Buying A House - Tax Free Borrowing Against Your Home

You probably could benefit by hearing more about tax benefits connected with buying a house.

Rare thinking people like you already know that the ability to borrow by taking advantage of the equity in your home is an important one. If you live in the United States, buying a house should be a priority of your personal financial plan because of the opportunity to shelter income from taxes.

Tip number one already discussed how expenses related to home ownership can be tax deductible. Two large deductions of owing a home are the mortgage interest deduction and the property tax deduction. It is easy to look at these deductions as the government helping to pay for the cost of owing or buying a house.

You probably recall the benefit that follows relates to selling a house tax-free. Individuals may be able to exclude up to $250,000 from tax liability due to the sale of a house or up to $500,000 if a married couple. By meeting the ownership test and the use test, it is possible to enjoy such an incredible benefit. The tax-free sale is in and of itself sufficient cause to add buying a house to the smart financial plan.

This third tip is amazing. The next benefit you can enjoy from buying a house is the ability to borrow tax-free against home equity without having to sell your house.

Accordingly, when your house appreciates in value you create equity in your home over and above the original loan amount for the mortgage. Over the years you also pay down the mortgage, freeing up more equity. You are then free to borrow against that equity.

Here is an example. Suppose you bought your home for $200,000 using a mortgage of $160,000. Since you purchased, the house has appreciated to $350,000 while you have paid down the balance to $150,000. Potentially you have equity of $200,000 that you may borrow against.

Also notice there are several ways to do this that you should discuss with your financial advisers and mortgage lender. You may choose to refinance the entire amount of the mortgage balance plus cash out, taking advantage of any additional equity you want to borrow against. During times of declining rates, you might even end up with a lower monthly payment.

Along these same lines there is another method to access your equity yet not have to take it in one lump sum. Ask your mortgage lender about applying for a line of credit. The difference between the value of your home and the amount you owe, the equity, becomes the basis for the mortgage.

Without a doubt a line of credit loan has several advantages. It is easy to see the benefit to having money on stand-by but without a payment until used. Any costs to establish a line of credit are usually small versus refinancing which usually includes origination fees and closing costs.

Finally, a line of credit, sometimes called an LOC, can be repaid easily but you still have the option of accessing the LOC again without a new application being formally submitted. The costs are also significantly lower versus a personal loan or credit card.

Other methods include applying for a 2nd mortgage sometimes referred to as an equity loan or home improvement loan. A favorite is the 15 year fixed rate although do not assume this as there are many variations. Rely on yourself to find out the terms of the 2nd mortgage such as payments, lump sums of money due later on in the loan, and whether the interest rate is fixed for life.

This advice applies to any mortgage whether it for buying a house, refinancing, or obtaining a line of credit, or equity 2nd.

Even though using a home in the manner described here may result in tax savings, consider the cost to refinancing. That mortgage companies are run for a profit is not a surprising concept. Whether you decide to refinance your 1st mortgage entirely, apply for a line of credit, or acquire a 2nd mortgage, you must be sure you understand completely what closing costs will be incurred, what is the period for the loan to be repaid, and what interest rate you will receive. In addition you must know if the interest rate and payment can adjust and if so, how much and how often.

Even though you are near the end of this article, pay attention to what could become a big headache. When getting any type of mortgage for buying a house or refinancing, you must inquire if the home loan is going to have a pre-payment penalty.

A pre-payment penalty is a stipulation by the lender that does not allow you to repay the mortgage prior to a certain date without penalty. This penalty can be enforced for up to five years, depending on the state you live in. Whether or not you accept a pre-payment penalty as part of the terms of your mortgage may or may not be important to you. However it is important that you are aware of it especially if you have plans to pay the loan off early.

Regarding tax implications, it is always recommended that you consult a qualified financial adviser.