Many people have heard that the federal government is offering "first-time" home buyers a tax credit of up to $8,000.
Here's some of the fine print:
- A "first-time" home buyer is anyone who has not owned a home in three years
- Closing has to take place between 1/1/09 and 12/1/09
- You must live in the home you buy as your primary residence
- The tax credit is equal to 10% of the purchase price of the home up to a maximum of $8,000
- The tax credit is refundable, so if for example you owe $2,000 in income tax in April 2010, you would not pay the $2,000 and the government would send you a tax refund of $6,000
- There are income limits to be eligible to receive the credit
A new twist to this was announced last Friday which allows certain nonprofit organizations and government agencies to purchase the tax credit a home buyer will receive in the future to give the home buyer some of the money they need to buy a home now.
I've been waiting for this shoe to fall.
Allowing people to use the tax credit toward the money they need to buy a home sounds good, but part of me thinks that this is the kind of lending policy that helped create the mortgage and financial melt-downs that started a few months ago.
Here's my solution to reduce the risk of buying a home you can't really afford without a government bailout and some creative bookkeeping: buy what you can afford on a 15 year loan, instead of a 30 year loan.
Every $1,000 you borrow at 5.5% for 30 years costs $5.68 per month. Every $1,000 you borrow at 5.0% for 15 years (15 year interest rates are lower than 30 year interest rates) costs $7.91 per month. The difference in monthly payments for a first time buyer's purchase of an $80,000 home (the sweet spot in the $8,000 tax credit) is only $178.23. If that $178.23 seems like a big increase to pay, please look at it in the context of your total monthly housing expense, which not only includes the principle and interest I am talking about, but also property taxes, homeowner's insurance, mortgage insurance, utilities, and savings for the future maintenance needs of your home.
The reason a 15 year loan helps protect you is that you pay down your mortgage balance at a much fast rate, more than three times faster, in the early years of your home loan.
- One year into a 5.5% 30 year loan, you would have paid off $13.47 (1.3%) for every $1,000 you borrowed.
- One year into a 5.0% 15 year loan, you will have paid off $45.94 (4.6%) for every $1,000 you borrowed.
- At five years, it's 7.5% paid off for the 30 year person, versus 25.4% for you on the 15 year loan. If you have to sell because of hard times, or simply because you want a bigger home, your lower mortgage balance allows you to easily cover the expenses of selling, even in a flat market, and gives you a nice payday for your discipline.
There's a lot of detail that goes into the tax credit and spending the tax credit before you receive it. Contact me and I'll try to answer your questions or point you in the right direction.