Tax Benefits of Homeownership

One of the benefits of owning a home is that the IRS and the state government allows you to deduct the mortgage interest and property taxes from your annual income tax return.

There are of course certain limits on the amounts that you can deduct. When you file your federal IRS form 1040, the mortgage interest and property taxes on your home are itemized as deductions on schedule A. On mortgage loans, you may deduct the interest on the 1st 1 million of the debt as well as the property taxes. The IRS also allows you to deduct interest cost on a home equity loan to a maximum of $100,000 borrowed.

Typically, you save on the state taxes as well as the federal. You should calculate the homeownership tax saving by including the state tax savings. However, to keep things simple and still get a reliable estimate, simply multiply your mortgage payment and property taxes by a federal income tax rate. This calculation works well because a small portion of your home loan that isn’t deductible approximately offsets the overlooked estate tax savings.

Once you have totaled what your home should cost on a monthly basis after factoring in the tax benefits of ownership you have a fairly good idea of how much you can afford for your new home.

Don’t forget to include these homeownership costs into your current monthly spending plans to make sure that you can afford to spend a certain amount of money on the homes on and still accomplish your financial goals.

Different Tax Treatment For Home Maintenance and Improvements

The IRS allows you to exclude a certain portion of your profit when you sell your home from taxation that was the result of capital improvement in the home made by you.

It is a good idea for this reasons, to keep a record of the expenditures you make on home improvements. The IRS sales-tax rules also enable qualifying taxpayers to exclude a large portion of their profit from federal taxation, up to $250,000 for single taxpayers and up to $500,000 for married couples filing jointly.

The IRS allows you to exclude the money spent on capital improvements but not the money that you spend as overall regular maintenance of the house.

The difference between the 2 can be very fine at times. For this reason it is a good idea to maintain the receipts of all the improvements and expenditure that you may come home. You can see professional advice as to which expenditure qualifies as improvement and which management in its when it comes to selling the home.

Capital improvements made in the house include things that permanently increase its value and length in its life.

Capital improvements include things like landscaping, adding a deck, installing new appliances [as long as they are left in the home when you sell], installing new air-conditioning system, putting a new roof, remodeling your kitchen, adding a bathroom, adding a new wing etc.

Maintenance and repair costs usually include the cyclical and periodic expenditure that needs to be made in order to keep the home and maintain its usability.

Maintenance costs include fixing up items throughout the home for time to time such as fixing a leaky, painting, lawn maintenance, swimming pool cleaning etc.

Keep a record of all the expense that you make on your home specially if you are not sure as to what qualifies as an maintenance and what qualifies as a capital improvement. This record will come in handy when you need to make the required deductions from your IRS return after selling the house.

How Much Does Home Maintenance Cost

Any home requires work done in order to keep and maintain it. Maintenance costs can be a little hard to budget for because you never know when something like an electrical problem or a plumbing problem can arise. However, there are other maintenance costs such as gardening, painting etc. which can be expected and budgeted for. Because they are both expected and unexpected costs involved in the maintenance of a home, it is usually advised to presume to have to spend 1% of the cost of the home every year for maintenance. For example if the value of the home is $200,000, you can provide for maintenance by budgeting $2000 per year for maintenance.

The maintenance cost for the home may be less in any given year and high in the next because of unexpected expenses such as replacing a leaking roof. As long as you have been saving and budgeting for annual maintenance, you will not have a problem because you would have saved up over the past few years.

There are certain kind of properties such as condominiums that require you to pay monthly fees to the housing Association to take care of the maintenance of the entire complex. You are required only to maintain the interior of the unit. The similar rules may apply when you take up a flat. Usually you can expect to pay a certain percentage of your rent or the value of your flat towards the society maintenance fee. Always inquire about the maintenance cost of the condominium unit or a flat as they can differ widely.

You should be aware of the difference between maintenance cost and home improvement. Many times these 2 can blend into one in the homeowner’s view. Buying new furniture, remodeling the kitchen, landscaping and other expenses on the home qualify as home improvement rather than home maintenance. There is no limit to the amount you can spend on home improvements and many new homeowners quickly fall into this trap. Excited by their new home purchase, they quickly spend a lot on bringing in improvements in the house and find themselves quickly financially strained.

You should also note at this point that the amount spent on home improvement may be deductible from the capital gain when you sell the house whereas the amount home maintenance costs is not according to the IRS rules.

The amount that you can expect to spend on home maintenance will defend from one person to another as well as the kind of property that you purchase. But as a general rule of thumb, providing for 1% of the purchase price of the property as maintenance cost in a given year should keep you covered.

How Much Does Mortgage Insurance Cost

It is unlikely that any mortgage lender will finalize the mortgage long before making sure that you have adequate insurance cover. This is not because the mortgage lender has any deep love for you but only because he wants to safeguard his own interest. Mortgage lenders have realized from the experience that in certain situations many homeowners are comfortable walking away from the property when they go into default. When the real estate boom ended, many homeowners who did not have any value left the property simply walked away from it leaving the lender with the loss.

Not only do you need to take private mortgage insurance because the lender will insist on it it also because you need to safeguard your own personal property. When you take a mortgage insurance, you should choose an insurance policy that covers your home against destruction and damage such as protection against fire as well as protection for your personal assets by taking a comprehensive home insurance policy. We will discuss home insurance in more detail in another section but enough to say now that you should take a complete policy that covers you the best with the largest deductible possible. You should remember that not just home you should insure but your personal belongings as well inside the home such as your appliances, clothes, furnishings etc. because they cost money can be expensive to replace. A comprehensive home insurance can protect you against loss for all of your personal property.

In circumstances where you make less than 20% down payment on the home purchase, the mortgage lender will definitely require you to pay the mortgage insurance and property taxes to him in advance. He may ask for up to 6 months of these payments in an escrow account during the time of finalizing the loan and require you to include these payments in the monthly mortgage payment as well.

In order to get an idea of the private mortgage insurance rate and premium that you are likely to pay, you can begin by calling a few reputable and well known home insurers in your area. You can tell them the area where you are looking to purchase a home as well as the price bracket. The insurance agent should be able to give you a fair idea of the kind of expense you are looking at as home loan insurance.

How Much Do Property Taxes Cost

If you own a property you are liable to pay property taxes as well. Paying taxes is never pleasant and paying property tax can be especially taxing because people feel that they have enough taxes to be aggravated about such as all the federal and state income and sales taxes. However, you should know that the property tax that you pay goes towards the up keeping of the community and developing of facilities such as public schools, road maintenance etc.

The local government collects the property tax typically through an office called the country tax collector.

You are usually required to pay the property tax once or twice a year. Although if you make a down payment of less than 20%, the home loan lender is liable to ask you to pay the property tax and insurance amount to him in advance every month. He may also ask you to pay 6 months worth of insurance and property tax to be kept in an escrow account.

The amount of property tax that you pay usually depends on the value of the house and is evaluated at 1.5% of the property value. However, this value differs from different counties and states to another. In order to find out what exactly it is in your area you can call the tax collector’s office, the phone number for which can be found in the local phone directories in the government Yellow Pages section.

Another thing that you should be aware of as far as property taxes are concerned is that when looking at real estate listings, the amount or the rate of the property tax mentioned there might be outdated. The agent who has prepared the real estate listing may have calculated taxation amount based on the previous amount which may have changed since then. Before buying the property you should confirm the amount of property tax that you will have to pay.

Cost of Homeownership – Mortgage Payments

Before you set out to buy a home, one of the most important questions that you must ask and answer is how much can you afford to spend. In order to answer that question accurately, you need to get a fair idea of your income and expenditure. You need to figure out your long-term financial goals and know what amount of your income you are going to need to achieve them. We have already discussed this in another section. In this section we will talk about the common costs of buying and owning a home.

Mortgage Payments – Your largest home ownership cost

Your monthly mortgage payment is going to be the single largest cost of owning a home. Later on in other sections we will discuss choosing the best kind of mortgage that suits your financial circumstances the best.

Mortgage loans in the United States are typically 15 year or 30 year mortgages. Suppose you are purchasing a home for $250,000, and as is advisable, you have made a 20% down payment, you will need to take a home loan for $200,000. Here is what your monthly mortgage payment is going to be like under both the 15 year and 30 year mortgage term.

$200,000, 15 year mortgage at 7% = $1800 approximately a month.

$200,000, 30 year mortgage 7.25% = $1366 approximately.

As is obvious from the above calculation, the interest rate that is chargeable on a 30 year mortgage is slightly higher than the 15 year mortgage. This is almost always the case because the risk to the home loan lender is more for a longer mortgage term. Longer mortgage term means that there are more opportunities for something to go wrong with the finances of the borrowers and for him to default. The payment on the 15 year mortgage is higher because you are attempting to pay off the home loan 15 years earlier as compared to the 30 year mortgage.

You should not let the higher payment on the 15 year home loans to be a detergent in choosing it because by paying it off earlier you are not only going to get rid of your financial obligation that much quicker but are going to save a ton of money on interest as well. Taking the example above, this is the difference between the amount of interest that you will pay for a 15 year and a 30 year mortgage respectively.

Mortgage Term –  Total Payment – Interest

15 Year            324000           124000

30 Year            491760           291760

As you can see from the above example, the amount of interest that you end up paying for a 30 year mortgage as compared to the 15 year mortgage is more than double. This should not come as a surprise because the time that you are going to take to pay off the mortgage is also double.

You should know that in the earlier years of keeping your home loan, almost all of your monthly payment is going to go towards payment of your interest. The ratio of the monthly payment that is divided between interest and principal payment will bend more towards principal payment as the mortgage loan progresses and in the later years of the mortgage you will rapidly begin to pay down your loan balance.

With an increase in the interest rate, the time required to pay off of the loan also increases. At 10% interest paying off the loan takes almost 24 years in a 30 year mortgage and at 14% interest rate paying off of the home loan takes over 25 years for the same mortgage term.

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