First Time Homebuyer Tax Credit: What You Need to Know
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Summary:
Although there is not currently a federal first-time homebuyer tax credit, a bill is making its way through Congress that would revive the tax credit implemented after the 2008 financial crisis. If made into law, the new First-Time Homebuyer Act would grant a $15,000 tax credit to those who qualify. There are also state tax credits and other benefits you should look into if you are a first-time homebuyer.
In the United States, politicians have a bit of a conundrum. On the one hand, they need to make sure that property prices stay stable and grow, as a rising housing market is good for politics. On the other hand, if property prices become too high, they can price young and first-time homebuyers out of the market. They usually walk this tightrope by implementing tax credits and other incentives for first-time homebuyers. This is why a federal tax credit for first-time homebuyers is back on the table, and many other public and private programs exist to help people get on the housing ladder.
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Tax credits in brief
Most people who have filed income tax returns are familiar with tax credits, such as the child tax credit that went up during the COVID pandemic. Tax credits are incentives that allow you to subtract an amount from your tax liability (taxes you owe). Tax credits are different from tax deductions in that they aren’t deducted from your taxable income calculation. Instead, they are used as a credit against your existing tax bill.
For instance, if you have a tax credit of $10,000 and owe $18,000 in federal income taxes, with the tax credit, you now only owe $8,000 in taxes. Likewise, if you have a tax credit of $10,000 and owe a tax bill of $4,000, you are now due a refund of $6,000. Traditionally this is how tax credits have worked, but how they are implemented is another story. With some tax credits, you can choose to have them paid upfront or claim them when filing taxes, whichever is easier.
First-Time Homebuyer Tax Credit: 2008 vs. 2021
A federal first-time homebuyer tax credit was originally implemented back in 2008. Although this tax credit was eventually phased out, similar legislation is making its way through Congress via the First Time Homebuyer Act of 2021.
2008 First Time Homebuyer Tax Credit
The 2008 First Time Homebuyer Tax Credit was implemented in 2009, after the property market started falling, to help stabilize and hopefully achieve a floor in the market. The American Recovery and Reinvestment Act of 2009 (Economic Recovery Act) stated that the following people would qualify for the tax credit.
- Homebuyers purchasing a home in 2008, 2009, and 2010
- An $8,000 tax credit was available to first-time homebuyers who purchased homes before May 1, 2010 (and closed on the home by June 30, 2010)
- A homebuyer credit of up to $6,500 ($3,250 for those married filing separately) for homebuyers who have lived in their homes for five years
- Credit phased out for those earning $125,000 individually or $225,000 jointly
2021 proposed First-Time Homebuyer Tax Act
The 2021 First Time Homebuyer Act is making its way through Congress, although there is never a guarantee it will be signed into law. The 2021 law differs in that it acts as more of an incentive for buyers to enter the market in a period of rising housing prices. The previous credit was designed to stabilize and assist buyers who bought during the market downfall of 2008, 2009, and 2010. For instance, the 2008 credit was available to people who had already lived in their homes for five years and might have bought before 2008. The 2021 legislation does not offer something similar. Here is the proposal:
- $15,000 tax credit or 10% of the purchase price, whichever is greater.
- The tax credit can be paid upfront, acting as a sort of interest-free loan.
- The tax credit is inflation-adjusted; therefore, the tax credit will rise yearly.
- You must live in the home for at least four years. Otherwise, you are liable to pay the tax credit back.
The tax credit is paid upfront, rather than strictly applying it to taxes owed when filing, which gives a bit more flexibility and allows people to use the tax credit towards a down payment and/or closing costs.
Pro Tip
Certified Financial Planner Timothy Ford says he recommended his clients take advantage of the first-time homebuyer tax credit back in 2009. “When the First Time Home Buyer tax credit was issued in 2008, it was basically a way for the government to say, ‘I’m sorry housing prices are falling.’ Now the newly proposed one should help some of my clients who are locked out of the property market to get on the ladder. I always see tax credits as ‘free giveaways’ from the government, so they should be used.”
What qualifies as a first-time homebuyer
To be considered a first-time homebuyer, you need to meet the following criteria:
- Have not owned a home (primary residence) or been on a mortgage for at least three years
- A former spouse whose primary duties were domestic, and the spouse owned the previous home
- A single parent who previously co-owned the previous home
- Have only owned a home not permanently fixed to a foundation
- Have owned a home that is not compliant with concurrent building codes and government regulation and would cost more to bring it up to code than it’s worth
Requirements for first-time homebuyers under the 2021 rules
For the proposed legislation, even if you are considered a “first-time homebuyer” by the book, it doesn’t mean you will qualify for the tax credit. You also must meet the following further requirements:
- Be a first-time buyer who has not owned a home in three years (exceptions above)
- Your income must not be more than 60% above the median income in your area to satisfy income limitations
- You cannot have used a previous FTHB tax credit in the last five years
- You cannot purchase a home from a relative
First-time buyers in a high-interest-rate environment
When the legislation was introduced in April 2021, the average interest rate for a 30-year fixed-rate mortgage was hovering around 2.65%. Since that time, however, interest rates have risen significantly.
First-time buyers might face two primary headwinds when buying in an environment with rising interest rates. First, mortgage rates are linked to the Fed’s base rate, so if interest rates increase, the mortgage rates will increase, making the mortgage payments more expensive. Second, the Fed has raised interest rates to purposely slow down the economy and control inflation, which can dampen the property market. So, are you buying a property at the wrong time with a value that will fall and an overpriced interest rate?
Historical interest rates
As most first-time home buyers will have come of age after the 2008 financial crisis, they are used to Fed interest rates that hover around 0%, with mortgage interest in the 3%-4% range and sometimes lower. In reality, however, the decade-plus following the financial crisis was an aberration, not the norm. You can see this on the graph below.
In fact, many economists say that we are returning to more normalized interest rates, which is needed to prevent asset bubbles from forming all over the place. (See PE ratios of the stock market). Scott Lawlor, the chief investment officer at Waypoint Residential, knows that this is more of a return to the norm. “We’re going through a period of adjustment, coming off of this bizarre aberrational decade of basically free money,” he says. “This has never been the case in history, nor does it need to be the case — we don’t need free money to do successful real estate investing.”
We're going through a period of adjustment, coming off of this bizarre aberrational decade of basically free money. This has never been the case in history, nor does it need to be the case. - Scott LawlorClick to Tweet
Housing supply is constricted
Unlike the real estate boom leading up to the 2008 financial crisis, when McMansions were being built faster than you could sell them, the market these days suffers from a dearth of supply/inventory. You can see this in the graph below dictating inventory since 2017.
Higher interest rates actually compound this problem because buyers with a low fixed mortgage rate will sit on their properties rather than trade them in for a new one. Traditionally, the property market works based on that turnover. This doesn’t mean the property market won’t go down; no one one can predict exactly what will happen. However, the lack of supply in the market could put a floor on a price drop much more quickly than falling housing prices after 2008.
Other first-time homebuyer incentives
While first-time buyers wait for word on the new federal legislation, they can look into other programs to help them afford to buy a home.
3% down Freddie/Fannie mortgages (conventional loans)
Fannie Mae and Freddie Mac offer the following programs to help FTHBs buy homes with as little as 3% down. Some of these are as follows:
- Conventional 97 Mortgage
- HomeReady Mortgage
- Home Possible Mortgage
- HomeOne Mortgage
Government-backed loans
The following loans are also available to first-time home buyers, with many benefits you can read about in our guides:
Good Neighbor Next Door Program
The Good Neighbor Next Door Program provides housing aid for crucial employees such as teachers, law enforcement, and firefighters. The program focuses on “revitalization areas” in which people who qualify can receive a 50% discount on the home’s purchase price.
State tax credits
Check with your state to see if they offer any benefits to first-time homebuyers, such as tax credits, down payment assistance, or help with closing costs.
Mortgage Tax Credit Certificates
Although not relegated to first-time homebuyers, Mortgage Credit Certificates (MCC) allow you to deduct a portion of your interest payments from your taxes.
Other tax write-offs
Again, these are not relegated to first-time home buyers, but many times you can deduct property taxes and mortgage loan interest on your taxes. Although these aren’t refundable tax credits, they can help reduce costs when owning a home. If you want to save on your federal or state taxes, it’s best to take advantage of the various write-offs. If you’re not sure which deductions to take, a tax professional can help.
FAQ
Who is eligible for the first-time homebuyer tax credit?
You must meet certain requirements to be considered a first-time homebuyer for the federal tax credit. Furthermore, you must not make more than 60% of the median income in your area and not have owned a home for at least three years, with some exceptions.
How much is the first-time homebuyer tax credit, and how is it calculated?
The 2021 proposed legislation states that the first-time homebuyer tax credit is either 10% of the purchase price or $15,000, whichever is greater. The phased-out 2008 tax credit was for significantly less money, and the new one will be inflation-adjusted as well.
How do I claim the first-time homebuyer tax credit on my taxes?
As the new one has yet to become law, you can not claim it yet. However, for the previous first-time buyer tax credit, you would fill it out using Schedule 2 (Form 1040) on your federal taxes.
Key takeaways
- Although there is not currently a federal first-time homebuyer tax credit, a bill is making its way through Congress that would revive the tax credit implemented after the 2008 financial crisis.
- The proposed federal tax credit is refundable, meaning you can receive a refund on your federal tax bill if it turns out you owe less than the credited amount.
- To be eligible for the new proposed tax credit, you must meet several eligibility requirements to be considered a first-time homebuyer.
- Being a first-time homebuyer in a high-interest-rate environment can be scary, but you can use federal and state tax credits and other benefits to help you afford a home.
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