Today I show you that you can probably buy your home instead of renting it. I will also quickly talk about the tax breaks you can get, both if you purchase or if you rent. Everybody talks about the tax advantage of being the owner of your house, however even if you rent you may get some tax breaks too. I will explain everything in this post. So, let’s start!
A common misconception:
A few days ago, I was with a friend, and he told me that he wanted to move. The rent is increasing, and it is now over his budget. We had an interesting conversation because like a lot of people, he does not have the money for a down payment, or at least he was thinking that. He heard about the 20 percent down required to avoid paying the PMI, and this figure stuck into his head. However, he does not have such amount of money sitting in his account. Then he told me he would rent again, and hopefully one day he will have the cash.
I said to myself, what a common misconception. I showed him how he could buy, stop paying rent, and own his home. So after a fun evening, I decided to share the essence of our discussion with you. Because you may be in the same spot, renting, possibly thinking about moving and not being aware of what your options are.
So, what if I showed you that you are probably able to buy today?
Renting is not inexpensive!
Before we even start, do you know how much does it cost to rent?
Let’s list the expenses to rent. I will not talk about the moving cost since you will have to pay it either if you buy or if you rent.
Let’s take an example with a monthly rent of $2,500. In North Jersey, where I live, it is common to have such figures.
You will have to pay for the first month, $2,500.
In some state, you may be required to pay for the last month of your rental, possibly $2,500 more. By the way, for my New York friends, the prepaid last month was banned only a few days ago, on the 14th of July, in a radical change to New York state’s rent laws.
Then you have the security deposit, usually between one month and two months.
Eleven states, plus Washington D.C. have laws that set a limit to the security deposit to one-month rent. On the other hand, twelves states do not limit the security deposit at all!
In New Jersey, where I live, a landlord cannot ask for more than one-and-a-half month’s rental figure for the security deposit. Also, if you rent in New Jersey, your security deposit has to be in an interest-bearing account, and the interest earned is yours. It does not belong to your landlord. This fact is not well known. Your landlord has to apply it as a credit toward your rent, on the anniversary of the lease.
To my New Jersey readers, you have to ask your landlord about that. Let’s assume a $2,500 rent, with a maxed-out security deposit to $3750, and a 2% interest-bearing account, you get once a year $75 toward your rent. If you live in another state, you should check if there is a similar statute. I love it when I show you guys how to make or save money.
To come back to the cost of renting, finally, you may have to use a Realtor® to rent a property. You are now looking to add between one month to ten percent of the annual rent. So something in the range of $2,500 to $3,000.
Overall it will cost you between $7,500 to $10,000, maybe less, but possibly more, to rent this $2,500 per month rental.
It is not small change! We are talking about a large chunk of money here!
It is the size of a down payment!
Let me show you how you can make this work to buy your house instead.
You can buy with a low down-payment!
Uncle Sam wants you to be an owner. The Federal Housing Administration guarantees loans to lenders to allow you to buy your house, with 3.5 percent down only! More, you may include the closing costs and fees in the loan. Also, your credit score may be as low as 580 to qualify for the low down-payment. Even if your credit score is between 500 and 580, you may still be eligible for an FHA loan. However, the down-payment has to be 10%.
Those FHA loans allow you to buy your primary home, and you have to live in it. FHA loans may not be used to finance a second home or an investment property. However, the home you buy can be a multifamily home, up to four units. Even if you live in one unit, you rent the others, and you have somebody else paying a part of your mortgage.
By the way, if you are a veteran, use the VA loan program. You can buy a house with zero percent down! Yes, zero!
In addition to the FHA and VA Loans, if you have a 401k or an IRA, did you know the IRS will allow you to take $10,000 from them? Without the 10% penalty for a first-time home purchase! Still, you will be required to pay income tax on the amount withdrawn, though, it is a great way to access the cash you have that would be unavailable in other circumstances. By the way, a first-time home purchase means for the IRS that you have not owned a home for the last two years, not a first-time home purchase ever.
To come back to our comparison between renting and buying, suppose renting will cost you right now $10,000. For the same $10,000, as down payment, you could buy a house for $285,000. And by tapping into your retirement savings, you could even buy a more expensive home.
Then would you rather buy a house, building your equity, or will you continue to pay somebody else mortgage?
The timeline of the first mortgage payment:
One more thing about buying, the first mortgage payment is due only after the first full month. Let’s say you buy a home; the closing is on the 15th of September. At the closing, you will have to pay the interest portion of your mortgage, for only the last half month, which is overall a small amount. In October you pay nothing. Your mortgage is due only on the 1st of November. You should know that in the U.S., you pay interest in arrears. It means that the interest you pay each month is on the money you owed, which is called the principal, for the previous month. In contrast, when you rent you have to prepay the first month.
You can use that fact to make the transition from renting to owning easier. I used that fact when I bought my home, which was in a moving-in condition with only minor defects. The closing was on the 30th of December. I paid only a few dollars for the last two days of the monthly interest. I was moving out from my rental at the beginning of January, so I paid only a fraction of my rent, and the mortgage payments kicked in only in February. That made the transition smooth from a monthly budget perspective. As always, it depends on your situation and how well you can organize the move, which may not be straightforward.
Should you buy your home?
So now guys, you know you can buy a house. Then should you buy one? I think the answer is yes for a lot of people.
I will talk about the tax advantages of owning in another blog post. However, you should know that you can deduct the interest you pay up to a certain point from the money you earn, which lowers your tax bill.
By the way, each dollar you deduct would have been taxed at your marginal tax rate, not your average tax rate. So it means that it has a real impact on the lowering of your tax bill. You can also deduct from your taxable income the property taxes, up to $10,000. As a tenant, you generally do not deduct the property taxes your landlord pays, even if the money to pay them comes from the rent you pay. All those elements have to be factored in. Comparing the cost of renting to the cost of owning a house can be tricky.
Before I forget, if you are a tenant in New Jersey, you can deduct from your state’s taxable income 18% of the rent paid during the year, because the state considers it as property taxes paid.
Let’s assume you pay a monthly rent of $2,500, which is $30,000 a year, and that your marginal tax rate in New Jersey is 6.37%. It means you can deduct $5,400, and you just saved about $344 on your New Jersey income tax. Or even better, maybe you can choose to get a refundable tax credit of $500 toward your New Jersey income tax instead of the deduction. As always please check with a CPA or a tax advisor if it applies to you!
If you do not live in New Jersey, you may still have similar tax breaks when you rent. You have to check what you can do in your state or city.
For example, I do believe that in New York City, if you make less than $200,000 a year, and have lived for at least six months in the same place, you should qualify for the “New York City Enhanced Real Property Tax Credit.” We are talking about up to $500 credit toward your state’s income taxes. So renters, do your homework check if you can qualify for a deduction or usually even better, a credit, where you live.
I usually want to talk about investment in general on this channel, that applies not only in the U.S., but at least the core concepts apply globally. However, if I know something specific about where you live, I will share it with you! By the way, if you are aware of tax breaks renters can get in your state, share them in the comments below.
To wrap up, I know it is not the full picture. More posts are coming to deep dive into investment in general, and real estate in particular. Still, I do believe it is worth thinking about, and you may have more options than you are aware.
If you want to know more about your specific situation, what you can afford, you should talk to a lender, and then to a real estate agent. Building your wealth today is better than trying to start tomorrow.