The benefits of owning a home are numerous. Homeownership not only provides tax and financial advantages, but there are also personal benefits of being a homeowner. However, owning your slice of the American dream also has risks. Before you begin shopping for a mortgage and a home, learn more about the responsibilities of homeownership.
What are the tax benefits of owning a home?
There are multiple tax benefits of owning a home. Between tax advantages on the initial home purchase, ongoing mortgage payments, and even home improvement, homeowners can take advantage of various homeowner tax breaks.
Mortgage interest deduction
One of the leading tax advantages of buying a home is the ability to deduct mortgage interest from your taxes every year. This tax break is one of the multiple benefits of owning a home vs. renting, since rent payments are not tax-deductible. And during the early years of a mortgage, when most of the monthly payment goes toward interest, this deduction can offset a significant amount of taxes.
However, not all homeowners qualify for the mortgage interest deduction. Since the Tax Cuts and Jobs Act (TCJA) made changes to eligibility rules in 2018, homeowners must file either Form 1040 or 1040-SR and itemize their deductions to qualify for this tax break.
Homeowners who meet those requirements can deduct mortgage interest paid on the first $375,000 of mortgage debt ($750,000 if married filing jointly).
Property tax deduction
The property tax deduction is one of the advantages of owning a home that affects homeowners with or without a mortgage. As a homeowner, you’ll pay property (or real estate) taxes to your town or state government every year. But homeowners who file either Form 1040 or 1040-SR and itemize their deductions can deduct what they pay in property taxes — up to $5,000 ($10,000 if married filing jointly) — from their taxable income. When you purchase your home initially, the amount of taxes you pay at closing is also deductible.
Capital gains exclusion
One of the benefits of being a homeowner comes into play when it’s time to sell your home. Generally, if a consumer makes a profit when selling personal assets, such as real estate, household furnishings, or stocks, they have to pay capital gains tax. But tax laws provide some relief to homeowners selling their main home.
The capital gains exclusion allows homeowners to exclude up to $250,000 of profit ($500,000 if married filing jointly). To qualify, homeowners must have owned and lived in the home for at least 24 months within the five years leading up to the sale. Homeowners can take advantage of the capital gains exclusion every two years.
If you buy discount points (prepaid interest) to lower your mortgage interest rate, the amount you pay is tax-deductible over the course of the mortgage. This deduction also applies to loan origination fees and any points paid by the seller. Additionally, if you take out a home equity loan on the property in the future, you can also deduct what you pay for discount points from your taxes as long as you use the loan proceeds to buy, build, or improve the home.
Private mortgage insurance
Most government loans, such as VA, USDA, and FHA loans, charge fees to help offset the cost of the mortgages. And buyers who put less than 20% down when purchasing a home with a conventional loan (non-government loan) have to pay private mortgage insurance (PMI).
While these fees have different names depending on the loan program (funding fee for VA loans, guarantee fee for USDA loans, mortgage insurance for FHA loans, PMI for conventional loans), they are all tax-deductible. This tax benefit applies both to upfront mortgage insurance paid at the time of purchase and ongoing mortgage insurance premiums throughout the life of the loan.
Currently, homeowners can claim federal residential energy credits when making energy-saving home improvements, such as installing solar panels, solar water heaters, fuel-cell equipment, and other items. Additionally, many state and local governments provide tax and other financial incentives to homeowners who make energy-efficient upgrades.
Sales tax breaks
Some states provide a “sales tax holiday” on energy-efficient home appliances or other home improvement purchases. For example, states prone to storms and floods may give a tax break on purchases such as generators and other storm supplies leading up to hurricane season.
What are the personal benefits of being a homeowner?
In addition to the financial benefits of owning a home, new homeowners experience many personal advantages. While these benefits of homeownership won’t necessarily put money in your pocket, they can provide great personal satisfaction in achieving the American dream.
- Pride of ownership. There’s a significant sense of pride in knowing the home you live in belongs to you. This sense of pride may also play a factor in how you care for the property.
- Stability. Of the many benefits of owning a home vs. renting, security is a significant one. As a homeowner, you won’t be subject to the instability or fear of a rent increase or having to move when your landlord sells the property.
- Sense of community. Owning a home can deepen your sense of belonging and investment in your local community.
- Freedom to make changes. When you own a home, you can do as you wish with the property, whether it’s choosing paint colors, customizing your floor plan, or designing your landscaping.
Why is buying a home a good investment?
In addition to the tax benefits, advantages of buying a home include increased financial stability and the opportunity to build wealth. The average net worth of homeowners is 45 times greater than that of non-homeowners, making homeownership a wise financial move for most buyers.
Opportunity to build equity
Equity is the portion of the home that you own. In other words, it’s the market value of your home minus what you owe on it. If you buy a $400,000 home and make a 20% ($80,000) down payment, you immediately have 20% or $80,000 equity in the home.
As your time in the home progresses, your equity can grow by two factors: the increase of the home’s value (appreciation) and the reduction of your mortgage. While there’s no guarantee that when you sell your home the value will be higher than when you bought it, home prices generally appreciate over time. This trend creates the potential for homeowners to capitalize on the growth. And data shows that homeowners who remain in their homes for seven years or more can usually expect to see their home’s value increase.
|Years in home||Average price appreciation (single-family home)|
Building equity not only increases your net worth, but also gives you borrowing power. Leveraging home equity is one of the benefits of owning a home many homeowners take advantage of. With enough equity in your home, you can use a home equity loan or home equity line of credit (HELOC) to fund a significant expense, fix up your home, or purchase an investment property. While this move decreases your equity in the home, it can provide an advantage over other forms of borrowing that may come at higher interest rates.
Protection against inflation is another one of the many financial benefits of buying a home. Inflation refers to the rise in the cost of goods and services. When inflation occurs, not only do home prices increase, but the cost of borrowing rises. The result is a decrease in consumers’ buying power.
Owning a home provides some protection against future inflation for a few reasons:
- You won’t be subject to potential rent increases as you would be if you were renting.
- If you have a fixed-rate mortgage, your loan payment will not increase even if interest rates do.
- You’ll benefit from increased home prices if you sell your home during a time of inflation.
Know the risks and responsibilities of homeownership
While the advantages of owning a home are significant, homeowners are often surprised by the additional expenses and responsibilities of homeownership. Prospective homeowners must weigh both the pros and cons of buying a house.
High upfront costs
In addition to the mortgage payment, you’ll need to prepare for some out-of-pocket costs before you can call the home yours.
- Closing costs. During the homebuying process, you’ll need to cover fees related to closing the loan, such as the home appraisal, inspection, title fee, lawyer fees, taxes, and other upfront expenses. These closing costs can run anywhere from 2% to 5% or more of the home purchase price. In our example of a $350,000 home, the closing costs would range from $7,000 to $17,500 or more.
- Down payment. While some zero-down loans exist, a borrower making even a small down payment will need to bring thousands of dollars to the closing table. Here’s an example of what a typical down payment may look like for a $350,000 home.
Home price: $350,000
|3.5% down||5% down||10% down||20% down|
To help reduce the amount of cash you need to pay upfront, you may be able to finance some closing costs or have the lender cover them. Keep in mind, choosing either of these options will make the loan more expensive. Another way to offset the down payment and closing costs is to take advantage of down payment assistance programs offered by many lenders, state governments, and community organizations.
Maintenance and financial responsibilities
When new homebuyers calculate how much home they can afford, they typically compare their current rent payment with an estimated mortgage payment. But this doesn’t give the complete picture of the financial responsibilities of homeownership.
Taxes and homeowners insurance. Some mortgage calculators only estimate the principal and interest of a home loan. But homeowners also will need to pay property taxes and homeowners insurance. So, be sure you calculate the PITI payment (principal + interest + taxes + insurance) and any additional ongoing fees related to the mortgage. Even when you pay off your mortgage, you’ll continue to pay homeowners insurance and property taxes. And over the years, both of these expenses can increase along with the home’s appreciation.
Home maintenance. Homeowners often underestimate the cost of maintaining a home. From routine lawn care to unexpected repairs to major expenditures, such as a roof replacement, home maintenance can add up over the years. A common rule of thumb is to expect to plan to spend 1% to 3% of the home’s value in maintenance every year. So for our $350,000 home, that’s $3,500 to $10,500 annually, or $291 to $875 per month. That’s a sizable expense on top of your mortgage payment, but home maintenance will also impact the home’s value and appreciation over the years.
Homeowners association dues or condo fees. If you purchase a condominium or co-op or your home is in a homeowners association community, you’ll need to pay additional fees on top of your mortgage payment, as long as you own the home.
One of the leading financial benefits of owning a home is that you can gain a significant return on your investment over time. However, the downside to that benefit is your returns aren’t liquid. In other words, the only way to access the increased value of a home is to sell it or borrow against the equity.
To learn more about how you can reap the benefits of owning a home, contact a FAM Loan Advisor today.