Looking to buy a house? Great, how much can you afford? Figuring out what we can spend is usually the prelude to any major expenditure.
But first-time home buyers using their current rent to figure roughly how much house they can afford have to learn that rent dollars aren't the same thing as mortgage dollars.
Mortgage dollars are (mostly) tax deductible, and you can pay a lot more of them than you now pay in rent dollars and still come out ahead, or at least even.
Of course a number of factors figure into the affordability of a particular house or condo. But a good preliminary step to getting into the real estate market is sitting down and figuring out, given your tax bracket and your current rent, how many mortgage dollars you can afford. (We're assuming your current rent is somehow affordable. David Bugen of Individual Asset Planning Corporation in Morristown, N.J., says, ''We recommend people spend no more than 25 percent of their gross income on rent.'' We're also assuming you have some sort of annual budget giving you a rough idea where your money is going. You do, don't you?)
And as you sit down to make this calculation, you should bear in mind that paying interest on a mortgage will generally let you itemize deductions, perhaps for the first time. To itemize, you need deductions in excess of the $3,400 ''zero bracket'' amount (or $2,300 if you're single), and most renters don't have that.
On the other hand, once mortgage interest payments let you itemize, you can increase your tax savings by itemizing a number of other expenses, such as state and local taxes, charitable donations, and credit-card interest payments.
Here is how Robert A. Hewitt, a certified financial planner and vice-president at the Financial Marketing Corporation in Carmel, Calif., calculates the rent-to-mortgage equivalence:
''Suppose you've been paying $750 a month in rent, and you're buying a $100, 000 house, putting 20 percent down,'' he says.
''That leaves you with $80,000 to finance, and let's say you've got a 14 percent fixed-rate loan for 30 years. Your monthly payment, principal and interest, will be $948.''
Gasp. We're already nearly $200 over the monthly rent payment. And we haven't begun to think about property taxes and insurance.
Using national average figures, Mr. Hewitt estimates insurance at $300 annually and property tax at $1,000; this works out to roughly $108 monthly - bringing the monthly total to $1,056.
Hewitt assumes you are married, with a combined gross income of $50,000 a year. And further, he assumes you have $1,000 in state income tax, charitable donations, and interest on miscellaneous charge accounts. (You may be able to claim other deductions as well - you can check any of a number of tax manuals for more information.)
Of that $948 principal-and-interest payment, Mr. Hewitt assumed $900 is interest - which is tax-deductible. So is the $83 monthly in property taxes. Thus, of the $1,056 monthly housing bill we've calculated, $983, or $11,796 a year, is tax deductible.
Taking that $12,796 in real estate and other deductions off the top of $50, 000, we end up with a taxable income of $37,204, which puts you in roughly the 33 percent marginal tax bracket. The $12,796 in deductible expenses is in effect pretax dollars. You have to spend them all to get the deduction, of course, but you don't have to share them with Uncle Sam.
To calculate monthly tax savings, take the $12,796, subtract the $3,400 (to clear the zero-bracket threshold), and multiply by 33 percent. This gives you $3 ,100.68, which, divided by 12 months, comes to $258.39.
Your $1,056 monthly payment, minus $258.39 in tax savings, leaves $797.61 - just about $48 more than your current rent. Thus, with this analysis, buying the
Now it's time to consider other factors than just cash flow, important though that is. You need to consider that you will be building up equity, and your property will presumably appreciate.
And as for making up that ''negative cash flow'': What other resources do you have? Perhaps you've been kicking $200 a month into your saving-for-a-down-payment fund. You should still set aside some money regularly, but you could reduce the amount to make up the $48 a month.
But how do swing that steeper payment each month? you may ask. Do I have to go into debt and wait for it all to come back in my tax refund check?
No, you can go to your employer and file a new W-4 form requesting additional exemptions; you can get a bigger paycheck all year long this way.
By now you're probably beginning to feel better about facing up to the numbers in those little books showing the breakdown of monthly mortgage payments at various rates.
You're not in the clear yet, however. As an owner instead of a renter, you will have to take responsibility for maintenance and also utility costs. You will probably not want to take out a mortgage loan that takes every last dollar that you can (theoretically) afford.
''We recommend counting on 3 percent of purchase price per year for maintenance of an old house, 15 years old or more,'' says Siri B. Bohannon, vice-president and director of marketing at W. J. Webster Planners Inc., in Timonium, Md.
Diana Jenkins of Financial Planning Services in Dallas says, ''We estimate moving costs will come to 10 to 15 percent of purchase price. That's actual moving costs, new furniture if you're moving into a bigger place, window treatments, and putting in the yard if it's a new house.''
And finally, if you've taken on a heavy mortgage responsibilities, it's especially important to have the ''emergency savings cushion'' of three to six months' salary that financial planners recommend.