Downpayment on First time home purchase

[saversaba08]

Hello everyone,

DH and I are now seriously considering purchasing our first house and all along we had assumed that 20% down was the way to go. However, after running some of the numbers, we realized with the price point that we are looking at, 20% down would mean annual interest payments totalling about 4K less than the standard deduction. So the tax advantage goes out of the window...should we consider putting down less and pay PMI and potentially higher interest rate?

Both of us have FICO scores in the upper 700s and no other debt so hopefully 10-15% down should not disqualify us for the mortgage. Then again, does it make sense to pay a higher int rate, larger monthly pmt and PMI just to lower taxes? In 2007, we were in the 25% tax bracket.

Thanks in advance,

saversaba08

[momof1in150]

The minimum for a home purchase right now with FHA is 3%. The only way to do no money down is a VA loan. Banks & Mortgage companies are getting stricter about down payments and gone are the days of 100% financing.

I don't think that it every makes sense to pay more interest or PMI if you don't have to. Find other ways to increase your deductions to add up to the minimum for deductions - charity, work deductions, education, etc.

[MonkeyMama]

Agreed.

Some other things to consider:

It doesn't make sense to pay another $4k interest to save $1k in taxes (25%).

Even if you did so, I am not sure how long you would have any benefit. Interest will go down every year. So if you borrow more, what you can itemize for? A year or 2 or 3?

Making long term tax strategies with current tax law is very shaky ground. The standard deduction for married filers was $7200 when I bought my first home in 1999. Today it is $10,900. IT hasn't even been 10 years. (It was increased considerably in 2003 - to double the single rate). On the flip side, we have a new presidency coming soon, which often means big tax changes. You could jump a lot of hoops to itemize just to find the standard deduction is decreased or increased soon after.

Considering all of this, it makes little sense.

You can give a bunch of money to charity if you want to itemize.

[jIM_Ohio]

Hello everyone,

DH and I are now seriously considering purchasing our first house and all along we had assumed that 20% down was the way to go. However, after running some of the numbers, we realized with the price point that we are looking at, 20% down would mean annual interest payments totalling about 4K less than the standard deduction. So the tax advantage goes out of the window...should we consider putting down less and pay PMI and potentially higher interest rate?

Both of us have FICO scores in the upper 700s and no other debt so hopefully 10-15% down should not disqualify us for the mortgage. Then again, does it make sense to pay a higher int rate, larger monthly pmt and PMI just to lower taxes? In 2007, we were in the 25% tax bracket.

Thanks in advance,

saversaba08

Don't pay PMI to get a deduction, that is silly.

The way mortgage interest works is if you pay $10000 in mortgage interest, 25% of that ($2500) would be deducted from tax liability.

This assumes:
you earn income in 25% tax bracket (if you make less than $66100 the benefit is only 15%)
you have more itemized deductions (such as property taxes) which exceeds the standard deduction of $10900 (assumes married filing jointly).

On a 100k mortgage at 6.125% interest, you would pay $6000+ in mortgage interest the first year.

Here are options to consider- a larger mortgage (which pays more interest) for a bigger house. Pros and Cons. You will get a bigger asset and a much larger tax deduction. There is a reason high income earners like living in a larger house. Most people in this situation will want to keep the mortgage for as long as possible.

Keep same size mortgage and skip the deductions. Consider a strategy in event you wanted to pay off mortgage sooner (because it is costing you interest with rewards for deductions).

I have a larger house with a higher deduction. This deduction lowers my overall tax burden (into 15% territory) which really helps my investments (with Roth IRA paying taxes at 15% level). If I ever get out of Roth eligibility (based on income), then I will look to pay off the mortgage sooner.

[saversaba08]

Thanks everyone for the quick responses.

We were looking at the tax angle because tax savings is often touted as the single largest adv homeowners have over renters.

Jim, we are looking at 120K mortgage tops with assumed interest rate of 6.25% That gives us first 12 month interest total of $7500 Property tax should run around 2K. Even after adding our annual charitable contributions, we would at best be even with the standard deduction.

Both of gross around $86K but we don't want to get into something big when the market is falling and there is always a chance that we may have to move.

[jIM_Ohio]

You have more than $10,900 of itemized deductions. You will be able to itemize without doing a thing for a year or two or three.

Some advice- if possible close before Jan 1, but as late in 2008 as possible (so 2009 is a full year of interest payments). Look at 15 year mortgages if you can afford it.

Itemizing opens up more deductions for you than just charities. Look up on web what other deductions exist (moving, unremibursed business expenses, small business expenses, property taxes, mortgage interest).

[savingmama]

You can also itemize state and city tax you paid throughout the year.

[Daylily]

saversaba08

I'm to the point in my mortgage where in 2008 I believe that my itemized deductions (morgage interest, property tax) will be less than the standard deduction. In 2007 we were just barely over the standard deduction. On the one hand, it hurts to know we pay more in taxes than other people but on the other hand, I guess I'm happier to be paying taxes than to be paying interest. I've considered the idea of buying a better, more expensive house (and thus more interest on the mortgage) but it just doesn't make sense to pay more interest so that I can deduct 25% of that for taxes and it just doesn't make sense to buy something beyond what I am comfortable paying on a monthly basis.

[MonkeyMama]

Thanks everyone for the quick responses.

We were looking at the tax angle because tax savings is often touted as the single largest adv homeowners have over renters.

.

Well, it's true, but it really is more to help the people who live in more expensive areas, etc. In your case, it won't make much difference. But if you lived somewhere expensive it would encourage you to buy a home rather than rent. (Whereas maybe there wouldn't be much incentive otherwise).

I guess it should be touted as tax savings for more expensive homes.

[saversaba08]

But if you lived somewhere expensive it would encourage you to buy a home rather than rent. (Whereas maybe there wouldn't be much incentive otherwise).

I guess it should be touted as tax savings for more expensive homes.

Very true. In the current hypothetical scenario (20% down, $120K loan, $2K property taxes) we will be only $350 more out of pocket than what we pay as rent. Of course maintenance and higher utility bills are not to be disregarded.

[jIM_Ohio]

This is a GREAT example of "rich" vs "poor", tax planning, and how deductions work.

Consider this- if OP is in 25% tax bracket and has $11000 of deductions, they would be getting 25% of the $11000 back ($2750). If OP is in 15% bracket they get back $1650 and in 28% bracket they get back $3080.

So in this case a tax deduction benefits someone in the higher bracket more than it benefits a person in the lower bracket. In general that is how deductions work, so hopefully not a huge surprise (rich get more back because they put more in).

The flip side to this is that the house is clearly LBYM for someone in 28% bracket (taxable income greater than 166k) and might be stretching it for someone in 15% bracket (earn less than 66k).

Then you need to ask yourself- is it better to have the larger mortgage and pay more interest or to pay more tax and have a smaller house (and smaller interest payment).

I don't know the math on this fully, but this is where tax planning trumps "saving money" at some point. Here is my attempt at the math:

15% bracket, 120k loan, $7500 in interest- cannot itemize and just pays $7500 with no writeoffs and in the end has a house worth 120k 30 years down the line.

28% bracket 240k loan $15,000 in interest (I more or less doubled each number). Pays the $15,000 in interest, gets $4200 back and has a house worth 240k in the end.

If you look at second set of numbers (15000-4200 back) that person is right at top end of the standard deduction for married filing jointly.

The biggest difference is in the end the person in 28% bracket has a house worth 240k and person in 15% bracket has a house worth 120k. This is where I think tax planning trumps the saving on interest camp.

Assuming both pay their mortgages on time (no early payments): (used 6.25% mortgage for 30 yr fixed)
120k mortgage is $149k of interest paid, got none of it back in taxes.
240k mortgage is $292k of interest paid and got 28% of this back ($81760) over 30 years.



My experinece suggests the larger homes appreciate more.. maybe 120k home 30 years of 2% appreciation is 217k. Maybe 240k home 30 years of 3% appreciation is 582k.


120k mortgage cost 269k for first person and is worth 217k (lost about 50k).
240k mortgage cost 450k for second person and is worth 582k (gained 130k).

Do you think this analysis is fair?

edit: I figured out 2-3 ways this calculation needs to change. The first example needs to get 15% of the standard deduction back. The second example would have gotten 28% of the standard deduction back regardless of mortgage. I need to consider a way to work that into analysis.

[saversaba08]

Interesting that you should mention LBYM. That is exactly what we have been aiming for all along. All the calculators and formulas say that we can "afford" a mortgage of roughly $300K - $320K. In our tax bracket of 25% that would translate into a tax savings of $4662 on interest alone. But I don't think we would be able to save nearly enough in real terms becuase such a house would have so many other expenses tied to it that it would make us a prime example of house poor.

And believe me in our area, $320K would fetch you a really nice pool home, new one at that. My, isn't that tempting

[jIM_Ohio]

Compare the 120k houses in area to 320k houses in same general area.

Which ones resell faster?
Which ones appreciate more (go back more than 10 years to get good history)
Will you ever see the need to sell the 120k house to get a 180k house or 240k house?

I agree the bank approval is not what to base decision on. Bank approval is needed to purchase, but analysis of the budget and tax implications can really swing the decision one way or the other.

I moved from a 180k condo to a 352k house in same town (same schools) to get more room and a place to raise a family (in Ohio). The house is bigger than we needed, and the house payment is close to 50% of what I take home, and about 25-33% of overall take home (both spouses in my house work).

Here are some issues that some friends pointed out (check your area, not all statements apply to all areas):
1) In other parts of city (different towns) the taxes are higher, but homes also sell much much quicker.
2) the same houses (from the same builder we used) in other towns cost around 40k more (because schools are better and richer people live there)
3) school levies tend to pass more in towns where property taxes are higher
4) move to a place which should grow before kids are school age (meaning if kids are 2, you need a place which will have good schools in 4 years, if kids are not born yet, you have 6-8 years for town to grow before schools are an issue).
5) If private schools are being considered, the town (and taxes) of where you live is less important.

We clearly bought more house than we needed 2 years ago. With twins here we are loving the decision to think ahead- our kids will be in a huge neighborhood with other kids their age, we have the budget established before the kids arrived (house budget anyways), and we don't have to move unless a job change requires it (both spouses dislike the thought of moving prior to retirement). We will not need to move because of 2 or 3 (or 4??) kids in a house because we have enough room with what we have now.

[saversaba08]

Actually the houses we are looking at are in the $150K range, $120K would be the loan amt, having put 20% down.

Being in Florida, homes are selling really slow regardless of the price point. People are probably waiting for the market to bottom out. The odds of a house move prompted by job change are better than even for us even though both of us would like to stay here for at least 5 years, if not more.

Property taxes and sales taxes are on the high side though we don't have state income tax. Schools for DD are good, so if we stay in the area another 5 years, she is all set for Middle school.

If we were also looking at a time span of 30 years, going in for a larger house would likely make sense.

[jIM_Ohio]

Actually the houses we are looking at are in the $150K range, $120K would be the loan amt, having put 20% down.

Being in Florida, homes are selling really slow regardless of the price point. People are probably waiting for the market to bottom out. The odds of a house move prompted by job change are better than even for us even though both of us would like to stay here for at least 5 years, if not more.

Property taxes and sales taxes are on the high side though we don't have state income tax. Schools for DD are good, so if we stay in the area another 5 years, she is all set for Middle school.

If we were also looking at a time span of 30 years, going in for a larger house would likely make sense.

You need to factor in the 5-30 year issue. Moving will cost 6% of house price to sell, around 5k to move, then between 2k and 5k to close. For a 150k house, this is $19,000.

So look at 150k house and a 170k house and see how much more you get (more space, more amenities) and realize you saved yourself 19k in moving costs by finding that slightly bigger house which prevents a move based on family size.

That was my thought going in from condo to single family home. How much space would I want when kids are 16-18, what would it cost me to get there in steps, and what would it cost me now.