Does your rent payment offer you a financial or tax benefit? With average rents at $1200 and going up , doesn’t it make sense to check if you can qualify for a home home loan and get some tax benefits out of making a monthly payment? You may be surprised at what you can afford.
Say you’re renting a 3 bed, 2 bath in at $1200/month and you have a one year rental agreement in place. Do you think your landlord will raise the rent at the end of it? Chances are he will, but maybe he’s kind hearted and will only raise it by $60/month instead of the usual 10%. Your new rent payment is now $1260. Currently, the total monthly payment for a $170,000 home purchased in the same area with a 3.5% down FHA loan with a rate of 4.25%, is $1084!
That’s not a lot of savings you say, but what if your rent moves up again in the next few years? Do you move again? Let’s say that $170,000 home for sale has been recently upgraded with new flooring, or new kitchen and new baths, or a new A/C and roof. (there are some just like that listed now) Does your current home compare? Do you have to constantly call the landlord to get things fixed because the wear and tear conditional issues on the rental home are always only temporarily addressed? You may not have to pay the price for those repairs directly, but you will pay indirectly by a rent increase or by accepting a lower standard for the place you call home.
What financial benefit do you receive from paying rent? None! Unlike rent, the payment of principal and interest on a fixed mortgage can’t go up. And you can deduct the mortgage interest paid on your income taxes every year. On that same $170,000 property purchase, with the same rate and down payment, you would have paid interest of $7005.00 in year one of home ownership– that’s a $7005 direct reduction of your taxable income if you itemize your taxes! * You can also deduct the property taxes paid annually. In this example, the property taxes total $1500/year. In total, you can reduce your taxable income in year one of home ownership by approximately $8500. If you are single using the standard deduction of $6350, you can deduct $2150 more by itemizing the interest and property taxes you've paid. So roughly speaking, with every monthly mortgage payment you make of $1084, $708.75 of it is a tax deduction.
Then there’s the build-up of equity in the property. Equity is the difference between what the property is worth and what is owed. When you make a monthly payment of principal, interest, taxes and insurance, every bit of that principal payment goes to reduce the debt and build equity. Although you make the same payment every month throughout the term of the loan, in the early years the portion of that payment that goes toward principal is smaller than the portion that is allocated to interest. About half way through the term of the loan, that starts to reverse and the portion of the monthly payment that goes towards principal is higher than the portion that goes towards interest. (Your equity also builds as the value of your house increases through natural market appreciation.)
What that means is that in the early years you get a bigger bang on tax deductions than you do on equity build up, but in the later years you build equity faster and your tax deductions are less. Either way these are financial benefits that renting does not offer you.
*consult with your tax accountant for advice on whether to use the standard or itemized deductions on your tax return
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