Guide to Mortgage Tax Credits: A First-Time Home Buyer’s Advantage

Buying your first home is a major milestone. It is likely to be the largest purchase you will ever make, so finding ways to make it more affordable is a good idea. One of the programs available to first-time homebuyers that can make monthly mortgage payments more affordable is the mortgage credit certificate (MCC) program.

In this post we’ll tell you how this program works, how it can reduce your federal taxes, how to access it, and other ways you can save money as a first-time homebuyer.

What are First-Time Homebuyer Tax Credits?

A Mortgage Tax Credit Certificate – or an MCC – provides first-time homebuyers with a federal tax credit against their federal income tax liabilities. The credit will be calculated based on a percentage of their homebuyer’s mortgage loan interest.

A tax credit is different from a tax deduction in that:

• Credit applies dollar-for-dollar to the amount you owe in federal income tax.
• A tax deduction reduces your taxable income from which the Internal Revenue Service (IRS) assesses your income tax bill.

MCC programs are intended to help make buying a home more affordable for low and moderate-income and first-time home buyers by reducing their monthly payments. They’re managed by their respective state Housing Finance Agencies (HFAs). State HFAs are managed by a board of directors that are appointed by that state’s governor, but typically act as independent entities from the state government.

How is a Tax Credit Calculated?

The tax credit is calculated as a percentage of the total annual mortgage interest expenses the borrower pays. The amount can range from 20%-40% of the annual mortgage interest expenses, depending on the state in which the property is located. So if the borrower pays $5,000 in annual interest on their mortgage debt, and their state MCC program credits 40% of their mortgage interest payments, the borrower will see their income tax bill reduced by $2,000.

The amount of your mortgage interest expense will depend on:

• Your mortgage interest rate
• Your loan term
• The original loan balance

Even though the mortgage tax credit applies to federal taxes, the amount of the credit is determined by the state in which the property is located. That’s because to fund this program, the federal government allows states to use a portion of their federally allocated private bonds. Each state will have their own formula for determining the percentage of private bonds they allocate to offering residents a mortgage tax credit.

How Can I Qualify for a Mortgage Interest Credit?

To qualify for a mortgage interest credit, borrowers must meet these qualifications:

1. Their annual income and home purchase price must fall within the limits set by their state.
2. They must be a first-time homebuyer, active military or veteran, or purchasing a home in an area targeted by the Department of Housing and Urban Development (HUD).
3. The home must be the buyer's principal residence.
4. The buyer may be required to complete pre-purchase homeownership counseling (depending on the MCC program).

How Do First-Time Homebuyer Tax Credits Work?

MCCs are paired with home mortgages, so a homebuyer must apply for an MCC when they apply for a mortgage to purchase their property. If you think you fall within your state’s MCC qualifications to receive a mortgage tax credit, you will want to look for a mortgage lender or mortgage broker that participates in the MCC program.

Once you’ve found your lender, this is how the process works:

• Your lender will qualify you as eligible to receive an MCC.
• If you qualify, your lender will assist you in completing the state’s required forms to apply for an MCC.
• Your lender will submit your MCC to the necessary governing body (state or local government).

If you’re approved, your MCC will be issued directly to you. You can take your tax credit in one of two ways:

1. You can take it when you file your Federal Income tax returns.
2. W2 employees can amend their W4 documents to have their employers withhold less of their taxable income from their paychecks.

There are some other rules that govern these mortgage tax credits. Let's break them down into three categories.

1. Homeownership Rules

This home must be your primary residence. This means:

• It must be owner-occupied.
• It can't be considered a rental property, nor can you collect rental income from the property.
• To qualify as a home, it must have space for you to sleep, provide an ability for you to cook, and toilet facilities. Examples: A house, condo, boat, mobile home, trailer house, etc.

2. Tax Credit Rules

There are several rules that apply to the amount of credit you can receive on your taxes:

• $2,000 is the maximum mortgage tax credit a homeowner can claim in any given year.
• You can’t have used this tax credit previously.
• Your tax credit can’t exceed your total federal income tax bill for the year.
• Any credits you have that are in excess of your federal tax bill can be carried forward to the following three years.

3. MCC Program Rules

Whether you are a first-time homebuyer or refinancing, take a look at the MCC requirements in your state. It may help you to save some additional money. That’s because:

• Some states allow homebuyers to combine an MCC with other first-time homebuyer assistance programs like down payment assistance.
• Typically, MCCs are only available for home mortgages used to purchase a property. But some state MCC programs may allow borrowers who are refinancing an original mortgage with an MCC attached to it to apply for a new MCC with the refinanced loan.

Are there Fees Associated with a First-Time Homebuyer Tax Credit?

Your state’s HFA and your lender may charge borrowers a one-time fee for participating in the MCC program. These fees will be added to closing costs. But there are other restrictions on fees that might offset this one time fee. For instance, some states cap lender fees (similar to loan origination fees) for loans that are coupled with an MCC.

What are the Benefits of Using First-Time Homebuyer Tax Credits?

For homebuyers who qualify for an MCC, participating in this program can make buying a home more affordable. It can also help borrowers qualify for a mortgage they may have otherwise not been able to obtain. These mortgage tax credits can also be paired with most types of first mortgages, including conventional fixed-rate and adjustable-rate mortgages, so borrowers have the flexibility to look for the type of loan that works for them.

What are Some Challenges That Come with Using First-Time Homebuyer Tax Credits?

For borrowers that qualify for their state’s MCC program, there is one drawback to participating in the program: The IRS could recapture a portion of your credited amount. While state HFAs report this rarely happens, it could if your situation satisfies all three of these conditions:

1. You sell your home within nine years of purchase.
2. At the time of the sale, your income is significantly higher than it was when you applied for the MCC.
3. You made money off the sale of the home.

The maximum amount of recapture is the lessor of:

1. 6.25% if the original mortgage balance
2. 50% of the gain on the sale of the home

Many State HFAs programs reimburse borrowers if they experience an IRS mortgage tax credit recapture.

Some Additional Ways First-Time Homebuyers Can Save Money

MCC’s aren’t the only way first-time homebuyers can save money on their purchase. Speak with your lender or mortgage advisor about the below options to see if any of the below options apply to you.

Mortgage Interest Tax Deduction

If you have itemized deductions, and consider your home mortgage a secured debt for tax purposes, you may be able to deduct at least a portion of your mortgage interest secured by your principal and secondary residences.

A mortgage interest deduction is calculated based on the mortgages’ origination date and the amount of the loan. If your mortgage closed prior to 10/13/1987 (i.e. grandfathered debt), you can deduct the full amount of your mortgage interest on all homes from your income taxes.

If your mortgage closed between 10/13/1987 and 12/16/2017:

• You can deduct interest on up to $1 million in mortgages if you’re an individual taxpayer or married filing jointly.
• You can deduct up to $500,000 if you’re married filing separately.

If you originated your loan post 12/16/2017:

• You can deduct your mortgage interest up to $750,000 of debt.
• If you take the standard deduction instead of an itemized deduction, you're ineligible to take a mortgage interest deduction.

Down Payment Assistance

Down payment assistance programs are run by state and local governments and can include grants and low- to no-cost loans, depending on what’s available in your area. HUD is a great resource for finding these programs in your area.

Discount Points

Discount points are essentially a way for borrowers to prepay some of their interest up front to lower their monthly mortgage costs. If this is interesting to you, ask your mortgage lender if they offer this capability. Keep in mind, this may impact your closing costs at the time of purchase.

Real Estate Taxes Deduction

If you pay property taxes, you can deduct the expense on your taxes. This tax deduction is available to all property owners, not just first-time homebuyers.

The Bottom Line

Buying a home for the first time is a major life event. To ensure the process goes smoothly and you’re able to financially manage the house you buy, it can be a good idea to research local and state programs that help first-time homebuyers.