nce a mortgage credit certificate (MCC) is
issued, the homeowner can file for credit on
their federal income taxes equal to a portion
of the annual mortgage interest paid. An MCC
offers a dollar-for-dollar reduction in federal
income tax liability.
These tax credits can help put extra cash
in the borrower’s pocket each month so the
borrower can more easily afford the housing
payment. Although alike in theory, a tax credit
is not the same as a tax deduction. A tax credit reduces the tax owed while a tax
deduction reduces taxable income.
An MCC provides a tax credit, based on a percentage (as determined by the
program guidelines) of the mortgage interest paid annually. The tax-credit rate
is set by the MCC provider (usually the local city, county or state housing-finance
agency), and the MCC benefit can equal 10 percent to 50 percent of the annual
first-mortgage loan interest paid.
The MCC remains in effect for the life of the mortgage loan, so long as the
home remains as the borrower’s principal residence. The amount of the annual
mortgage credit is calculated on the basis of the tax-credit rate (i.e., 20 percent)
of the total interest paid on the mortgage loan for that year. The mortgage interest credit is a non-refundable tax credit, so the homebuyer must have tax liability
in order to take advantage of the tax credit.
Buyer benefits
Let’s look at some of the benefits. In this example, assume the first mortgage is
a 30-year fixed-rate mortgage with a loan amount of $300,000 at a 5 percent
interest rate. The borrower would pay $15,000 in mortgage interest the first year
of ownership. If the MCC tax-credit rate were 20 percent, then the credit for the
first year would equal $3,000 ( 20 percent of $15,000).
If the MCC tax-credit rate is above 20 percent (as it is in some areas nationally),
then the maximum annual credit allowed by the IRS is set at $2,000. If the MCC
tax-credit rate for the program is at or below 20 percent, there is no maximum
dollar amount.
In this case, if the MCC was 30 percent at the time of purchase, then the borrower
would be subject to the maximum of $2,000 each year. Since, the tax-credit rate
is at 20 percent, the borrower could utilize the full amount of $3,000.
That $3,000 can directly reduce the overall amount due to the IRS. If the borrower
owes $5,000 in taxes, they would be able to reduce it to only $2,000 owed by applying the $3,000 MCC tax credit. The borrower does not receive $3,000 as a rebate.
They must owe the IRS in order to apply the $3,000 credit at the end of the year.
In this example, the tax credit converts to $250 per month ($3,000/12 months)
which can be used in mortgage qualification. For Federal Housing Administration (FHA) and conventional loans, the underwriter can add $250 per month in
additional disposable income, which helps reduce the borrower’s debt-to-income
ratio. For Veteran Affairs (VA) loans, the $250 can be added to the residual income
to meet the VA minimum residual-income requirement. For U.S. Department of
Agriculture (USDA) loans, $250 would be treated as a deduction from the monthly
payment, which is underwritten as a reduction in principal, interest, taxes and
insurance.
While the tax credit is redeemed annually on the borrower’s federal taxes, the
borrower can realize the benefit much sooner by increasing their withholdings on
their paycheck. The borrower will want to adjust it so that they will owe the IRS
at the end of year, thus taking home an extra $250 per month (as in the example
provided above).
In this scenario, the borrower will need to owe the IRS $3,000 at the end of the
year to get the full benefit of the available MCC credit. In California, the savings
could be as high as $500 per month in high cost areas such as Orange and Los
Angeles counties. (This MCC calculation is an estimate only, and is not intended to
be tax advice as savings may differ from an individual’s final MCC credit.)
O
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