Mortgage Credit Certificates: A top first-time option

Few first-time home buyers are aware of a subsidy that could prove to be a huge benefit for cash-strapped consumers.

The Mortgage Credit Certificate Program was authorized by Congress in the 1984 Tax Reform Act as a means of providing housing assistance to low- and moderate- income families. To qualify, buyers must not have owned a home in the previous three years, must meet income and purchase price restrictions, and must intend to use the new home as a primary residence.

MCCs are now available in 26 states, including Washington. The household income and home purchase price limits vary by area. “Targeted” income areas have higher limits. The Mortgage Credit Certificate is a written document issued by the federal government. It states that the borrower is entitled to a tax credit equal to 20 percent of the interest on the borrower’s home loan each year, capped at $2,000.

The credit is typically applied to the borrower’s federal tax bill after all other deductions are used. Borrowers may use this option to increase purchasing power, reduce tax liability or both.

MCCs reduce taxes on a dollar-for-dollar basis – unlike tax deductions, which reduce taxable income. Here’s how the MCCs work:

• Buyer obtains a 30-year, fixed-rate loan of $250,000 at 6 percent interest. The monthly principal and interest payments are $1,499 and a MCC credit rate of 20 percent.
• In the first year, the buyer pays a total of $14,916 of interest on the mortgage loan. The MCC would then provide a federal income tax credit of $2,983 (20 percent of $14,916).
• If the buyer’s income tax liability is $2,983 or greater, the buyer receives the full benefit of the MCC tax credit. If the amount of the tax credit exceeds the amount of tax liability, the unused portion can be carried forward (up to three years) to offset future income tax liability. The remaining 80 percent of mortgage interest, or $11,933, qualifies as an itemized income tax deduction.
• To receive the immediate benefit of the MCC tax credit, the buyer files a revised W-4 withholding form with the buyer’s employer to reduce the amount of federal income tax withheld from wages, increasing take home pay by $249 per month ($2,983 divided by 12).
• By applying the increase in take home pay of $249 towards the monthly mortgage payment of $1,499, the effective monthly payment becomes $1,250 ($1,499 minus $249).

Persons with a MCC need to be careful about refinancing and understand the rules regarding the possible “recapture” of the subsidy if the home is sold within nine years of closing.

During the nine years in which the recapture tax may apply, several factors determine the amount. The tax is based on the original mortgage amount, the borrower’s income at the time of sale and the gain realized on the sale of the residence. The tax could never equal more than half the gain of the sale. If the borrower’s income does not rise significantly over the life of the loan (more than 5 percent a year), he or she would not be required to pay a recapture tax.

If the house is sold within the first nine years, the tax must be paid in the year of sale. Because income and family size may change during the period the borrower owns the house, it would be difficult to predict the amount owed.

While some real estate agents have complained that the program sets people up to pay a tax, the MCCs were designed to get people in the door of their first home – not to guarantee them a gain.

Tom Kelly’s book “Cashing In on a Second Home in Central America: How to Buy, Rent and Profit in the World’s Bargain Zone” was written with Mitch Creekmore, senior vice president of Houston-based Stewart International and Jeff Hornberger, the National Association of Realtors’ international market development manager. Signed copies are available on www.crabmanpublishing.com