Three GOOD Reasons to Buy a Home This Year

Hi Kerry

Thanks for the information. Have a great week.

Great Flyer! Good information and very clear. Thanks for sharing

Bill

The interest rate decrease is absolutely going to be a big money saver over time.  The longer they are in the house the more money saved on interest expense. 

However, I believe the example you cited (from the Denver Post - here is the link to the article) is too simplistic.  Reducing the interest amounts paid over the term on the loan by the tax credit 30 years earlier does not factor in the compounded earnings of receiving the $8k thirty years earlier.  

Investing the $8k in tax free 30 year Treasuries on April 30, 2010 would yield a return of 4.53%.  At the end of 30 years that is $22,220 of earnings to offset the interest expense paid. That does not include the $8k.

Interest expense is also deductible on your tax return, subject to limitations.  Assuming the limitations do not apply (it applies only for a small portion of taxpayers), there is a $39,160 tax benefit, at a 25% marginal tax rate.   

Loan in April with $8k tax credit:         Interest costs of $156,644 less $22,220 (earnings on $8k of 30 year Treasuries) plus the tax benefits of $39,160 means a cost of $95,260.  And it is also reduced by the $8k received in 2010 for a real cost of $87,260.

Loan in Aug with lower interest rate:    Interest costs of $129,119 with taxable benefits of $32,280 for a real cost of $98,839.

Conclusion 1:    Over a full term of the loan, the person receiving the tax credit is better off after recognizing the earnings from investing in tax free Treasuries.

This too is probably overly simplistic as most people do not invest in tax free treasuries.  A more likely scenario might be investing in the stock market.  Over the long term (30+ years for comparability), the average before tax return from the stock market has been 8-10%.  Assuming an 8% return, there are total earnings of $72,500.  This is taxed at the marginal rate of 25% ($18,125) reducing the after tax earnings to $54,375.  This is an additional benefit of $32,155 over the Treasuries example making the real cost for the person receiving the credit $55,105.  That means the person missing the tax credit but getting the lower interest rate "paid" $40,155 (72% more!) more in real costs than the buyer receiving the tax credit.

Conclusion 2:     I'd rather have the tax credit. Now I can refinance and get the lower interest rate too. 

If you made it through all the numbers and arrived here - all of the above is most likely not going to happen.  Very few people actually keep their 30 year mortgage; most have an earlier time horizon.  It could be interest rates are lower and they refinance, or they move or ....... Life "happens" over 30 years.

The above analysis does not incorporate the present value of money, which brings all of the money streams back to a common point.  No, I won't have you go through that analysis.

Final conclusion:

Be careful/skeptical of overly general and simplistic "news" in the business section.  Real life is a lot more complicated than a lowest common denominator news article.

Mel's comment definitely makes one think, reminds me of my old professor and all his theories, but he is right one .... always do your own research for your individual situation.  Thanks for the blog.