Mortgage credit can make first home affordable
By JEFF LAZERSON / CONTRIBUTING COLUMNIST
I was very troubled when my oldest daughter, who is in graduate school outside of the state, told me she wonders if she will ever be able to afford to move back to California and buy a home with prices in the Golden State being what they are.
Come rain or shine, I’m retiring by my 94th birthday. So that means she’s on her own on the home buying front.
But, I can at least point her and every first-time buyer to a little known program that synergistically reduces your federal income tax liability and boosts your home loan qualifying ratios.
The Mortgage Credit Certificate, or MCC, is different than receiving a percentage of mortgage interest as a tax deduction based upon your federal tax rate. MCC is a dollar for dollar tax credit for 20 percent of your annual mortgage interest for the life of the loan.
For a simple illustration (always consult your tax preparer), let’s say you have a $500,000 mortgage at 3.5 percent. The annual mortgage interest charge is $17,500. Twenty percent of that equals $3,500.
Let’s say you are in a 25 percent tax bracket and your income is $100,000. The standard tax formula is $100,000 (annual income) minus $17,500 (mortgage interest) equals taxable income of $82,500. At 25 percent of $82,500, your federal taxes owed are $20,625.
With the MCC, your mortgage interest deduction is $14,000 ($17,500 mortgage interest at 3.5 percent minus the 20 percent MCC credit of $3,500). The income tax formula is $100,000 (annual income) minus $14,000 (mortgage interest deduction) equals income of $86,000. At 25 percent tax rate of $86,000 your taxes owed are $21,500.
Now, deduct the $3,500 tax credit and you end up owing Uncle Sam $2,625 less, or $18,000 in taxes. That’s almost 13 percent less in federal income taxes. Nice!
The MCC does have an upfront cost of $500, paid at closing. Federal Housing Administration, Veterans Administration and conventional financing are eligible.
The Orange County maximum sales price for a house, townhome or condo is $589,785 and up to $720,845 in targeted lower income areas.
With the exception of some targeted lower income communities and veterans in good standing, you must not have owned a primary residence in the last three years to qualify.
Income caps are from $117,000 to $136,500, depending upon the number of people in your household and whether the home is in a targeted area or not.
When calculating your monthly house payment and other bills against your monthly gross income (debt-to-income ratio), FHA gives you the biggest boost by chopping the 20 percent MCC interest credit from your front-end housing payment.
From our earlier example, that means the monthly house payment calculation would be $291 lighter for qualifying purposes ($3,500 divided by 12 months).
Conventional financing adds the tax credit to the income and VA has a more complicated offsetting formula.
If you refinance under MCC, you are still eligible for the new life of loan tax credit so long as you re-up another $500 fee.
If you convert your home to a rental, you are no longer eligible for the additional tax credit. If you sell your home within the first nine years, a portion of your tax credit may be subject to recapture by the IRS.
Maybe this can help more first-time buyers squeeze into O.C. homeownership.
Jeff Lazerson - Mortgage Columnist since 2011