A recent Associated Press article, Mission nearly impossible this spring: Finding a home to buy, talks about the challenges that many homebuyers face, a lack of options.
What makes this especially challenging for first time buyers is the price ranges where most first time buyers are shopping often have the most competition.
When your income limits the home price range that you are eligible for, the only way to really open up your options is to increase your income, right?
A Mortgage Credit Certificate can do this.
A Mortgage Credit Certificate is a unique, little known, and incredibly powerful tool for boosting your purchasing power as a first time homebuyer.
Also known as a MCC program, this homebuyer tax credit can be offered by the County or State that you are buying in. In my State, the State of California Housing Finance Agency (CalHFA) offers a Mortgage Credit Certificate program which is available anywhere in California.
While most Mortgage Credit Certificate programs are similar in nature, we will be using the California program as an example of how this program works.
Mortgage Credit Certificate tax credits are available to first time homebuyers, which means that you have not owned a primary residence in the past 3 years.
Exceptions to the first time homebuyer requirement include eligible Veterans, and homes purchased in a federally designated target area. Contact an approved lender for more information about exceptions to the first time homebuyer requirement.
As a federal tax credit, you will see a direct and significant reduction in your tax liability when you file your tax returns. In addition to this tax season treasure, you have the ability to “anticipate” the reduction in your tax liability, and leverage these savings when qualifying for your mortgage.
How to Calculate Your Tax Savings
First, let’s calculate what your tax deduction would be by simply buying your home. Here’s an example using a mortgage credit certificate with a 20% tax credit, with a $200,000 purchase money loan amount:
Maximum MCC tax credit that can be used in any given tax year is limited to $2,000 if the mortgage credit is greater than 20%. Consult your CPA or accountant for details. Also see: IRS Tax Form 8396
After subtracting the MCC tax credit of $2,700, you now have $10,800 that you can deduct from your net taxable income on your yearly federal tax return.
The $2,700 is a dollar for dollar credit that you can use to pay your total tax liability, or have refunded to you if you’ve already had more than your tax liability withheld by your employer.
In addition to having this tax season savings, the $2,700 tax credit can be used to help you qualify for the purchase of your home.
This can be a little tricky, so don’t be afraid to ask questions if you cannot wrap your head around this. It took me a long time myself to understand how this works. Hopefully, I can explain this in a way that’s easy to understand.
Because you now have a tax credit, in our example it’s $2,700, you can potentially adjust your W4 withholdings to absorb this credit, which breaks down to $225.00 a month. This is best done by consulting your tax preparer, CPA or accountant for advice on how to adjust your W4 to compensate for the credit.
As a lender, we have the ability to use your $2,700 credit to boost your purchasing power. This credit can be applied towards either reducing your qualifying mortgage payment, or increasing your qualifying income the amount of the savings you will realize.
I can already feel this going down a rabbit hole. Let me show you what I mean:
Using the above tax credit example of $2,700 that we can use for qualifying, we are going to divide this credit by 12 (months) to establish your monthly debt to income boost.
MCC Tax Credit: $2,700
Divided by 12 = $225 a month that we can use to help you qualify
Now, depending on the type of loan you are using to purchase your first home, this monthly credit can be applied in one of two ways to boost your purchasing power.
If you are trying to qualify for an FHA insured loan, your maximum Debt to Income Ratio (DTI) is 56.99%. This essentially means that your total monthly obligations, plus your proposed mortgage payment, cannot exceed 56.99% of your gross monthly income.
If you are qualified for the absolute maximum purchase price you can afford, for qualifying purposes only, we can subtract this $225 from your proposed monthly mortgage payment, which lowers your DTI, and increases the maximum purchase price on the home you’re trying to buy.
NOTE: By subtracting $225 from your qualifying payment, it DOES NOT lower your actual payment. This credit is for qualifying purposes only.
If you are using Conventional financing, along with a MCC, again, you can use the full 20% credit as a qualifying factor for boosting your purchasing power. Maximum DTI when using Conventional financing is typically 45%, and up to 50% with compensating factors.
Using an MCC to boost your debt to income ratio when using Conventional financing differs from FHA in that your $225 credit is added to your qualifying income, and not subtracted from the proposed payment.
In both cases, a Mortgage Credit Certificate can give you a little extra competitive edge if you are running up against being on the borderline of qualifying for your dream home.
The most common challenge I find with mortgage credit certificates, is that many lenders do not know about them, or they don’t talk about them because it’s not a money maker for the loan officer for the bank.
It actually requires a little more paperwork, and it only benefits you, the buyer.
If you’re shopping for your first home, and your lender never brought up the topic of a mortgage credit certificate, you might want to get a second opinion. You’ll find us online most days, and can reach out for advice, or an introduction to a lender that understands these programs.
Feel free to leave a comment below, send me a direct question through the chat window on the bottom of the page, or submit a question through the link on the top of the page. Either way, I’ll answer your questions promptly, and try to get you pointed in the right direction.