According to the National Association of Realtors, the sale of homes in 2020 has increased by 22%! Many people are looking to purchase a home and for many, buying a home is one of the largest purchases they will make in their lifetime.
Many people cannot afford to buy a home outright, meaning they will need to secure a mortgage loan. A mortgage is a promissory note or agreement signed by a purchaser and lender, where the purchaser puts their home up as collateral for the loan. This is known as a secured loan. If a borrower stops making their mortgage payment, or defaults, the lender has the right to foreclose on (or repossess) the borrower’s home. The collateral involved lowers the risk associated with financing considerable amounts of money to borrowers and incentivizes borrowers to keep making their mortgage payments. A secured debt will have a lower the interest rate compared to unsecured debt, such as a credit card. Unsecured debt has no collateral associated with it which causes interest rates to be higher. Some credit cards could have rates higher than 20%.
How does a borrower obtain a mortgage loan? The lender will access the risk of financing a specific borrower by looking over the borrower’s financial history including credit score, tax returns, bank statements, debts, etc. to determine a financial position. For this reason, it is important for a borrower to be in the best financial standing to receive a deal or qualify with the lender at a lower, preferential interest rate.
Additionally, it is important for a borrower to understand what exactly is included in buying a home and obtaining a mortgage. Research is key to achieving an accurate view of the cost of buying a home. Below are key points and ingredients any buyer will need to outline a mortgage equation.
Questions to ask yourself and research:
- How much home can you afford? This is usually the best place to start. Based on a firm budget, a buyer needs to determine what they can afford. A common rule of thumb is 50% of a monthly budget is allocated to fixed expenses, meaning the portion of your monthly budget that is consent such as monthly rent, utility, and subscriptions payments. In other words, what can you afford to pay each month, based on your budget?
- Consider your down payment amount: Usually a lender agrees with borrowers offering 20% of a home’s purchase price as a down payment. In some circumstances, a borrower may qualify for a down payment that is less than 20%. The size of the down payment will significantly affect the amount of the monthly mortgage payment because the principal of the mortgage will consist of the amount left after the down payment.
- For borrowers who put less than a 20% down payment, mortgage lenders will request an additional insurance called Private Mortgage Insurance (PMI). This insurance helps the lender recover their money when the borrower is unable to make a payment or default on the mortgage. Many lenders will allow down payments as little as 3%, however, the PMI will need to be a factor calculated into monthly mortgage payments.
- Study current interest rates: Mortgage interest expense is the amount of money charged to the borrower for financing the home. Interest rates are calculated based on the total amount of principal still due on the mortgage and will lower as the principal amount lowers. The interest rate associated with an individual mortgage will be tied to the following factors: mortgage lender, a borrower’s credit score and history, the type of loan a borrower chooses, and the amount of the down payment.
- Determine the type of loan for the situation: Most mortgages are categorized as fixed-rate or adjustable-rate obligation, however there are many other mortgages for a borrower to choose from.
- A Fixed-Rate obligation is preferable for a buyer who plans to live in a home for five or more years and who has a lower tolerance for risk. Fixed-Rate mortgage is usually a 15 to 30-year loan where the interest rate remains “fixed” or stays the same, over the lifetime of the loan.
- An adjustable-rate obligation is more suitable for a borrower who expects to reside in the home for only a few years, usually less than 5, and demonstrates a higher tolerance for assuming risk, as interest rates could increase year-to-year.
- Types of mortgages: There are many types of mortgages such as biweekly mortgage, balloon payment mortgage, graduated payment mortgage, conventional mortgage, VA/FHA mortgages, reverse mortgage, and more. The type of loan you may be able to qualify for depends on your personal circumstances.
- Research annual property taxes: Researching the County Appraisal District in the area you are considering your purchase, will inform a buyer of what to expect with property taxes in that jurisdiction.
- Estimate your homeowner’s insurance: Insurance costs depend on the insurance carrier, home square footage, materials used in the home, the area in which the property will reside, and other factors. Depending on those factors, homeowners’ insurance payments can be substantial or minimal within the budget.
There could be potential tax benefits to purchasing a home. The IRS allows taxpayers to itemize certain deductions on Schedule A of Form 1040. Taxpayers have the option of taking a standard deduction or itemized deductions (Schedule A) and should choose the option that provides the most advantage for their tax situation. For 2021, the standard deduction is $12,550 for single filing status and $25,100 for married filing jointly status.
On Schedule A, a taxpayer may report itemized deductions that originated with a mortgage or the personal ownership of a home:
- Mortgage interest deduction on up to $750,000 of debt used to acquire a main residence, with debt acquired after December 2017; up to $1,000,000 of debt on a personal home purchased after October 13, 1987, and before December 16, 2017. All homes purchased before October 13, 1987, are considered grandfathered debt, and are not limited under the IRS code, meaning any amount of debt, and the full amount pf interest paid on that debt is deductible.
- Mortgage Insurance Premiums expenses are also allowable as an itemized deduction. There is a phase out and a decrease of the allowable deduction for taxpayers with an Adjusted Gross Income over $100,000; Furthermore, the deduction will not be allowable for Taxpayers with an Adjusted Gross Income over $109,000.
- Mortgage points are also allowed as an itemized deduction, as long as the points paid are for building a main residence or home, substantially improving the taxpayer’s main residence, or purchasing a home.
- Tax payments, specifically state and local real estate taxes: For 2021, real estate tax, and other taxes, are allowed an itemized deduction of up to $10,000.
Another tax benefit the IRS provides to Taxpayer when they sell their main residence is an exclusion of tax if there is a gain on sale. This is known as Section 121. For married couples, who file a joint tax return, you will not have to pay taxes on the first $500,000 of the gain on sale of your main residence. Anything above the floor of $500,000, will be subject to short-term or long-term Capital Gain Tax rates, depending on the holding period of the home. Single Filers have an exclusion of gain on sale of up to $250,000. You are allowed the claim the exclusion if the following requirement have been met: (1) Living in the main residence for the past two years out of the last five years, (2) Owned the home for the last two years of out the past five years, (3) and have not claimed the exclusion in the last 2 years. If you do not meet all the requirements, you may still qualify for a partial exclusion
Our team of professionals at ADKF have extensive experience working with individuals and assessing their financial position to provide personal financial planning, such as a new home purchase, or new business venture. Please reach out to us for assistance with any matter as we are “with you all the way.”
ADKF is the largest, locally owned public accounting firm in San Antonio, Texas, with branch offices in Boerne and New Braunfels. We have been serving our community since 1991. We are a full-service CPA firm dedicated to providing a broad range of tax, audit, bookkeeping, tax controversy, and consulting services with superior customer service to help our clients meet their goals and objectives. Please click here to set an appointment with us.
