How Buyers Can Find Their Money Sooner in 2011

How Buyers Can Find Their Money Sooner is a reprint of our blog from 2009.

This topic is still one of the least understood concepts by so many buyers that we decided to update and re-post it.

One of the scariest financial mysteries to many home buyers surrounds the tax advantages of mortgage interest and property taxes. Although most buyers conceptually get that there are advantages to home ownership, the actual numbers don’t generally make their way into most people’s financial planning and typically come as pleasant news at tax time. The news turns less pleasant when buyers who weren’t aware of the tax advantage realize they might have made other decisions (specifically affording more house) than they really did.

Buyers that do understand these tax advantages can lower their monthly withholdings and get the advantage when they need it most: when paying their monthly bills.

The Basics:

If a buyer earns $100,000 per year and pays 20% taxes, they must have withheld $20,000 throughout the year to not owe anything. If our buyer has $25,000 in deductions (reductions to their gross income), their taxable income would be reduced to $75,000.

If we can assume the same tax bracket, their tax liability would then be $15,000, which is 20% of $75,000.

Can that $5,000 provide a nice refund? You bet it does, however it can also serve another even more important purpose many people don’t consider. Our buyer can decrease his withholding by $400 a month ($4,800 to make the math easy), and essentially have an extra $400 in hard cash to pay for their mortgage or other living expenses.

This is not Enron monopoly money. This is simply figuring out your taxes for the coming year and adjusting your withholdings so they match your taxes prospectively.

I certainly grew up thinking about tax refunds (a retroactive adjustment) as the only option but I learned this was not the only way to think about it. For me, it was not even the best way to think about it.

Taking a real world scenario where a buyer has a 30 year $400,000 mortgage at 5%, the interest the first year will be $19,866. Now let’s assume a realistic yearly property tax of $10,000. This creates a simple gross income deduction of $29,866.

Having this deduction can be thought of as a traditional refund or as having an extra $500 a month by withholding less! Plug your numbers into the live spreadsheet below to see how your interest and taxes can be used monthly. 

Speak with your accountant to validate how this affects your particular situation as Uncle Sam doesn’t like people not withholding enough to cover their taxes. Do it well however, and you can use the money when you need it and break out even at tax time. Talk to your accountant, then talk to us!