are in the 25% tax bracket, deducting the interest basically means Uncle Sam is paying 25% of it for you. A $1,000 deduction will reduce your tax bill by $250.
Points. When you buy a house, you usually have to pay "points" to the lender 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 number of points you pay is typical for your area, the points are deductible as interest if you paid enough cash at closing -- via your down payment, for example -- to cover the points. For example, if you paid two points on a $300,000 mortgage -- $6,000 -- you can deduct the points as long as you put at least $6,000 into the deal. And, believe it or not, you get to deduct the points even if you persuaded the seller to pay them for you as part of the deal. The deductible amount should be shown on your 1098 form.
Real-estate taxes. 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 purchase 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 payments made from the account by your lender.
New for 2008: For the first time, homeowners who take the standard deduction instead of itemizing can deduct part of their property taxes. Joint filers can add in up to $1,000 of property taxes paid to the amounts shown above. Singles can add in up to $500 of real estate tax payments.
PMI premiums. Buyers who make a down payment of less than 20% of a home's cost usually get stuck paying premiums for private mortgage insurance (PMI), an extra fee that protects the lender if the borrower fails to repay the loan. For mortgages issued after 2006, PMI premiums can be deducted by home buyers.
This write-off phases out as income increases above $50,000 on married filing separate returns and above $100,000 on all other returns. (If you're paying PMI on a mortgage issued before 2007, you're out of luck on this one.) As it stands now, the write-off is set to expire at the end of 2010, although Congress may extend it.
Credit for first-time home buyers. If you purchased a primary residence after April 8, 2008, and before July 1, 2009, and are a "first-time" home buyer, you can qualify for a new tax credit for 10% of up to $75,000 of the purchase price. To be eligible, you must not have owned a residence in the U.S. in the previous three years. Nor can the credit be taken if your mortgage is funded with tax-free bonds that states and localities issue to give below-market mortgages.
The credit phases out between $150,000 and $170,000 of AGI for married couples and $75,000 to $95,000 for single filers. It is refundable to the extent it exceeds your regular tax liability -- which means that if the credit more than offsets your tax liability for the year, you'll get a refund check for the balance -- but does not offset the AMT. If you buy your home in the first five months of 2009, you can elect to take the credit on your 2008 income tax return.
Beware: This credit is more like an interest-free loan from Uncle Sam rather than a gift, because it will be recaptured ratably over 15 years. The recapture period starts two years after the year the credit is claimed. Thus, if you claim a $7,500 tax credit for a purchase in 2008, you will have to pay an extra $500 of income tax in 2010 and in subsequent years until you have repaid the full $7,500. If you sell the residence before the credit is fully repaid, the balance is due in the year of the sale. (If your profit on the sale is less than the unrecaptured credit, though, the amount due is limited to the amount of your profit.)
Penalty-free IRA payouts for first-time buyers. As a further incentive to homebuyers, Congress offers to waive the normal 10% penalty for or first-time homebuyers who withdraw from traditional IRAs before age 59½. At any age you can withdraw up to $10,000 penalty-free to buy or build a first home for yourself, your spouse, your kids, your grandchildren or even your parents. That $10,000 is a lifetime limit, not an annual one.
To qualify, the money must be used to buy or build a first home within 120 days of the time it's withdrawn. And, 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 would go to federal and state tax collectors rather than toward a down payment.
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, you can always withdraw your contributions to a Roth IRA tax and penalty free at any time for any purpose. And, once the account has been opened for at least five years, you can also withdraw up to $10,000 of earnings tax and penalty free to buy a first home.
D.C. homebuyer's credit. Buyers in the nation's capital get extra frosting on the home buyer's incentive cake. First-time buyers (liberally defined) get a federal tax credit of up to $5,000. That's the same as having Uncle Sam kick $5,000 into your down payment. Even if you own a home somewhere else (including the D.C. suburbs), you can qualify for this sweet tax break if the house you buy is the first one you own in D.C. In fact, you can qualify even if you have owned a home in D.C. before ... as long as you have not been an owner for at least one year.
This tax break phases out as income rises between $70,000 and $90,000 on single returns and between $110,000 and $130,000 on joint returns. D.C. residents must choose between this credit and the new first homebuyer credit discussed above; they can’t claim both. But, since this credit does not have to be repaid, it’s a better deal for those who qualify.
Home improvements. 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.
Energy credits. Some energy-saving home improvements to your principal residence can earn you an additional tax break in the form of an energy tax credit. 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 10% of the cost of energy-efficient skylights, outside doors, windows and high-efficiency furnaces, water heaters (but not for your swimming pool) and central air units. The total credit claimed cannot exceed $500. The maximum amount available for windows is $200, and no more than $150 can be claimed for furnaces and water heaters. This break is scheduled to lapse after 2009. And there's a separate credit of 30% of the cost of solar-powered generators and water heaters. This credit is capped at $2,000, and now expires after 2016.
Tax-free profit on sale. 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 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 owned the house as a primary home for two of the five years before the sale and both husband and wife lived there for two of the five years before the sale. Thus, in many cases, you won'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 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 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 house before passing those tests because of a change of employment or a change of health or because of other unforeseen circumstances such as a divorce or multiple births from a single pregnancy. A partial exclusion does not mean you can exclude part of your profit; it means you get a part of the $250,000/$500,000 exclusion. If you qualify 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.
