First-time Buyers Should Take Advantage of Housing Tax Credit

Kathy Kristof

If ever there was a great time to buy a first home, it's now.

Interest rates and housing prices are low, and the federal government is giving money to buyers in the form of an $8,000 tax credit. But if you want to take advantage of the credit, you'll need to move fast -- it's available only to buyers who complete a deal by Nov. 30 and earn less than $95,000 if single or $170,000 if married.

"If you have the cash and a stable job, this is a perfect time to buy a house," said Ilyce Glink, author of "100 Questions Every First-Time Home Buyer Should Ask." "But people are running out of time."

It can be tough to complete the purchase of a home in less than two months, even for an experienced buyer. That's particularly true now, when lending standards are far tighter than they've been in decades.

It's even more challenging for first-time buyers, who often don't know what's expected. For those who'd like to try, here's a quick primer.

WHAT YOU CAN AFFORD

It's fun to look at million-dollar homes, but unless you've got a fortune stuffed in your sock drawer, you'll need a loan to buy. And because lenders have tightened their standards over the last two years, you'd be wise to figure out your price range before shopping.

There are two ways to do that: You can get pre-qualified for a loan by going to your bank and filling out the necessary paperwork, or you can come up with a pretty accurate guesstimate by using an online calculator. The Federal Housing Administration offers one at www.fha.com.

But to make sense of what the online calculator determines you can borrow, you should know that lenders will base how much house you can afford on three factors -- your gross income, your down payment and your outstanding debts. Let's deal with these one at a time.

INCOME

Lenders now figure that you shouldn't be spending more than 28 percent to 30 percent of your gross, or before-tax, income on housing costs, said Greg McBride, senior financial analyst with Bankrate.com. In the past, they'd let you spend as much as 40 percent.

Housing costs encompass more than your mortgage payment. They also include the cost of property taxes and insurance. And if you are buying a condominium or town home, there probably are monthly homeowner's fees, too.

To get a conservative estimate of how much house you can afford, multiply your annual gross income by three. That would mean that a person with $60,000 in annual income could borrow about $180,000.

In dollars and cents: At about 5.5 percent for a no-point 30-year fixed-rate loan with a traditional down payment, a $180,000 loan would mean a monthly mortgage payment of $1,022.

Property taxes and insurance, which are based on the home's value rather than the loan amount, are estimated at $302 a month by MortgageGrader.com, an online mortgage shopping service. If you add in a $100 condominium association fee, your total monthly cost is $1,424, or about 28 percent of your $5,000 in monthly gross income.

DOWN PAYMENT

A traditional down payment is 20 percent of the home's amount. So if you're buying a $200,000 home, you'll need $40,000 for the down payment.

If you have generous relatives, some of the money could come from gifts. If it does, your lender is likely to require documentation -- maybe a letter from Mom and Dad saying the $20,000 that suddenly appeared in your bank account was a gift and not a loan.

But if you don't have enough funds for a traditional down payment, you may be able to get a government-insured FHA loan, which requires a down payment of as low as 3.5 percent. The downside of FHA loans is that they require mortgage insurance, which can add almost 2 percent to your closing costs and will boost your monthly payments.

OUTSTANDING DEBTS

In addition to looking at your housing costs as a percentage of your monthly income, lenders are going to look at your outstanding debts such as student loans, auto loans and credit cards. The reason: They want to make sure that you'll have money after paying your mortgage and other debt for food and transportation expenses.

That's not really because they care whether you can afford to eat and get around town. It's because they realize that if you're short on gas money, you can't get to work, and you're likely to eat whether you can afford it or not.

So if there's not enough money for both, lenders will assume that you'll have trouble paying your loans.

MORE CASH FOR CLOSING

In addition to a down payment, you are likely to need between 3 percent and 7 percent of the home's value to handle closing costs, Glink said. The money will be needed to pay for as many as 35 different items including title insurance, inspections and loan fees.

COST OF OWNERSHIP

With all these costs, it's easy to tap every dollar of your available cash. But you'd be foolish to drain your emergency fund, McBride said. Home ownership requires constant maintenance that you'll eventually learn to budget for. But initially, a broken refrigerator, a leaky roof or a broken pipe is going to seem like an emergency.

"Buying a house is a lot like getting married," McBride said. "You have to be in it for the long haul and be prepared for the financial commitment."

TAX CREDIT

On the bright side, the tax credit may help restore your emergency savings. This credit amounts to $8,000 or 10 percent of the home's value, whichever is less. The full amount can be claimed by single taxpayers earning less than $75,000 and by married couples who earn less than $150,000. After that, the credit begins to phase out.

But to claim the credit, you have to complete the purchase by Nov. 30. It normally takes 45 to 60 days to close the deal, even when you're organized. So, if you want the tax credit, you'll have to move fast.

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