Home Affordability Calculations

[Tortoise]

A while back I created a detailed spreadsheet to do home affordability calculations (i.e., "how much home can I afford?"), similar to the many online calculators out there but with each line item clearly displayed to allow more granular "what-if" calculations.

However, this past weekend it occurred to me that I was not accounting for the tax benefits of owning a home -- namely, the mortgage interest deduction and property tax deduction. I noticed that most online home affordability calculators don't seem to account for them, either, but others (such as this one) claim to.

On the one hand, I want to include the tax benefits of those deductions in my calculations so that I'm not being overly conservative. (Here in coastal Southern California, it's nearly impossible for most people to be financially conservative when purchasing a home, let alone very conservative.) On the other hand, I've read that at least 50% of homeowners -- the ones that take the standard deduction since it's larger than their itemized deductions -- are actually getting zero tax breaks from those deductions. In general, I've read that the tax benefits of the homeowner deductions tend to be greatly overestimated and overemphasized in mainstream personal finance.

The rule of thumb I often see is that the annual tax break a homeowner gets from the mortgage interest and property tax deductions is very roughly (combined federal + state tax rate) x (annual mortgage interest + property tax).

However, I've also read that that's a misleading calculation because it completely ignores the fact that everybody, whether homeowner or renter, always gets at least the standard deduction. So the relevant homeowner-specific tax benefit is really the difference between the standard deduction and your itemized deductions when you include the mortgage interest and property tax. If the latter is the same or smaller than the former, there is no tax break.

For those of you who crunched the numbers to figure out "how much home" you could comfortably afford, how did you account for the tax deductions for mortgage interest and property tax? Or did you leave them out of your calculations completely in order to be conservative?

[farjean2]

I crossed the threshold about two years ago where the standard deduction exceeds any benefit from the interest deduction so it's a moot point for me now and I don't have to factor it in. Owning a home is no longer of any tax benefit to me and I don't plan on buying a more expensive home now that I'm retired so it probably will never be.

[WiseOne]

Depends on whether you can itemize without mortgage interest and property tax. If you can't, then you should only count whatever amount of interest/tax brings you over the standard deduction.

Since you're in California and I assume pulling down a decent income (given that you're able to even contemplate buying a home), I would guess that you already itemize due to the state/local income tax deduction. In which case yes, you will benefit from every penny of the home ownership deductions. Definitely worth considering.

Interestingly, in a high tax environment, this factor skews the decision hugely in favor of buying. When you rent, you pay the full cost of the mortgage interest and property tax, plus often extra fees imposed by the building on landlords (e.g. a 10% maintenance surcharge is common) with no tax benefit whatsoever. When I sold my last apartment, I calculated exactly how much I'd spent on it, including mortgage, maintenance, assessments, extra expenses/improvements, etc, then set this against the tax benefits & net gains from the sale. It turned out that my "rent" for the 7 years of ownership was less than $800/month, for an apartment that would have rented for $2500-$3000/month. I suppose this isn't fair in a way since I did buy another place, but I switched to a different neighborhood that I like better and is lower cost.

This would all change if the Republicans succeed in eliminating the state/local tax deduction of course. I don't see that happening without a major political firestorm though. And it would virtually ensure that Republicans will never again carry NY, NJ or CA.

[Xan]

And it would virtually ensure that Republicans will never again carry NY, NJ or CA.

LOL, when was the last time a R presidential candidate carried any of those states? I don't foresee that ever happening again, regardless. Even with a R governor, NJ and IL always go to the D in the national election.

HW Bush took California and New Jersey in 1988. Reagan took all three in 1984. It's been a while.

[Pointedstick]

Count me as a member of the group whose standard deduction exceeds the benefit from itemizing. I think itemizing is mostly for rich people and property owners who live on the coasts with huge mortgage interest payments and property tax bills. I'm continuously surprised that Republicans don't end this favorable tax treatment and use the savings to boost the standard deduction. It would be a windfall for their voters, who are poorer, less coastal, and older (= more likely to have paid off their mortgage).

[Tortoise]

As usual, thanks for the great advice and explanations, everyone!

After thinking about this a bit more and also talking to a financially conservative family member, I think I'm leaning toward ignoring the tax deductions when doing my home affordability calculations.

I suppose the main reason is because over time, the tax benefit will decrease as the interest portion of the fixed mortgage payment gradually decreases, meaning if I'm counting on that benefit, it's likely to hurt as it disappears over time. Better to view the tax benefit as a temporary bonus rather than a required cash flow.

The other reason is because -- as some of you pointed out -- the tax benefit isn't guaranteed going forward; it could always be taken away by politicians. Perhaps unlikely, but definitely possible. People thought Trump getting elected was unlikely, and look what happened there.

Based on what I've seen at open houses recently, it may not be possible with my budget to find a modest 3-bedroom house in my area that's bigger than a walk-in closet and isn't a total fixer-upper. If that turns out to be the case, I'll just have to convince my wife to rent for another year or two while we wait for the next real estate downturn so that we can buy something at a reasonable price without having to get into a bidding war with other buyers.

Rents have been skyrocketing around here for the past year or two, which is overheating the real estate market even more. For a lot of people, rent is so high that paying an uncomfortably large mortgage suddenly doesn't look so bad in comparison. I kind of remember this same thing happening shortly prior to the housing crash of 2008 -- both rent and home prices skyrocketed in parallel to unsustainable levels -- so I think it's just a matter of time before we see another housing downturn.

I just happen to have a spouse who wants to settle down and start nesting in the midst of this housing bubble. The timing is unfortunate.