Q:  My husband and I finally made a decent amount of money this year and we are going to have to pay a fairly big income tax bill for the first time.  We don't own a home so we don't have a mortgage deduction and therefore we don't have enough deductions to itemize our income tax return.  We'd like to save money on taxes, but we don't want to increase our $1,100 monthly rent expense.  Is it really worth it to buy a home for the tax savings?

A:  I wouldn't recommend buying a home just for the tax benefits, but the savings are significant, so you are missing out on the last great tax "loophole" available to the average American if you don't own a home.

But let's turn your question around.  Rather than looking at
how much you'd save in taxes by purchasing a home, let's see how the tax savings might allow you to buy a home without blowing your household budget. 

You said you are paying $1,100 per month in rent but you didn't mention how much cash you have available for a down payment and closing costs.  Let's assume you have $15,000.  How much home could you afford if you keep your housing expense at $1,100 per month?

First, you have to subtract a monthly amount for property taxes and homeowner's insurance.  Property taxes vary from home to home.  You can obtain the amount of the actual property tax bill on any given home from the listing agent.  However, if this information is not readily available, you can use this simple "rule of thumb" to estimate the property tax bill:  Divide the home price by $1,000.  For example, $200,000 divided by $1,000  equals $200.  Using that number, the property tax bill on a $200,000 home would be approximately $200 per month.  This is a very rough calculation, of course, property taxes vary widely from community to community.  But at least it gives you a number to work with until you can obtain property tax amount on the homes you are considering.  Homeowner's insurance costs can easily be determined by obtaining a quote from your current insurance agent.  

Using the $200,000 home as an example, if we assume the property taxes are approximately $200 per month and homeowners insurance costs approximately $40 per month, you would subtract $240 from your $1,100 monthly payment, leaving your with $860 per month for the loan payment.

You can get a lower interest rate by selecting an adjustable rate mortgage or "buy down" loan program of some kind, but let's say you're conservative and you want to stick with a 30-year fixed rate mortgage because you like the certainty of knowing exactly what your payment will be each and every month for the life of the loan.  At today's interest rates, you could get a 30-year fixed rate mortgage at about 7.5 percent.  At 7.5 percent, an $860 monthly payment would allow you to borrow $123,000.  Combined with your $15,000 in savings, you would only be able to purchase a home that cost about $138,000 -- and that assumes the seller is willing to pay all of your closing costs!  

Should you give up on buying a $200,000 home and settle for something less expensive?  No.  Wait until you see what happens when we factor the tax savings into the equation.  

Let's say you decide to take the plunge and go ahead and buy a $200,000 home with a $10,000 down payment, using the remainder of your savings for closing costs.  The payment on your $190,000 mortgage at 7.5 percent would be $1328.50 per month.  Adding $240 for taxes and insurance, your total monthly housing expense would be $1568.50 -- $468.50 per month more than you are paying today for rent.  But after one year of payments on this loan, you will have paid $14190.61 in interest plus $2,400 in property taxes, for a total tax deduction of $16,590.61.  If you are in the 28 percent income tax bracket, that deduction will save you $4,645.37 in taxes.  If you divide that figure by 12, the tax savings equal more than $387 per month.  That means the true cost of owning the home is not $1568.50  per month, but only $1,181 per month after subtracting the tax savings  ($1,568 - $387).  In other words, you would be paying only $81 more than you pay today for rent.   

Now, please be aware that I simplified the example above by leaving out factors such as mortgage insurance on the loan and the "standard deduction" available to taxpayers who do not itemize.  But the point is, you have to look at the "after tax" cost of owning a home.

As you can see, buying a home will definitely save you money on income taxes, but it will not necessarily improve your overall cash flow situation.  Which brings me back to my first point:  Don't buy a house just for the tax benefits.  Make sure you plan to stay put for at least five years and buy a home for your personal enjoyment.   Think of the tax deduction as just the "icing on the cake."

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