Friday, January 17, 2014

One Benefit of Buying vs. Renting

It's that time of year again. You go out to the mailbox to pick up your mail, and what do you find? That lovely W2, which tells you how much (or little!) you earned this year. That can only mean one thing: it's tax season. Tired of cutting a check to the IRS every year? Buying a home can help with that. 

Of course, I'm not saying that buying a home will ease all of your tax woes, but there are tax benefits to home-ownership that can lessen the burden. The biggest benefit is that you are able to deduct the interest you pay on your mortgage (which I will explain in detail below), but you can also deduct the Real Estate taxes you pay each year. These things can easily become the difference between writing a check to the IRS and cashing a check from the IRS.

There are a few things that are important to understand here. First of all, the interest on your mortgage is amortized in your payments throughout the life of the loan (often 30 years). You pay the majority of the interest in the beginning of the loan. So, here's an example: Let's say your mortgage is $400,000 with an interest rate of 4% for a 30-year fixed loan. Based on those numbers, your payment would be approximately $1,900 per month (this is assuming there is nothing else included in your payments, such as mortgage insurance, taxes, etc.) In your first payment, about $1,325 of that $1,900 would be applied toward interest and only $575 would be applied to the principal of the loan. Those numbers gradually change over the life of the loan. So, in year 15 of the loan for example, you would pay about $850 toward interest and $1,050 toward principal. 

Ok... so... what does this have to do with taxes? Well, you can deduct A LOT of interest from your taxes, especially in the first 10 years or so of the loan when money is often the tightest for people. Just take that example above. That person will be able to deduct over $15,000 of interest in the first year. Like I said... A LOT!

However, it's even more important to understand what a deduction means. It does NOT mean that this person is going to get $15,000 back from the IRS or that they owe $15,000 less in taxes. It means that they will be able to deduct $15,000 from their taxable income. So, that's $15,000 less that they will be taxed on. For instance, let's say that the person in the example above makes $75,000. (To make this example easier, let's just assume that the $75,000 is after all other deductions, withholding's, etc.) They will be able to subtract that $15,000 from their income to make their Adjusted Gross Income (AGI or taxable income) $60,000. So, instead of being taxed on $75,000, they will only be taxed on $60,000 of their earnings. Depending on the other factors involved (and yes, there are MANY other factors involved), this may mean that our example person is going to get a couple hundred or even a couple thousand dollars back from the IRS, instead of having to pay more or breaking even.

Ok, so now that I've got your head spinning, I'll wrap this up. The point is, this is just one of the many benefits to buying a home that you cannot get when renting. Maybe your rent payment is only $1,500 a month and paying that extra $400 a month for your own place seems daunting. This is one benefit that can make that stretch a little more attainable.

DISCLAIMER: I am not a tax expert or a mortgage expert. The numbers used in the examples are simply estimates, and everyone's situation varies when it comes to taxes. If you'd like to know more about how buying a home can benefit your tax situation, please consult your tax professional. For more information about these deductions, here is a link to the IRS website:

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