Some Basic Non-Tax Information

Now that I have illustrated for you the significant tax benefits that flow out of home ownership, let's explore certain issues relevant to your owning a home, whether you are a first-time homeowner or a repeat buyer.

In your own mind, you have a dollar range for a home you think you can afford.  Exactly how much home you can actually buy will be affected less by the actual dollar purchase price of the home and more by the following two factors: (1) closing costs (the actual costs you will incur in the year when you purchase the home, including your cash down payment to the seller and other costs paid to the Bank through which you are mortgage finance the purchase of the home), and (2) the type of mortgage you get and the interest expense charged on that mortgage.  Until you have a handle on these two things you will not be able to analyze how much home you can actually afford.

Since few of us have the wealth reserves to purchase a home outright, we must borrow money from a Bank in order to purchase our home.  This form of loan is called a mortgage.  The Bank (lender) takes a mortgage security interest in the home.  If the borrower defaults on the mortgage, the Bank can compel the sale of the home to satisfy the debt.

Because the Bank does not want to get caught short in a default situation, the general rule of thumb is that it will lend 80% of the purchase price.  Thus, in a standard situation, the new homeowner will come up with 20% or more of the purchase price and borrow the balance from the Bank.

What if we do not have the 20% down payment?  Here are a few solutions.  Your Bank of choice probably participates in a FHA (Federal Housing Authority) or VA (Veterans Administration) insured home loan program.  Under these programs the purchaser might come up with only 5% of the purchase price and finance the 95% balance.  However, under these programs the borrower must purchase "mortgage insurance" until he or she pays down the mortgage to the 80% equity level.

In my own situation, my wife and I bought our first house in 1983 and financed it with an FHA/VA mortgage.  I put 5% of the purchase price down and financed the 95% balance.  It took me about 4 or 5 years to pay off enough of the mortgage principal to get the remaining balance to the 80% threshold that allowed me to drop the mortgage insurance.

NOTE:  In many cases the Bank will not clearly notify you when the mortgage insurance is no longer necessary, so it is prudent that you keep tabs on this mortgage insurance point if you go this route.

Another approach with regard to funding the ideal 20% down payment would be to borrow against your account balance if you participate in a company sponsored retirement plan like a pension, profit-sharing or Section 401(k) plan (discussed under the Retirement Planning section of the book).  If you look at my discussion on Consumer Interest Expense on page 147 in the Miscellaneous section of the book, I detail for you how to effect such borrowing against your plan and, in many cases, making the interest expense on such a loan tax deductible.

When you sell or buy a home, a person called an escrow agent acts as an intermediary for the buyer and the seller.  Your Bank or the real estate agent can advise you on an appropriate escrow agent.  The function of the escrow agent is to accommodate the transfer of funds and the deed and other necessary documentation on the home between the buyer and the seller.