Mortgage credit certificates can be a good first-time option
Most potential homebuyers are well aware of the tax credits available before June 30, but few first-time buyers know about another subsidy that has no deadline but could prove to be a huge benefit for cash-strapped consumers.
The Mortgage Credit Certificate Program was authorized by Congress in the 1984 Tax Reform Act as a means of providing housing assistance to low- and moderate-income families. To qualify, buyers must not have owned a home in the previous three years, must meet income and purchase price restrictions, and must intend to use the new home as a primary residence. MCCs are now available in 26 states. The household income and home purchase price limits vary by area. “Targeted” income areas have higher limits.
The MCC is a document issued by the federal government. It states that the borrower is entitled to a tax credit equal to 20 percent of the interest on the borrower’s home loan each year, capped at $2,000. The credit is typically applied to the borrower’s federal tax bill after all other deductions are used.
Borrowers may use this option to increase purchasing power, reduce tax liability or both.
MCCs reduce taxes on a dollar-for-dollar basis, unlike tax deductions, which reduce taxable income. Here’s how the MCCs work:
•Buyer obtains a 30-year, fixed-rate loan of $250,000 at 6 percent interest. The monthly principal and interest payments are $1,499.
•In the first year, the buyer pays $14,916 in interest on the loan. While the MCC calculation computes to $2,983, the buyer would be limited to the program maximum of $2,000.
•If the buyer’s income tax liability is $2,000 or greater, the buyer receives the full benefit of the MCC tax credit. If the amount of the tax credit exceeds the amount of tax liability, the unused portion can be carried forward (up to three years) to offset future income tax liability. The remaining 80 percent of mortgage interest qualifies as an itemized income tax deduction.
•To receive the immediate benefit of the MCC tax credit, the buyer files a revised W-4 withholding form with the buyer’s employer to reduce the amount of federal income tax withheld from wages, increasing take-home pay by $167 per month ($2,000 divided by 12).
•By applying the increase in take-home pay toward the mortgage payment of $1,499, the effective monthly payment becomes $1,332.
Persons with MCCs need to be careful about refinancing and understand the rules regarding the possible “recapture” of the subsidy if the home is sold within nine years of closing.
During the nine years in which the recapture tax may apply, several factors determine the amount. The tax is based on the original mortgage amount, the borrower’s income at the time of sale and the gain realized on the sale of the residence. The tax could never equal more than half the gain of the sale. If the borrower’s income does not rise significantly over the life of the loan (more than 5 percent a year), he or she is not required to pay a recapture tax.
If the house is sold within the first nine years, the tax must be paid in the year of sale. Because income and family size may change during the period the borrower owns the house, it is difficult to predict the amount owed.
While some real estate agents have complained that the program sets people up to pay a tax, MCCs were designed to get people in the door of their first home – not to guarantee them a gain.
Check with your state housing finance commission for a participating lender.
Tom Kelly is a former real estate editor for the Seattle Times. His book “Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border” was written with Mitch Creekmore of Stewart International.