Cover story: Tax credit can help, but first, figure debt

The extension - and expansion - of the federal tax credit for homebuyers encourages potential first-time buyers and repeat buyers to buy property before the expiration date of May 1, 2010 (and loans must be closed by July 1, 2010). While consumers want to make the best use of this tax credit, they also need to spend time determining how much they can comfortably spend on housing costs.

Some lenders qualify buyers on strict debt-to-income ratios, which look at both the “front-end” ratio of housing costs compared with gross monthly income and the “back-end” ratio that compares all monthly debt obligations with the gross monthly income.

For some lenders, a desirable range for housing costs is about 30 percent of the gross monthly household income, while other lenders are willing to stretch those limits all the way up to 50 percent if the borrowers have significant assets.

The National Association of Realtors Housing Affordability Index tracks the median price of a single-family home and matches it with the median family income to determine how many homes in a region are affordable to local residents. The qualifying income for a median-priced home of $237,800 in the Northeast was $50,160 based on a 25 percent ratio of monthly housing expenses to gross monthly income, with an expected 20 percent down payment. (It is interesting to note that this qualifying income is the highest for all four regions.)

No matter how much a consumer may be allowed to borrow, the final decision on how much to spend on monthly housing costs should be made according to the borrowers’ comfort level and their understanding of their overall budget. The homebuyer tax credit can be an excellent source of income to replenish a savings account depleted for down payment and closing costs, but most financial experts agree it should not be used to push individuals into buying a home before they are ready.

“The homebuyer tax credit should be viewed as a great opportunity only if all other elements are in place to buy a home,” says Mark Atherton, a certified financial planner with Ticknor, Atherton and Associates in Reston. “In order to decide if you are ready to buy a home, you need to know if you have a big enough cushion in the bank and the financial and job stability to buy. Then you can look at how to best take advantage of the tax credit.”

The basics of the federal tax credit include:

A credit of up to 10 percent of the purchase price for both first-time buyers (buyers who have not owned a home as a principal residence during the previous three years) and repeat buyers (as long as they lived in one residence for five consecutive years of the past eight years). The credit is limited to $8,000 for first-time buyers and $6,500 for repeat buyers.

The price of the home must not exceed $800,000.

The tax credits are phased out for single taxpayers with a modified adjusted gross income between $125,000 and $145,000; and for married couples, a modified adjusted gross income between $225,000 and $245,000.

The home must be the principal residence of the buyers for at least the next three years, or the credit will need to be repaid.

The tax credits are refundable, which means that even if the taxpayers do not owe taxes, they can receive a check from the IRS for the balance of the credit.

“No one should buy a home just because of a tax credit,” says Marv Stanger, a certified mortgage planning specialist with Primary Residential Mortgage in Springfield. “But it can be a good thing that the tax credit gets people to talk about buying a home. The tax credit cannot help anyone qualify for a loan because it cannot be used as money upfront. It is most useful as a way to replenish an account, such as a 401K or an IRA, that the buyers have borrowed from for their down payment.”

Donna Evers, founder and president of Evers & Co. Real Estate Inc. in the District, believes the expanded tax credit may help move-up buyers even more than first-time buyers. Move-up buyers will be able to take advantage of the credit personally as well as benefit from a potential buyer using the credit.

Mr. Stanger says that another way for buyers to use the tax credit is for the inevitable spending, which comes with a new home for improvements or new furniture.

Story Continues →