How to Apply “Free Money” Wisely Toward a Home Purchase?

In my previous blog, some prospective homebuyers and comments have expressed that the $8,000 tax credit in the Stimulus Package is “just not enough” to stimulate them to get off the fence. Understandably, the incentive seems too insignificant when we are talking about an average housing price of $500,000 in the Bay Area.

On the flip side of the coin, $8,000 is unarguably a substantial amount of money – don’t we all wish to have an extra $8,000 in our bank account? Since a tax credit is a dollar for dollar reduction in income taxes (e.g. if you have $8,000 tax credit, you will pay $8,000 less tax that year regardless of your tax bracket), it is essentially like “free money”. Therefore, for someone who intends to purchase a home this year, there could be a number of ways in which this money can be wisely applied toward the purchase. Here are a few examples:

1. Down payment – Many buyers have admitted that coming up with enough down payment is the toughest part. Nowadays, in order to get a loan from most conventional lenders, a buyer has to put at least 20% down. For example, a $400,000 home, the down payment would be $80,000. $8,000 would subsidize 10% of the down payments. For FHA loans, when the minimum down payment requirement is 3.5%, $8,000 can cover a large portion of it.

2. Closing costs – There are closing costs associated with every transaction. A buyer’s closing costs may be anywhere from 1%-3% of the purchase price. For a $500,000 home, the costs would be $5,000-$15,000. $8,000 would pay for, if not all, a substantial amount of the closing costs.

3. Points buy-down – Interest rate can be reduced by buying down the points. For example, if the loan amount is $400,000, the mortgage payment is $2,334 per month at 5.75%. Pay 2 points (equivalent of $8,000) to shave off 0.75%-1.25%, a buyer may save about $200 or more a month; that is, a saving of $2,400 per year. If the property is held for 10 years, total saving is $24,000.

4. Property tax – Annual property tax is about 1.2% of the home value. Deriving this mathematically, $8,000 covers one full year of property tax for a $650,000 home or two-years for a $350,000 home.

5. HOA fee – For people who are looking into townhomes or condos, the HOA fee runs about $300 a month on average. By calculation, $8,000 covers over 2 years of HOA fee.

6. Renovations – Most new homeowners would be inclined to update or remodel parts of the house. Depending on the extent of the renovation, $8,000 may serve very well to give a kitchen or a bathroom a good facelift.

In a nutshell, the tax credit in the Stimulus Package may not appear to be as attractive to some prospective Bay Area homebuyers at first. But for those who are willing, able, and ready to become homeowners in 2009, it definitely offers a better financial advantage.

Just a reminder: the $8K no-repayment tax credit applies to those who purchase home between January 1 and December 1, 2009. Carefully planning the timing of the closing could be worth thousands of dollars.