If you own a home or are looking to downsize, or are planning on buying your first house, historically, the time has never been better. Mortgage rates are still near all-time lows, and despite some appreciation in home prices over the last several years they are still well below 2007 levels before the market collapsed.
Whether you are selling your existing home, or in the market to buy your first home, there are tax implications you should be aware of so you are not caught off-guard later.
The following should not be considered as tax advice and you should always seek counsel from an experienced tax advisor when dealing with complicated home ownership scenarios.
Here are some basic terms for the first-time home buyer.
What are Points?
If you are buying a home, chances are you will need a mortgage. If you want to lower your interest rate, you can pay extra money to your bank at the time of closing. This extra money is known as points.
So what does that mean?
One percent of the purchase price is consider one point. Therefore, if you agree to pay 2 points, you are agreeing to pay an additional 2% of the purchase price in order to secure a lower interest rate for your mortgage.
Other than securing a lower interest rate, the other advantage of paying points is that they are tax deductible, although there are some strict rules on how you can use the deduction. You will need to consult a tax preparer and the language in your mortgage. Some points are deductible in full the tax year you paid them, while others have to be deducted periodically over the life of the loan.
Private Mortgage Insurance
When you are negotiating your loan, if your down payment is less than 20 percent of the purchase price of the home, you are required to have private mortgage insurance.
This protects the lender if you decide you to stop making payments and the property enters foreclosure.
This monthly insurance premium is added to your loan increasing it anywhere from $50 to $500 a month depending on the value of your home.
In most cases, private mortgage insurance is tax-deductible and is usually sent on a Form 1098 from your lender at the end of the year.
As the equity in your home reaches the 20 percent threshold, there is no legal requirement to carry this insurance so be sure to cancel it or the lender will keep collecting it every month.
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What are Closing Costs?
Closing costs are fees paid at the closing of a real estate transaction. They can be paid by either the buyer or the seller. Typically the seller will agree to pay a portion, or all of the closing costs particularly if they are setting on a huge capital gain on the sale.
So what is usually included in closing costs?
Well, it depends on where you live and what kind of property you are purchasing. Some examples could be:
- Cost of pulling your credit report
- Appraisal fee for the property
- A loan origination fee
- Attorney’s fees
- Home inspection fee
- Title insurance
- Title search fees
- Escrow deposit
Again, there are many other things that can appear at closing, but it is important to rely on your closing attorney to guide you in this phase.
If you are a homeowner, you know you have to pay property taxes every year. These can be substantial depending on the county you live in. Some governments collect these once per year, while others allow 2 installment payments during the year.
If you think you may have an issue coming up with your property taxes each year, there is an option set up a mortgage escrow account and paying it monthly in smaller increments.
The downside to this would be that it will increase your monthly payment by those increments, but it will keep you from having to write a very large check once or twice a year at tax time.
If you are someone that needs this type of discipline, I highly recommend it.
The Federal government allows you to deduct taxes paid from your gross income when figuring taxable net income.
At the beginning of every mortgage, the majority of your monthly payment will be paying interest on the loan. This is how the banks set it up to get as much of their money up fron as possible.
However, this works in your advantage as a new homeowner because you can deduct the mortgage interest from your Federal taxes.
Your lender will send you a Form 1098 at the end of the year which will tell you how much mortgage interest you paid in that tax year.
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Cash Back from the Seller
When purchasing your first home, you have the ability to request cash back from the seller by making a deal with them. For your part, you agree to pay a higher sale price for the home and the seller agrees to give you that same amount toward payment of closing costs or any repairs or renovations needed before they move in.
There are restrictions on how this concession money can be used and is usually set by the lender or loan type.
The advantage of cash back from the seller is that you can reduce your out-of-pocket expenses. It will result in a higher monthly payment, but that also means you will have more mortgage interest to deduct.
As a first-time home buyer, the first few years of your mortgage interest tax deduction are going to be significant so be sure to seek professional tax representation to ensure you are doing everything right.
There are differences in each state with variations in property tax laws as well as points and closing costs. Your real estate agent and closing attorneys will be key at this phase so be sure to follow their advice.