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The Tax Professionals

Buying & Selling a Home

This section is dedicated to another major life event. Within you will find a series of articles chosen to bequeath you with the knowledge necessary to make the best decisions you can when buying or selling a home.

Table of Contents

Buying a Home: What To Do and How To Do It

Once you are ready to buy a home, you will need to be as informed as possible. This guide discusses how much money to save for a down payment, how to work with a real estate agent, how to negotiate, and what you need to know about closing on your new home--including fees and other costs.

Because home ownership is a substantial investment and a long-term commitment, it is important to become as knowledgeable as possible about the process of buying a home including how much you need to save for a down payment, the process of finding the right home for you, negotiating the best possible deal, and the various aspects of closing.

Deciding How Much to Spend

Before deciding on the price range of the home you plan to buy, think about how much you want to pay out each month in mortgage payments. Use a mortgage calculator (online) to figure out what your payments would be and try to make as large a down payment as possible to reduce your principal loan amount.

The Mortgage Payment

A mortgage payment consists of the mortgage loan payment (principal and interest), property taxes (in most cases), and homeowner's insurance. It might also include private mortgage insurance if your down payment is less than 20%.

Caution: The lender will set a maximum on how much you can borrow, but you use the maximum only as a starting point in deciding how much you will borrow.

Tip: To get an estimate of the maximum mortgage amount ask a real estate agent to help you get "pre-qualified" by a lender.

When deciding how much to borrow, be sure to take into account saving for your retirement, your financial goals, and your current lifestyle. If your monthly payments do not allow you to meet these needs, buying that particular home may not make financial sense.

Caution: To avoid having your dream home turn into a nightmare, calculate how much you realistically can spend on the monthly mortgage payment. Do not forget to add in the real estate taxes and mortgage insurance.

Lenders will be happy to pre-qualify you by giving you a preliminary limit on the amount they would be willing to lend you. This pre-qualification is not a commitment on the lender's part; lenders will not commit to a mortgage until they have the property appraisal and all of your supporting documentation, but the maximum loan amount they are willing to offer can be helpful for planning purposes.

The maximum debt is based on your income and debt level. It depends on current interest rates, the term of the mortgage, and the property taxes. To get a rough idea, the maximum debt amount is usually about three times your annual gross income.

The Purchase Price

Having decided how much of a monthly mortgage payment you can realistically afford, you are now ready to set a price range for your new home. Give this range to potential real estate agents during your first visit or use it to rule out homes that are out of your price range.

Planning Aid: See the Financial Calculator: How much house can I qualify for?

Tip: Don't be afraid to look at homes that are 15% to 20% over your price range. In many cases, you will be able to negotiate the price down.

The Down Payment

Try to make as large a down payment as possible. There are two reasons for this: (1) lenders will generally not require you to pay for private mortgage insurance if you can come up with a 20% down payment and (2) the sooner you pay off your mortgage, the better off you will be financially.

To save the 20% down payment, you may need to go on an "austerity plan" for a year or two. Many home buyers also use cash gifts or loans from family members to meet the 20% figure. If you cannot save 20% of the purchase price, you will still be able to get financing however.

Working With Your Real Estate Agent

You can save yourself much time and trouble by knowing what to look for in a real estate agent.

If you find that your real estate agent is not doing his or her best to find you the home you want or is otherwise not meeting your expectations, don't hesitate to make a change. Avoid the mistake of staying in the relationship because you have invested time in it. Rather, get out as soon as you can. The real estate agent will cost you money, so make sure you are getting your money's worth.

You can shop for and buy a home without an agent, but you will need to put in much extra time to do an agent's work: search for properties, schedule appointments to see them, coordinate inspections, and negotiate. Home buyers who already have a property in mind that they want to buy are the best candidates to do the deal without an agent.

Agents' Titles and What They Mean

When looking for a real estate agent, you may come across the following commonly used titles. Here is a basic definition of each:

  • Principal broker: This is a person who is licensed to operate a real estate office. He or she may either work alone or employ other agents. Several years of experience are required to obtain this licensure. Anyone selling realty must work under the supervision of a principal broker.
  • Realtor: A realtor is a member of the National Association of Realtors, along with a state realtors' association and a local board of realtors. Realtors are bound by a code of ethics. They are able to access a local computerized database of homes for sale known as the multiple listing service.
  • Agent: This is the general term for any licensed professional in the real estate sales business.
  • Listing agent: A type of agent who signs up the home seller and lists the home with the multiple listing service.
  • Selling agent: An agent who finds a home for sale (through the multiple listing service) and finds a buyer for it.

Note: On a home sale, the listing agent and the selling agent split the commission with each other and with their principal brokers.

Positive Traits to Look For in a Real Estate Agent

To find such a competent and experienced real agent, interview several candidates at different agencies and ask the following:

  • Is the Agent Full-Time?
    Make sure the agent works in the field full-time. Otherwise he or she may not be up-to-date on the fast-changing information and skills required for the job.

  • Is the Agent Experienced?
    Be sure the agent has been doing the type of work you will need him or her to do for at least a few years. For example, if you are looking for a modest single family home in the suburbs, make sure the agent has not spent the last five years handling mostly rentals or mansions.

  • Does the Agent Listen and Communicate Clearly?
    The agent must be able to understand your priorities in purchasing a home and to tell you what you need to know about a home. For instance, if you tell the agent repeatedly that you must have wood floors and a tree-lined neighborhood, and he or she persists in showing you linoleum floors on crowded streets, then get a new agent.

  • Is the Agent Willing to Negotiate For You?
    To get the best home for your dollar you will have to negotiate with the seller on the price. The agent plays a crucial role in the negotiation process between the buyer and seller. If he or she is not willing to show you houses that are 20% over your price range or to vigorously negotiate with the seller, find a new agent.

  • Is the Agent Careful In His or Her Work?
    You need an agent who will cover all the details that go into buying a home. Someone who takes shortcuts in order to generate as many home sales as possible will not do you any good.

Tip: Ask the candidates for references from recent clients in neighborhoods where you are house-hunting. That will help you determine whether the agent has the traits you want.

What Traits to Watch Out For

Here are some traits a good buyer's real estate agent should not have. Most of them have to do with the conflicts of interest that arise with any commissioned salespeople. Basically, a commission salesperson's goal is to see that as many deals close as possible while putting in the minimum of hours. However, many agents still provide good service.

  • The agent who tries to push you into making a decision before you are comfortable doing so is to be avoided.
  • Avoid agents who urge you to go over your price range.
  • Avoid agents who push you to buy their agency's listings over other properties, or who push you to use the attorneys or inspectors they recommend.
  • Dishonest agents have been known to help the seller hide a defect, or to look the other way. The only way to protect yourself from such deceit is to use an objective inspector.

Finding the Right Home

When searching for a home, you must remember to remain focused on what you want (and don't want) in a home. You may want to keep a list of items that are important to you, such as the location of the neighborhood, building materials used in a home, and proximity to schools.

Do not take anyone's word for it. Investigate for yourself. Visit schools, walk around the neighborhood, look under carpets to see what the floors are made of and stay in the basement for a while to see how damp it is. You may also want to drive through the neighborhood after dark to see if it is a safe place to live.

Tip: In order to have a benchmark for comparing home prices, find out what the price per square foot is for homes you are looking at. To find the price per square foot, divide the asking price by its square footage. Sources of a home's square footage include the local tax assessment agency, the real estate agent, and the home builder. You should verify any statement that might be self-serving.

Negotiating the Selling Price

Buying a home requires negotiating skills because successful negotiation can often save you tens of thousands of dollars. Here are some tips to keep in mind when negotiating for your hoped-for home:

  • Be willing to walk away from a deal. If you decide you must have a certain house, you have already lost negotiating power. There are other good properties out there.
  • Learn everything you can about the property before making your offer. For instance, how long has it been on the market? Has the buyer dropped the asking price? Why is the owner selling? The answers to these questions will help you to negotiate.
  • Know what comparable homes are selling for.
  • If the seller refuses to budge on price, try to negotiate for something else. For instance, try to get the seller to pay for repairs or improvements you would have done yourself.
  • Don't forget the real estate agent's commission. It may also be negotiable.

Arranging for the Mortgage

When you and the seller finally agree upon a price and sign a contract, the next step (unless you're paying cash or have arranged another type of loan) is to get a mortgage. In fact, most home sales are contingent upon the buyer obtaining a mortgage.

Getting the right mortgage is also important in that it too can result in savings of tens of thousands of dollars over the term of the mortgage. Because the discussion of mortgages is quite extensive, it is beyond the scope of this Financial Guide. Rather, it is covered in detail in other related Financial Guides such as:

Related Guide: Please see the Financial Guide: MORTGAGES ALTERNATIVES: How To Choose The Right One.

What is a Mortgage Service Provider?

A mortgage servicer collects your monthly payments and handles your escrow account. It also is required to give you an annual statement that details the activity of your escrow account. This statement shows your account balance and reflects payments for property taxes and homeowners insurance.

When you apply for a home mortgage, you may think that the lender, or loan originator, will service the loan until it is paid off or your house is sold. This assumption is not always true. In today's market, mortgage servicing rights often are bought and sold.

If you are notified that your home mortgage servicing has been sold to another company, you may wonder how it will affect your loan terms and monthly payments. Some consumers have complained that they were not given enough notice of loan servicing transfers and were unfairly charged late fees and penalties. The National Affordable Housing Act was passed to address some of these concerns.

To protect borrowers, the National Affordable Housing Act requires lenders or mortgage servicers (the company that borrowers pay their mortgage loan payments to) to do the following.

  • They must provide a disclosure statement that says whether the lender intends to sell the mortgage servicing immediately; whether the mortgage servicing can be sold at any time during the life of the loan; and the percentage of loans the lender has sold previously.

  • The lender also must provide information about servicing procedures, transfer practices, and complaint resolution.

They must notify you at least 15 days before they sell your loan unless you received a written transfer notice at settlement. If your loan servicing is going to be sold, you should receive two notices, one from the current mortgage servicer and one from the new mortgage servicer. The new servicer must notify you not more than 15 days after the transfer has occurred.

The notices must include the following information:

  • The name and address of the new servicer

  • The date the current servicer will stop accepting mortgage payments, and the date the new servicer will begin accepting them

  • Toll-free or collect call telephone numbers for both the current servicer and the new servicer that you can call for information about the transfer of service

  • Information about whether you can continue any optional insurance, such as credit life or disability insurance; what action you must take to maintain coverage; and whether the insurance terms will change

  • A statement that the transfer will not affect any terms or conditions of the contract you signed with the original mortgage company, other than terms directly related to the servicing of such loan

For example, if your old lender did not require an escrow account, but allowed you to pay property taxes and insurance premiums on your own, the new servicer cannot demand that you establish such an account. They must grant a 60-day grace period, in which you cannot be charged a late fee if you mistakenly send your mortgage payment to the old mortgage servicer instead of the new one.

If you believe you have been improperly charged a penalty or late fee, or there are other problems with the servicing of your loan, contact your servicer in writing. Include your account number and explain why you believe your account is incorrect.

Within 20 business days of receiving your inquiry, the servicer must send you a written response acknowledging your inquiry. Within 60 business days, the servicer must either correct your account or determine that it is accurate. The servicer must send you a written notice of what action it took and why.

If you believe the servicer has not responded appropriately to your written inquiry, contact your local or state consumer protection office. You can also send your complaint to the FTC. Or, you may want to contact an attorney to advise you of your legal rights. Under the National Affordable Housing Act, consumers can initiate class action suits and obtain actual damages, plus additional damages, for a pattern or practice of noncompliance.

Tip: Do not subtract any disputed amount from your mortgage payment. Many mortgage services will refuse to accept what they consider to be partial payments. They may return the check and charge a late fee, or declare the mortgage is in default and start foreclosure proceedings.

Inspecting the Home

The home inspection is an objective visual examination of the physical structure and systems of the house from the roof to the foundation. The standard home inspector's report will include an evaluation of the condition of the home's heating system; central air conditioning system (temperature permitting); interior plumbing and electrical systems; the roof, attic, and visible insulation; walls, ceilings, floors, windows and doors; the foundation and basement; and the visible structure.

If problems or symptoms are found, the inspector will refer you to the appropriate specialist or tradesperson for further evaluation.

Why is the inspection necessary? The purchase of a home is probably the largest single investment you will ever make. Therefore, you should learn as much as you can about the condition of the property and the need for any major repairs before you buy, so that you can minimize unpleasant surprises and difficulties afterwards.

Of course, a home inspection will also point out the positive aspects of a home as well as the maintenance that will be necessary to keep it in good shape. After the inspection, you will have a much clearer understanding of the property you are about to purchase and will be able to make a confident buying decision.


The inspection fee for a typical one-family house varies geographically, as does the cost of housing. Similarly, within a given area, the inspection fee may vary depending upon the size of the house, particular features of the house, its age, and possible additional services, such as septic, well, or radon testing.

Tip: Check local prices on your own.

Tip: Do not let cost be a factor in deciding whether or not to have a home inspection or in the selection of your home inspector. The knowledge gained from an inspection is well worth the cost, and the lowest-priced inspector is not necessarily a bargain. The inspector's qualifications, including experience, training, and professional affiliations, should be the most important consideration.

Why You Can't Just "Do It Yourself"

Even the most experienced homeowner lacks the knowledge and expertise of a professional home inspector who has inspected hundreds, perhaps thousands, of homes. An inspector is familiar with all of the elements of home construction, proper installation, and maintenance. The inspector understands how the home's systems and components are intended to function together, as well as how and why they fail.

Further, most buyers find it very difficult to remain completely objective and unemotional about the house they really want, and this may affect their judgment. For the most accurate picture, it is best to obtain an impartial third-party opinion by an expert in the field of home inspection.

How to Find a Home Inspector

The best source of recommendations is a friend or business acquaintance who has been satisfied with a home inspector they have used. Real estate agents are also generally familiar with home inspectors and should be able to provide you with a list of names from which to choose.

Whatever your referral source, be sure to ascertain the home inspector's professional qualifications, experience, and business ethics before you make your selection. You can do this by checking with your local Better Business Bureau as well as by verifying the inspector's membership in a reputable professional association such as the American Society of Home Inspectors.

When Do You Call In the Home Inspector?

A home inspector is typically called right after the contract or purchase agreement has been signed. It is not necessary for you to be present for the inspection, but it is recommended. By following the home inspector around the house, by observing and asking questions, you will learn a great deal about the condition of the home, how its systems work, and how to maintain it. You will also find the written report easier to understand if you've seen the property first-hand through the inspector's eyes.

Tip: Before you sign, be sure that there is an inspection clause in the contract, making your purchase obligation contingent upon the findings of a professional home inspection. This clause should specify the terms to which both the buyer and seller are obligated.

What if the Report Reveals Problems?

No house is perfect. If the inspector finds problems, it does not necessarily mean you should not buy the house, only that you will know in advance what to expect. A seller may be flexible with the purchase price or contract terms if major problems are found. If your budget is very tight, or if you do not wish to become involved in future repair work, this information will be extremely important to you.

What if you find problems after you move in? A home inspection is not a guarantee that problems will not develop after you move in. However, if you believe that a problem was already visible at the time of the inspection and should have been mentioned in the report, your first step should be to call and meet with the inspector to clarify the situation. Misunderstandings are often resolved in this manner. If necessary, you might wish to consult with a local mediation service to help you settle your disagreement.

Tip: Though many home inspectors today carry Errors & Omissions liability insurance, litigation should be considered a last resort. It is difficult, expensive, and by no means a sure method of recovery.

Checklist of Home Needs

For each home you are considering, bring a copy of the following list and fill it in. This form will enable you to have a record of all the homes you visit and to compare their features. You may be able to fill in much of the information from the multiple listing service sheets your real estate agent provides. Write down the size, materials, and any other comments you have about each item.

Date of visit:________________
Asking price:________________
Square footage________________
Price per square foot________________
Financing available (FHA, VA, other)________________
Number of bedrooms:________________
Number of baths:________________
Location of sunrise:________________
Size of master BR:________________
Size of 2nd BR:________________
Size of 3rd BR:________________
Size of 4th BR:________________
Size of 5th BR:________________
Size of master closet:________________
Size of 2nd closet, location:________________
Size of 3nd closet, location________________
Size of master bath:________________
Size of 2nd bath, location:________________
Size of 3rd bath, location:________________
Size of kitchen, location:________________
Size of DR, location:________________
Size of living room, attributes:________________
Other rooms, size and attributes:________________
Appliances (number, condition):________________
Attic, attic vents:________________
Ceiling fans:________________
Garage, adequacy:________________
Garage, door opening convenience:________________
Cost of utility bills (ask homeowner):________________
Floors (material, condition):________________
Humidity, mildew:________________
Lead-based paints:________________
Year of construction:________________
Comments about exterior, siding:________________
Doors (ext.):________________
Grading, drainage:________________
Lot size:________________
Landscaping, yard:________________
Septic system:________________
Swimming pool:________________
Overall comment:________________
Accessibility during bad weather:________________
Nearby properties (use of property and comments on neighbors):________________
Driving time to:________________
Place of worship:________________
Day care:________________
Noise levels:________________
Proximity of police, firefighters:________________
School district:________________
Restrictions (e.g., on landscaping):________________
Flood, earthquake, other disaster likely:________________
Garbage removal:________________

Renting vs. Buying

Other than whether you can afford a new home, here are some additional factors that you should consider when deciding whether to rent or buy:

  • When home prices are down, home ownership is a less valuable investment. Of course, owning a principal residence is not just an investment
  • When comparing the costs of renting against the costs of owning, factor in the valuable income tax deductions available for mortgage interest payments
  • You may not have to pay tax on the capital gain when you sell your principal residence
  • In a period of high interest rates, owning a home is more costly
  • Those who move frequently, every four years or less for example are often better off renting than buying

Additional Resources

Consumer Information Center

Request the consumer information catalog. Handbooks cover subjects such as adjustable rate mortgages, mortgage lock-ins, and mortgage refinancing. Other titles cover home safety issues, such as asbestos and the use of wood-burning stoves.

Homeowner's Insurance: How To Get The Best Coverage and Value

Maintaining adequate homeowner's insurance is a vital part of owning a residence and your homeowner's policy should be chosen carefully. This Financial Guide discusses the policy provisions to consider when deciding which homeowner's insurance policy to buy to be sure that your home is adequately insured and that you are getting the most insurance value for your money.

This Financial Guide offers guidance about homeowner's insurance such as what questions to ask your insurance broker or agent and how to find the best insurer for your needs. It also explains why you need to keep a list of personal possessions and provides a homeowner's inventory sheet for you to use to make a list of your belongings, as well as offers useful tips on how to qualify for a discount and helps you purchase the policy that best fits your needs at an affordable price.

What Homeowner's Insurance Generally Covers

Tip: It is equally important that renters maintain insurance. Many renters neglect to obtain insurance, perhaps deterred by cost or perhaps, or because unlike homeowners, they are not required to maintain insurance. Studies show that about three-quarters of all those who rent a residence do not have renter's insurance. Adequate replacement cost coverage and liability insurance can be obtained for about $200 per year--less if combined with an auto policy for instance since most insurers offer discounts for multiple policies.

Note: Homeowner's insurance is usually required by mortgage lenders

What's Covered

Although exact coverage and policy limits vary, homeowner's insurance usually covers damage caused by the following events or catastrophes:

  • Fire
  • Lightning
  • Explosion
  • Smoke
  • Vandalism
  • Theft, including check forgery and counterfeit currency
  • Unauthorized use of credit cards
  • Falling objects
  • Ice, snow, or sleet weighing on vehicles
  • Windstorm
  • Hail
  • Riot
  • Volcano
  • Freezing of plumbing
  • Flooding due to plumbing overflow
  • Hot water heater bursting
  • Heating system malfunction
  • Power surges

Basic coverage may also include food spoilage, lock replacement, temporary repairs, and removing debris. If these items are not initially included in your basic coverage, it is possible to have them added.

Planning Aid: For information about the standard types of homeowner's policies, see consumer resource library at the National Association of Insurance Commissioners.

If you incur expenses for temporary living quarters because your home is rendered uninhabitable by an insured event/casualty, most policies will reimburse you in part for this so-called "loss of use."

Tip: Earthquakes and sinkholes are not covered under standard policies; however, earthquake insurance can be purchased as an endorsement for an additional fee in all states except California. Flood insurance, which also includes mudflow, must also be purchased as a separate policy. It is only available National Flood Insurance Program run by the federal government. Other types of water damage such as overflows or backups from a sump pump, sewer system, or drains are also excluded and require a separate endorsement.

There is usually a deductible of $100 to $500 for personal property losses. Raising the deductible can lower the premium.

Actual Cash Value Or Replacement Cost

If you insure your belongings for their "actual cash value," you will not get their replacement value at the time of a loss. Actual cash value refers to the value of your belongings after taking into account depreciation and wear and tear. this is also known as Fair Market Value (FMV). For instance, the actual cash value of a television you bought ten years ago may be worth only $50. On the other hand, "replacement cost" coverage provides you with the costs to replace your belongings. Thus, you would get the $500 you need to replace that ten-year-old television, not the $50 "actual cash value."

Limits on Coverage

You choose the limits on the amounts of coverage on your home and personal property. The premium you pay depends on the limits you choose. Regardless of the policy limit, there is a separate limit on the replacement of high-value items, such as jewelry and artwork. If you want increased coverage for certain items, you must purchase an endorsement or floater (also known as a "rider"). You must generally pay extra for the following:

  • High-value items (e.g., jewelry, furs, silverware, weapons)
  • Personal computers and other home-office equipment
  • Waterbeds
  • Business operated in the home
  • Earthquake, flood, and hurricane (depending on location)

Policy Coverage: What to Consider

If your home is damaged or your possessions are stolen, will your homeowner's policy pay as much as you are expecting? If you are willing to pay the premium for full protection, here are the policy coverages you might consider.

100% of Rebuilding Costs

The amount of insurance that you buy should be based on the cost of rebuilding--not on the price of your home. The cost of rebuilding your house is usually higher than the price you originally paid for it, and often, even the price you could sell it for today. Most insurance companies recommend you insure your home for 100% of the cost of rebuilding it.

Tip: Your insurance agent or company representative may be able to help you calculate rebuilding costs. If not, you could hire an appraiser to do this. Real estate agents can provide you with the names of appraisers.

The cost of rebuilding is affected by local construction costs and by the type of house you have; however, the following are some of the factors that enter into the calculation:

  • The type of exterior wall construction such as wood frame, masonry (brick or stone) or veneer
  • The square footage of the structure
  • The style of the home, ranch or colonial, for example
  • The number of bathrooms and other rooms
  • The type of roof and materials used
  • Whether the home was custom built
  • Whether the home has an attached garage, a fireplace, exterior trim, or any special features such as arched or bay windows

Tip: For a rough estimate of the cost of rebuilding your house, calculate the square footage and multiply it by local building costs per square foot for your type of house. Ask a real estate agent or appraiser for average building costs in your area.

If you already have homeowner's insurance, it's very important to make sure that you have enough. If your home is one of the few that are totally destroyed, and it is insured for less than 100% of the rebuilding cost, you risk not having enough money to replace it with one of similar size and quality.

Make sure your insurance agent or broker knows about any improvements or additions to your house that have been made since you last discussed your insurance policy. If you haven't increases your policy limits to cover the cost of rebuilding that new deck, second bathroom, or other improvements that have increased the value of your home, then you risk being under-insured. If you lack sufficient insurance, your insurer may pay only a part of the cost of replacing or repairing damaged items--depending on the kind of policy you have.

Look at your policy to see what the maximum amount that your insurance company would pay if your house was damaged and had to be rebuilt. The limits of the policy usually appear on the Declarations Page under Section 1, Coverage A Dwelling. Your insurance company will pay no more than this amount to rebuild your home--no exceptions.

Some banks require that you buy homeowner's insurance to cover the amount of your mortgage. However, if the limit of your insurance policy is based only on your mortgage, your policy is unlikely to cover the cost of rebuilding. Make certain that the value of your insurance policy keeps up with increases in local building costs.

Caution: If the limits of your policy have not changed since you bought your home, it is likely that you are under-insured.

Tip: Ask your agent about adding an "inflation guard clause," which automatically adjusts the limit to reflect current construction costs when you renew your policy.

Replacement Cost

Consider buying replacement cost coverage for structural damage. A replacement cost policy will pay for the repair or replacement of damaged property with materials of similar kind and quality. The insurance company will not deduct for depreciation. Depreciation is the decrease in value due to age, wear and tear, and other factors.

If you own an older home, you may not be able to buy a replacement cost policy. Instead, you might buy a modified replacement cost policy that will pay for repairs using standard building materials and construction techniques in use today, rather than repairing or replacing features typical of older homes, like plaster walls and wooden doors, with similar materials.

Insurance companies differ greatly in the way they insure older homes. Some refuse to insure older homes for 100% of replacement cost because of the expense of re-creating special features like wall and ceiling moldings and carvings. Other companies will insure older homes for 100% of replacement cost as long as the dwelling is in good condition.

Caution: If you cannot insure your home for 100% of replacement cost--or choose not to do so--because the cost of replacing a large old home is prohibitive, then make sure the limits of the policy are high enough to provide you with a house of acceptable size and quality.

Guaranteed Replacement Cost Insurance

A guaranteed replacement cost policy will pay whatever it costs to rebuild your home as it was before the fire or other disaster, even if it exceeds the policy limit. This policy protects you against sudden increases in construction costs due to a shortage of building materials, for example, or other unexpected situations, but generally does not cover the cost of upgrading the house to comply with building codes.

Tip: Building codes require structures to be built to minimum standards. If your home is severely damaged, there may be an extra cost in rebuilding it to comply with standards enacted since the home was built. Complying with building code may require a change in design or building materials. Generally, homeowner's insurance policies will not pay for this extra expense, but some insurers offer an endorsement (a form attached to an insurance policy that changes what the policy covers) that pays a specified amount toward these costs.

Note: A guaranteed replacement cost policy may not be available if you own an older home.

Flood Insurance

If your home is located in an area prone to flooding, contact your insurance agent or the National Flood Insurance Program (800-427-4661).

Contents Insurance

This list should include everything you and other members of your household own in your home and in other buildings on the property, except your car and certain boats, which must be insured separately. Among the items you should include are indoor and outdoor furniture, appliances, stereos, computers and other electronic equipment, hobby materials and recreational equipment, china, linens, silverware and kitchen equipment, and jewelry, clothing and other personal belongings.

Check your homeowner's policy to find out how much insurance you have for the contents of your home. The limit of the policy is shown on the Declarations Page under Section 1, Coverage, Personal Property. The contents limit generally is 50% of the amount of insurance on the dwelling. For example, on a home insured for $100,000 the contents would be limited to $50,000. Now compare the contents limit with the total value of the items on your list of personal possessions. If you think you are under-insured, give your insurance agent or broker a call.

As discussed before, there are two ways of insuring your personal possessions. If you have a homeowner's insurance policy, find out whether claim payments for damage to your personal property would be based on replacement cost or actual cash value. Check your policy under Section 1, Conditions, Loss Settlement or ask your agent. As with insurance for the structure, a replacement cost policy pays the dollar amount needed to replace a damaged item with one of similar kind and quality without deductions for depreciation. An actual cash value policy pays the amount needed to replace the item minus depreciation.

Special Limits

Check the limits on certain kinds of personal possessions, such as jewelry, art, silverware, and furs. This information is in Section 1, Personal Property, Special Limits of Liability. Some insurance companies also place a limit on what they'll pay for computers and other home office equipment. If the limits are too low, consider buying a special personal property endorsement or rider.

Note: An endorsement is an addition to your policy. A floater is a form of insurance that allows you to insure valuable items separately. Under a rider or floater, you will be able to insure these items for higher amounts than under a standard homeowner'spolicy.

Tip: If you have a claim, the more information you have about the damaged items--a description of each and the date of purchase and purchase price--the faster the claim can usually be settled.

Videotape or take photographs of rooms and their contents. Note where and when you bought each item and the price. Write down the brand names and model numbers of appliances and electronic equipment. Add new items as you buy them, and keep receipts with the list.

Store the list, photos, and other records in a safe place outside the home-in a bank deposit box or with a neighbor or relative-so that they are not destroyed if your home is damaged.

Shopping For A Policy

The price you pay for homeowner's insurance can vary by hundreds of dollars, depending on the insurance company. Companies offer several types of discounts, but they do not offer the same discount or the same amount of discount in all states. Here are some things to consider when buying homeowner's insurance:

Shop Around

Although it may take a few phone calls to shop around for the best insurance, you could save a few hundred dollars by taking the time to do so. Conduct a preliminary search by compiling a list of possible insurers. Check with your insurance broker or agent, ask your friends, check the Yellow Pages, search online, check consumer guides, and/or call your state insurance department. A thorough investigation of available insurers will give you an idea of price ranges and tell you which companies or agents have the lowest prices.

Tip: Do not consider price alone. The insurer you select should offer both a fair price, good coverage and excellent service. Quality service may cost a bit more, but it provides added conveniences. Talking to insurers will give you a feel for the type of service they offer.

When talking to insurers, ask them what they would do to lower your costs. Once you've narrowed your search to three companies, get price quotes.

Raise Your Deductibles

Deductibles on homeowners' policies typically start at $250. You might save up to 12% of the premium by increasing your deductible to $500, up to 24% by increasing it to $1,000, up to 30% by going up to $2,500, and 37% by raising it to $5,000.

Considering Buying Home And Auto Policies From the Same Insurer

Many companies that sell homeowner's, auto and liability coverage will take 5 to 15% off your premium if you buy two or more policies from them. This is called a multiple policy discount.

Consider Insurance Cost Before Buying A Home

When buying a home, don't overlook the insurance costs. These may affect the price you are willing to pay for the home. Among the factors to consider:

  • The home's construction in relation to the geographical region. For example, brick houses may result in less costly premiums in the East whereas frame houses are less costly in the West. Choosing wisely could cut your premium by 5 to 15%.
  • Whether the area is prone to floods (if so, you will have to pay additional money for an endorsement). Visit to determine your flood risk and find out whether you are in a flood zone.
  • Whether the home is new or used (insurers may offer you a discount of 8 to 15% for a new home).
  • The electrical system, plumbing, and structure.
  • Whether the town has full-time or volunteer fire service and whether the home is close to a hydrant or fire station (the closer it is, the lower your premium will be).

Don't Insure Land

When deciding how much homeowner's insurance to buy, do not include the value of the land under your house. It is not at risk against theft, windstorm, fire, or other disasters, so why pay for wasted coverage.

Increase Home Security

You can usually get discounts of at least 5% for a smoke detector, burglar alarm, or dead-bolt locks. Some companies offer to cut your premium by as much as 15 or 20% if you install a sophisticated sprinkler system and a fire and burglar alarm that rings at the police station or other monitoring facility. Although these discounts are incentives to invest in home security and yard maintenance systems, be aware that these systems are not inexpensive and that not every system qualifies for the discount.

Tip: Before you buy an alarm system, find out what kind your insurer recommends and how much you'd save on premiums.

No Smoking Discounts

Insurers may offer lower premiums if all the residents in a house do not smoke.

Senior Discounts

If you are at least 55 years old and retired, you may qualify for a discount of up to 10% at some insurers.

Investigate Group Coverage

Employers, alumni and business associations can often benefit from an insurance package at competitive rates. Ask your company's human resources department or your association's director if such a package is available.

Stay With the Same Insurer

If you've kept your coverage with one company for several years, you may get a reduction in your premiums of 5 or 10%, depending on the insurer.

Check Your Policy Once A Year

Compare the limits in your policy with the value of your possessions at least once a year to make sure your policy covers major purchases and/or additions to your home.

Tip: On the other hand, you do not want to spend money for unnecessary coverage. If your five-year-old fur coat is no longer worth the $20,000 you paid for it, reduce your rider and cut your premium.

Look For Private Insurance First

If you live in a high-risk area, that is, one that is vulnerable to coastal storms, fires, or crime, and have been buying your homeowner's insurance through a government plan, you may find that there are steps you can take to buy insurance at a lower price in the private market. Check with your insurance agent or broker.

* * * *

To be sure you have adequate homeowner's insurance, ask your insurance agent questions about the issues discussed in this Financial Guide. A thorough inquiry into specific coverage and costs should result in a policy that offers the best coverage and value. It is also important to ask your agent or broker to explain what factors were used to calculate the policy limits for the dwelling.

Planning Aid: National Flood Insurance Program provides information about National Flood Insurance.

Tip: If you have a problem or need more information, contact the Consumer Federal of America (CFA) Insurance Group.


For your convenience, several common insurance terms are defined below:

Actual Cash Value. The current value of property measured in cash, arrived at by taking the replacement cost and deducting for depreciation brought about by physical wear and tear, age and other factors.
Endorsement. A written form attached to a policy that alters the policy's coverage, terms or conditions.
Floater. A policy or endorsement that applies to moveable property whatever its location. The coverage floats or moves with the property.
Guaranteed Replacement Cost Insurance. Insurance providing for payment of the cost of replacing the damaged property without deduction for depreciation and without a dollar limit
Inflation Guard Clause Provision. In a policy or endorsement that automatically adjusts the dwelling limit at policy renewal time to reflect current construction costs in your area.
Replacement Cost Dwelling Insurance. Insurance providing that the policyholder will be paid the cost of replacing the damaged property without deduction for depreciation, but limited by the dollar amount displayed under Section 1, Coverage, A. Dwelling on the Declarations Page of the policy.
Replacement Cost Contents Insurance. Insurance that pays the dollar amount needed to replace damaged personal property with that of similar kind and quality without deducting for depreciation.

Inventory of Belongings

Use this form to document and determine whether your personal property coverage is adequate. Go through each room and inventory your belongings. Write in the year you bought the item and how much you paid for it. Then write in the approximate cost to replace the item today. Finally, calculate the totals at the end of the form. This list will also help in case you need to submit a claim.

Tip: Make a photographic or video record of your belongings, too, and of the outside of your home. This will help should you ever need to submit a claim.

KITCHEN & DINING ROOMYear of PurchaseCostReplacement Cost
Table, chairs
Hutch, sideboard
Large appliances (list)
Small appliances (list)
Dishes, two sets
Silverware, flatware
LIVING ROOMYear of PurchaseCostReplacement Cost
TV, VCRs, DVD Players and other electronics
Book shelves
CDs, videos, tapes, albums
Carpeting, rugs
BEDROOMSYear of PurchaseCostReplacement Cost
TVs, VCRs, radios, stereos, and other elctronics
Bedding, sheets
Personal Computers
Formal Wear
Sports, Hobbies, Bathroom, MiscellaneousYear of PurchaseCostReplacement Cost
Grooming gear
Bathroom appliances
Golf clubs
Ski gear
Camping equipment
Exercise equipment
Telephones, answering machines
Fans, heaters, air conditioners
Desk, chairs
Piano, musical instruments
Sewing machine
Lawn mower
Garden tools
Office equipment

Mortgage Alternatives: How To Choose The Right One

If you've been thinking about buying a home, you may wonder how to select the right financing for your budget and needs. This Financial Guide will explain the basics of most of the mortgage loans that are available today.

If you've been thinking about buying a home, you may be wondering how to select the best way to finance your purchase. With so many choices available--from traditional fixed rate loans to adjustable rate loans and reverse mortgages--it's more important than ever to educate yourself in order to find the right mortgage for your needs.

Traditional Mortgage

Many people prefer a traditional or a fixed-rate mortgage with fixed monthly payments, a fixed interest rate, and full amortization (or transfer of equity) over a period of 20 to 30 years. Because the interest rate is fixed, monthly payments that remain constant over the life of the loan and there is a maximum (and known) amount on the total amount of principal and interest that you pay during the loan. Traditionally, these mortgages have been long-term. As the loan is repaid, ownership shifts gradually from lender to buyer. These features work in the buyer's favor because inflation makes your payments seem less and your property worth more. So, although the payments seem hard to meet at first, that monthly payment becomes easier over time.

Example: You borrow $50,000 at 8% for 30 years. Your monthly payments on this loan would be $366.89. Over 30 years, your total obligation for principal and interest would never exceed this fixed, predetermined amount.

Tip: Fixed rate mortgages are usually available at higher rates than many other types of loans. But if you can afford the monthly payments, inflation and tax deductions may make a fixed rate mortgage a good financing method, particularly if you are in a high tax bracket and need the interest deductions.

Non-Traditional Mortgages

On the other hand, many home financing plans today differ materially from traditional mortgages. They may help you buy a home you couldn't otherwise afford, but they may also involve greater risks for buyers. For example, the interest rate and monthly payments may change during the loan to reflect what the market will bear. Or the interest rate may fluctuate while the payments stay the same, and the amount of principal paid off may vary. The latter approach allows the lender to credit a greater portion of the payment to interest when rates are high.

Some plans also offer below-market interest rates, but they may not help you build up equity.

When shopping for financing sources today, keep the following in mind:

  • The sales price minus your down payment, i.e., the amount you finance
  • The length, or maturity, of the loan
  • The size of the monthly payments
  • The interest rate or rates
  • Whether the payments or rates may change
  • How often and how much the payments or rates may change
  • Whether there is an opportunity for refinancing the loan when it matures, if necessary

These concepts will be discussed in greater detail as we explore the different types of non-traditional financing.

15-Year Mortgage

The 15-year mortgage is a variation of the fixed-rate mortgage that is becoming increasingly popular. This mortgage has an interest rate and monthly payments that are constant throughout the loan. But, unlike other plans, this loan is fully paid off in only 15 years. And, it is usually available at a slightly lower interest rate than a longer-term loan. But it also requires higher payments.

In the 15-year mortgage, you pay off the loan balance faster than a long-term loan. Because of this, a smaller proportion of each of your monthly payments goes to interest.

Tip: If you can afford the higher payments, this plan will save you interest and help you build equity and own your home faster. The downside however, is that you are paying less interest and you may also have fewer tax deductions.

Adjustable-Rate Mortgage (ARM)

If you see an ad for a low-rate mortgage, it might be for an adjustable rate mortgage (ARM). These loans may have low rates for a short time-maybe only for the first year. After that, the rates can be adjusted on a regular basis. This means that the interest rate and the amount of the monthly payment can go up or down.

With an adjustable-rate mortgage, your future monthly payment is uncertain. Some types of ARMs put a ceiling on your payment increase or rate increase from one period to the next. Virtually all must put a ceiling on interest-rate increases over the life of the loan.

Tip: Whether an ARM mortgage is right for you depends on your financial situation and the terms of the ARM. ARMs carry risks in periods of rising interest rates, but can be cheaper over a longer term if interest rates decline. You will be able to answer the question better once you understand more about adjustable-rate mortgages.

Today, many loans have interest rates (and monthly payments) that can change from time to time. To compare one ARM with another or with a fixed-rate mortgage, you need to know about indexes, margins, discounts, caps, negative amortization, and convertibility. You need to consider the maximum amount your monthly payment could increase.

Most important, you need to compare what might happen to your mortgage costs with your future ability to pay.

Planning Aid: See The Financial Calculator: Which Loan Is Better, Fixed or Adjustable?

Interest Rate Variation. Adjustable rate mortgages have an interest rate that increases or decreases over the life of the loan based upon market conditions. Some lenders refer to adjustable rates as flexible or variable.

Caution: Because adjustable rate loans can have different provisions, evaluate each one carefully.

In most adjustable rate loans, your starting rate, or "initial interest rate," will be lower than the rate offered on a standard fixed rate mortgage. This is because your long-term risk is higher-your rate can increase with the market-so the lender offers an inducement to take this plan.

Changes in the interest rate are usually governed by a financial index. If the index rises, so may your interest rate. If it falls, your interest rate also falls.

Rate Caps. To build predictability into your adjustable rate loan, some lenders include provisions for rate caps that limit the amount of any interest rate change. These provisions limit the amount of your risk. A periodic rate cap limits the amount the rate can increase at any one time. Because they limit the lender's return, capped rates may not be available through every lender.

Example: Your mortgage provides that even if the financial index it's tied to increases 2% in one year, your rate can only go up 1%. An aggregate rate cap limits the amount the rate can increase over the entire life of the loan. This means that even if the index increases 2% every year, your rate cannot increase more than 5% over the entire loan.

Many flexible rate mortgages offer the possibility of rates that may go down as well as up. In some loans, if the rate can only increase 5 %, it may only decrease 5%. If no limit is placed on how high the rate can go, there may be a provision that also allows your rate to go down along with the index.

Payment Caps

If the interest rate on your adjustable rate loan increases and your loan has a payment cap, your monthly payments may not rise, or they may increase by less than changes in the index would require.

Example: Your mortgage provides for unlimited changes in your interest rate, but your loan has a $50 per year cap on payment increases. You started with an 8% rate on your $75,000 mortgage and a monthly payment of $550.33. Now assume that your index increases 2 percentage points in the first year of your loan. Because of this, your rate increases to 10 %, and your payments in the second year rise to $658.18. Because of the payment cap, however, you'll only pay $600.33 per month in the second year.

Thus in the above example, your monthly payment should increase to $658.18, but because of a cap, it increases to only $600.33. Because this change in interest rates increases your debt, the lender may now apply a larger portion of your payment to interest. If rates get very high, even the full amount of your monthly payment won't be enough to cover the interest owed; the additional amount of interest you owe will be added to the principal. This means you now owe and eventually will pay interest on interest.

Negative Amortization. If your ARM contains a payment cap be sure to find out about "negative amortization." Negative amortization means the mortgage balance is increasing and occurs whenever your monthly mortgage payments are not large enough to pay all of the interest due on your mortgage.

Because payment caps limit only the amount of payment increases, and not interest-rate increases, payments sometimes do not cover all of the interest due on your loan. This means that the interest shortage in your payment is automatically added to your debt, and interest may be charged on that amount. You might therefore owe the lender more later in the loan term than you did at the start. However, an increase in the value of your home may make up for the increase in what you owe.

Prepayment and Conversion

If you get an ARM and your financial circumstances change, you may decide that you don't want to risk any further changes in the interest rate and payment amount. When you are considering an ARM, ask for information about prepayment and conversion.

  • Prepayment. Some agreements may require you to pay special fees or penalties if you pay off the ARM early. Many ARMs allow you to pay the loan in full or in part without penalty whenever the rate is adjusted. Prepayment details are sometimes negotiable. If so, you may want to negotiate for no penalty, or for as low a penalty as possible.

  • Conversion. Your agreement with the lender can have a clause that lets you convert the ARM to a fixed-rate mortgage at designated times. When you convert, the new rate is generally set at the current market rate for fixed-rate mortgages. The interest rate or up-front fees may be somewhat higher for a convertible ARM. Also, a convertible ARM may require a special fee at the time of conversion.

Variations of Adjustable Rate Mortgages. Another variation of the adjustable rate mortgage is to fix the interest rate for a period of time, 3 to 5 years, for example, with the understanding that the interest rate will then be renegotiated. These variations are:

  • Rollover mortgages are loans with periodically renegotiated rates. Such loans make monthly payments more predictable because the interest rate is fixed for a longer time.

  • Pledged account buy-down mortgage is another variation with an adjustable rate. This plan was introduced by the Federal National Mortgage Association (Fannie Mae), which buys mortgages from lenders and provides a major source of money for future mortgage offerings. In this plan, a large initial payment is made to the lender at the time the loan is made. The payment can be made by the buyer, the builder, or anyone else willing to subsidize the loan. The payment is placed in an account with the lender where it earns interest. This plan helps lower your interest rate for the first year.

Tip: This plan may not include any payment or rate caps other than those in the first years. But, there also may not be negative amortization, so possible increases in your total debt may be limited. Because of the buy-down feature, some buyers may be able to qualify for this loan that otherwise would not be eligible for financing.

Shopping for a Mortgage

When shopping for any type of adjustable rate mortgage, always remember to ask about the following:

  • The initial interest rate
  • How often the rate may change
  • How much the rate may change
  • The initial monthly payments
  • How often payments may change
  • How much the payments may change
  • The mortgage term
  • How often the term may change
  • How much the term may change
  • The index that rate, payment, or term changes are tied to
  • The limits, if any, on negative amortization

Balloon Mortgage

Balloon mortgages have a series of equal monthly payments and a large final payment. Although there usually is a fixed interest rate, the equal payments may be for interest only. The unpaid balance, frequently the principal or the original amount you borrowed, comes due in a short period, usually 3 to 5 years.

Example: You borrow $30,000 for 5 years. The interest rate is 13%, and the monthly payments are only $325. But in this example, the payments cover interest only, and the entire principal is due at maturity-in 5 years. That means you'll have to make 59 equal monthly payments of $325 each and a final balloon payment of $30,325. If you can't make that final payment, you'll have to refinance (if refinancing is available) or sell the property.

Some lenders guarantee refinancing when the balloon payment is due, although they do not guarantee a certain interest rate. The rate could be higher than your current rate. Other lenders do not offer automatic refinancing.

Tip: Without such a guarantee, you could be forced to start the whole business of shopping for housing money once again, as well as paying closing costs and front-end charges a second time.

A balloon note may also be offered by a private seller who is continuing to carry the mortgage he or she took out when purchasing the home. It can be used as a second mortgage where you also assume the seller's first mortgage.

Graduated Payment Mortgage

Graduated payment mortgages (GPM) are designed for home buyers who expect to be able to make larger monthly payments in the near future. During the early years of the loan, payments are relatively low. They are structured to rise at a set rate over a set period, say 5 or 10 years. Then they remain constant for the duration of the loan.

Even though the payments change, the interest rate is usually fixed. So during the early years, your payments are lower than the amount dictated by the interest rate. During the later years, the difference is made up by higher payments. At the end of the loan, you will have paid off your entire debt.

Tip: One variation of the GPM is the graduated-payment, adjustable-rate mortgage. This loan also has graduated payments early in the loan. But, like other adjustable rate loans, it ties your interest rate to changes in an agreed-upon index. If interest rates climb quickly, greater negative amortization occurs during the period when payments are low. If rates continue to climb after that initial period, the payments will, too. This variation adds increased risk for the buyer. But if interest rates decline during the life of the loan, your payments may as well.

Growing-Equity Mortgage (GEM)

The growing equity mortgage (GEM) is tailored for first time homebuyers or young families whose incomes are likely to rise. These mortgages combine a fixed interest rate with a changing monthly payment. The interest rate is usually a few percentage points below market. Although the mortgage term may run for 30 years, the loan will frequently be paid off in less than 15 years because payment increases are applied entirely to the principal.

Monthly payment changes are based on an agreed-upon schedule of increases or an index.

With this approach, your income must be able to keep pace with the increased payments. The plan does not offer long-term tax deductions. However, it can permit you to pay off your loan and acquire equity rapidly.

Shared Appreciation Mortgage (SAM)

In the shared appreciation mortgage (SAM), you make monthly payments at a relatively low interest rate. You also agree to share with the lender a sizable percent (usually 30% to 50%) of the appreciation in your home's value when you sell or transfer the home, or after a specified number of years.

Because of the shared appreciation feature, monthly payments in this plan are lower than in many other plans. However, you may be liable for the dollar amount of the property's appreciation even if you do not wish to sell the property at the agreed-upon date.

Tip: Unless you have the cash available, this could force an early sale of the property. Also, if property values do not increase as anticipated, you may still be liable for an additional amount of interest.

There are many variations of this idea, called housing equity plans in the US. Some are offered by lending institutions and others by individuals.

Example: Suppose you've found a home for $100,000 in a neighborhood where property values are rising. The local savings and loan is charging 9% on home mortgages, assuming you paid $20,000 down and chose a 30-year term, your monthly payments would be $643.70, or about twice what you can afford. But a friend offers to help. Your friend will pay half of each monthly payment, or $321.85 for 5 years. At the end of that time, you both assume the house will be worth at least $125,000. You can sell it, and your friend can recover his or her share of the monthly payments to date plus half of the appreciation. Or, you can pay your friend that same sum of money and gain increased equity in the house.

Another variation may give your partner tax advantages during the first years of the mortgage, after which the partnership is dissolved. You can buy out your partner or find a new one. Your partner helps make the purchase possible by putting up a sizable down payment and/ or helping make the monthly payments. In return, your partner may be able to deduct a certain amount from his or her taxable income.

Shared appreciation and shared equity mortgages were partly inspired by rising interest rates and partly by the notion that housing values would continue to grow over the years to come. If property values fall, these plans may not be available.

Tip: Before proceeding with this type of plan, check with a tax advisor to determine deductibility of interest.

Assumable Mortgage

An assumable mortgage is a mortgage that can be passed on to a new owner at the previous owner's interest rate.

During periods of high rates, most lending institutions are reluctant to permit mortgage assumptions, preferring to write a new mortgage at the market rate. Some buyers and sellers are still using assumable mortgages, however. This has recently resulted in many lenders calling in the loans under "due on sale" clauses. Because these clauses have increasingly been upheld in court, many mortgages are no longer legally assumable. Be especially careful, therefore, if you are considering a mortgage represented as assumable.

Tip: Read the contract carefully and have an attorney or other expert check to determine if the lender has the right to raise your rate in this mortgage.

Seller "Take-Back" Mortgages

This mortgage, provided by the seller, is frequently a second trust and is combined with an assumed mortgage. The second trust (or second mortgage) provides financing in addition to the first assumed mortgage, using the same property as collateral. (In the event of default, the second mortgage is satisfied after the first).

Seller take-backs frequently involve payments for interest only, with the principal due at maturity. Some private sellers are also offering first trusts as take-backs. In this approach, the seller finances the major portion of the loan and takes back a mortgage on the property.

Tip: Another development now enables private sellers to provide this type of financing more frequently. Previously, sellers offering take-backs were required to carry the loan to full term before obtaining their equity. However, now, if an institutional lender arranges the loan, uses standardized forms, and meets certain other requirements, the owner take-back can be sold immediately to Fannie Mae. This approach enables the seller to obtain equity promptly and avoid having to collect monthly payments.

Wraparound Mortgage

Another variation on the second mortgage is the wraparound. Wraparounds may cause problems if the original lender or the holder of the original mortgage is not aware of the new mortgage. Upon discovering this arrangement, some lenders or holders may have the right to insist that the old mortgage be paid off immediately.

Land Contract

Borrowed from commercial real estate, this plan enables you to pay below-market interest rates. The land contract or installment sale agreement as it is also known permits the seller to hold onto his or her original below-market rate mortgage while "selling" the home on an installment basis. The installment payments are for a short term and may be for interest only. At the end of the contract the unpaid balance, frequently the full purchase price, must still be paid.

Caution: The seller continues to hold title to the property until all payments are made. Thus, you, the buyer, acquire no equity until the contract ends. If you fail to make a payment on time, you could lose a major investment.


A buy-down is a subsidy of the mortgage interest rate that helps you meet the payments during the first few years of the loan. There are several things to think about in buy-downs:

  1. Consider what your payments will be after the first few years. If this is a fixed rate loan, the payments in the above example will jump to the rate at which the loan was originally made. If this is an adjustable rate loan, and the index to which your rate is tied has risen since you took out the loan, your payments could go up even higher.

  2. Check to see whether the subsidy is part of your contract with the lender or with the builder. If it's provided separately by the builder, the lender can still hold you liable for the full interest rate, even if the builder backs out of the deal or goes out of business.

  3. See if the sales price has been increased to cover a builder's interest subsidy. A comparable home may be selling around the corner for less. At the same time, competition may have encouraged the builder to offer you a genuine savings. It pays to check around.

There are also plans called consumer buy-downs. In these loans, the buyer makes a sizable down payment, and the interest rate granted is below market. In other words, in exchange for a large payment at the beginning of the loan, you may qualify for a lower rate on the amount borrowed. Frequently this type of mortgage has a shorter term than those written at current market rates.

Rent with Option to Buy

In a climate of changing interest rates, some buyers and sellers are attracted to a rent-with-option to-buy arrangement. In this plan, you rent property and pay a premium for the right to purchase the property within a limited time period at a specific price. In some arrangements, you may apply part of the rental payments to the purchase price.

This approach enables you to lock in the purchase price. You can also use this method to buy time in the hope that interest rates will decrease. From the seller's perspective this plan may provide the buyer time to obtain sufficient cash or acceptable financing to proceed with a purchase that may not be possible otherwise.

Reverse Mortgage

If you already own your home and need to obtain cash, you might consider the reverse annuity mortgage (RAM) or equity conversion. In this plan, you obtain a loan in the form of monthly payments over an extended period of time, using your property as collateral. When the loan comes due, you repay both the principal and interest.

A RAM is not a mortgage in the conventional sense. You can't obtain a RAM until you have paid off your original mortgage. Suppose you own your home and you need a source of money. You could draw up a contract with a lender that enables you to borrow a given amount each month until you've reached a maximum of, for example, $10,000. At the end of the term, you must repay the loan. But remember, if you do not have the cash available to repay the loan plus interest, you will have to sell the property or take out a new loan.

Related Guide: Please see the Financial Guide: REVERSE MORTGAGES: How They Can Enhance Your Retirement.

Some Cautions

Before going ahead with a creative home loan, have a lawyer or other expert help you interpret the fine print. You should consider some of the situations you could face when paying off your loan or selling your property. And make sure you understand the terms in your agreement-such as acceleration clauses, due on sale clauses, and waivers.

Acceleration Clause

An acceleration clause allows the lender to speed up the rate at which your loan comes due. Suppose you've missed a payment, and your contract gives the lender the right to "accelerate" the loan when a payment is missed. This means that the lender now has the power to force you to repay the entire loan immediately.

Sample acceleration clause: "In the event any installment of this note is not paid when due, time being of the essence, and such installment remains unpaid for thirty (30) days, the Holder of this Note may, at its option, without notice or demand, declare the entire principal sum then unpaid, together with secured interest and late charges thereon, immediately due and payable. The lender may without further notice or demand invoke the power of sale and any other remedies permitted by applicable law."

Note: The use of the term without notice above. If this contract provision is legal in your state, you have waived your right to notice. In other words, you've given up the right to be notified of some occurrence, for example, a missed payment. If you've waived your right to notice of delinquency or default, and you've made a late payment, action may be initiated against you before you've been told; the lender may even start to foreclose.

Tip: Know whether your contract waives your right to notice. If so, obtain a clear understanding in advance of what you're giving up. Try to get the clause removed. Have your attorney check state law to determine if the waiver is legal.


A due on sale clause gives the lender the right to require immediate repayment of the balance you owe if the property changes hands. Here's an example of a due on sale clause: "gall or any part of the Property or an interest therein is sold or transferred by Borrower without Lender's prior written consent. . . Lender may, at Lender's option, declare all the sums secured by this Mortgage to be immediately due and payable."

Due on sale clauses have been included in many mortgage contracts for years. They are being enforced by lenders increasingly when buyers try to assume sellers' existing low rate mortgages. In these cases, the courts have frequently upheld the lender's right to raise the interest rate to the prevailing market level. So be especially careful when considering an "assumable mortgage." If your agreement has a due on sale provision, the assumption may not be legal, and you could be liable for thousands of additional dollars.

Mortgage Terms

To buy or sell a home today, it's important to know the vocabulary. Understanding terms like amortization or appreciation can save you time and money; it can also prevent you from obtaining a mortgage ill-suited to your needs.

When you first buy a home you're likely to make a down payment on the property. However, because you financed the purchase, you are now in debt and the lender owns most of the property's value. In traditional mortgages, the monthly payments on the loan are weighted. During the first years, they are largely interest; in time, more of each payment is credited to the loan itself, or the principal.

Gradually, as you pay off principal, you build up equity, or ownership. Your equity also increases if the value of the home increases. This process of gradually obtaining equity and reducing debt through payments of principal and interest is called amortization.

Repaying debt gradually through payments of principal and interest is called amortization. Today's economic climate has given rise to a reverse process called negative amortization. This means that you are losing, not gaining, value, or equity, because your monthly payments may be too low to cover the interest rate agreed upon in the mortgage contract. Instead of paying the full interest costs now, you'll pay them later, either in larger payments or in more payments. You will also be paying interest on that interest.

In other words, the lender postpones collection of the money you owe by increasing the size of your debt. In extreme cases, you may even lose the equity you purchased with your down payment, leaving you in worse financial shape a few years after you purchase your home than when you bought it.

Example: Suppose you signed an adjustable rate mortgage for $50,000 in 1996. The index established your initial rate at 9.15%. It nearly doubled to 17.39% by 1999. If your monthly payments had kept pace with the index, they would have risen from $408 to $722. But because of a payment cap, they stayed at $408. By 1999 your mortgage had swelled from $50,000 to $58,350, even though you had dutifully paid $408 every month for 48 months. In other words, you paid out $20,000 but you were $8,000 more in debt than you were three years earlier. During the next few years despite the fact that the index fell gradually, you were still paying off the increases made to your principal from earlier years.

Certain loans, such as graduated payment mortgages, are structured so that you regain the lost ground with payments that eventually rise high enough to fully pay off your debt. And you may also be able to pay off the extra costs if your home is gaining rapidly in value or if your income is rising fast enough to meet the increased obligation. But if it isn't, you may realize a loss if, for example, you sign a below-market adjustable rate mortgage in January and try to sell the home in August when interest rates are higher. You could end up owing more than you'd make on the sale.

Home Mortgage Interest Deductions

This Financial Guide discusses the home mortgage interest deduction. It explains what tests must be met for interest on a home mortgage to be deductible and discusses the rules that apply in hybrid situations such as the business use of a home.

Note: For a discussion of the deductibility of points, please Click here.

Deductibility of Home Mortgage Interest, In General

Generally, home mortgage interest is any interest you pay on a loan that is secured by your main home or by a second home. The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.

You can deduct home mortgage interest as an itemized deduction only if you are legally liable for the loan. In other words, you cannot deduct payments you make for someone else if you are not legally liable to make them. Further, there must be a true debtor-creditor relationship between you and the lender.

And, finally, the mortgage must be a "secured debt" on a "qualified home." These two terms are explained later.

When Is Mortgage Interest Fully Deductible?

In most cases, you can deduct all of your home mortgage interest. Whether it is all deductible depends on the date you took out the mortgage, the amount of the mortgage, and your use of the mortgage proceeds.

If all of your mortgages fit into at least one of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. If one or more of your mortgages does not fit into any of these categories, you may be able to deduct part of the interest. The three categories are:

  1. Mortgages you took out on or before October 13, 1987.
  2. Mortgages you took out after October 13, 1987, to buy, build, or improve your homes as long as these mortgages plus any mortgages in (1) totaled $1 million or less throughout the year ($500,000 or less if married filing separately).
  3. Mortgages you took out after October 13, 1987, for reasons other than to buy, build, or improve your home (home equity debt), as long as these mortgages totaled $100,000 or less throughout the year ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).

The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.

What is "Secured Debt"?

You can deduct home mortgage interest only if your mortgage is a secured debt. A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that:

  1. Makes your ownership in a "qualified home" security for payment of the debt,
  2. Provides, in case of default, that your home can be used to satisfy the debt, and
  3. Is recorded or is otherwise perfected under any state or local law that applies.

In other words, your mortgage is a secured debt if you put your home up as collateral to protect the interests of the lender. If you cannot pay the debt, your home can then serve as payment to the lender to satisfy the debt.

Note: A debt is not secured by your home if it is secured solely because of a lien on your general assets or if it is a security interest that attaches to the property without your consent (such as a mechanic's lien or judgment lien).

A wraparound mortgage is not a secured debt unless it is recorded or otherwise perfected under state law.

Example: Beth owns a home subject to a mortgage of $40,000. She sells the home for $100,000 to John, who takes it subject to the $40,000 mortgage. Beth continues to make the payments on the $40,000 note. John pays $10,000 down and gives Beth a $90,000 note secured by a wraparound mortgage on the home. Beth does not record or otherwise perfect the $90,000 mortgage under the state law that applies. Therefore, that mortgage is not a secured debt, and the interest John pays on it is not deductible as home mortgage interest.

What is a "Qualified Home"?

To deduct home mortgage interest, the debt must be secured by a qualified home. This means your main home or your second home, but not a third home except as described below under "More than one second home". A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities.

Tip: The interest you pay on a mortgage on a home other than your main or second home may be deductible if the proceeds of the loan were used for business, investment, or other deductible purposes. Otherwise, it is considered personal interest and is not deductible.

Main home. You can have only one main home at any one time. Generally, this is the home where you spend most of your time.

Second home. A second home is a home that you choose to treat as your second home.

Second home not rented out. If you have a second home that you do not hold out for rent or resale to others at any time during the year, you can treat it as a qualified home. You do not have to use the home during the year.

Second home rented out. If you have a second home and rent it out part of the year, you also must use it as a home during the year for it to be a qualified home. You must use this home more than 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental, whichever is longer. If you do not use the home long enough, it is considered rental property and not a second home.

More than one second home. If you have more than one second home, you can treat only one as the qualified second home during any year. However, you can change the home you treat as a second home in the following three situations.

  1. If you get a new home during the year, you can choose to treat the new home as your second home as of the day you buy it.
  2. If your main home no longer qualifies as your main home, you can choose to treat it as your second home as of the day you stop using it as your main home.
  3. If your second home is sold during the year or becomes your main home, you can choose a new second home as of the day you sell the old one or begin using it as your main home.

Hybrid Situations

The only part of your home that is considered a qualified home is the part that you use for residential living. If you use part of your home for other than residential living, such as for a home office, you must allocate the use of your home. You must then divide both the cost and fair market value of your home between the part that is a qualified home and the part that is not. These calculations may reduce or even negate your deduction.

Renting out part of home. If you rent out part of a qualified home to another person (tenant), you can treat the rented part as being used by you for residential living only if all three of the following conditions apply.

  1. The rented part of your home is used by the tenant primarily for residential living.
  2. The rented part of your home is not a self-contained residential unit having separate sleeping, cooking, and toilet facilities.
  3. You do not rent (directly or by sublease) the same or different parts of your home to more than two tenants at any time during the tax year. If two persons (and dependents of either) share the same sleeping quarters, they are treated as one tenant.

Office in home. If you have an office in your home that you use in your business, you may be entitled to deductions for the business use of your home, including the business part of your home mortgage interest.

Other Situations

You can treat a home under construction as a qualified home for up to 24 months, but only if it becomes your qualified home at the time it is ready for occupancy.

The 24-month period can start any time on or after the day construction begins.

You may be able to continue treating your home as a qualified home even after it is destroyed in a fire, storm, tornado, earthquake, or other casualty. This means you can continue to deduct the interest you pay on your home mortgage, subject to the limits described in this guide.

You can continue treating a destroyed home as a qualified home if, within a reasonable period of time after the home is destroyed, you:

  1. Rebuild the destroyed home and move into it, or
  2. Sell the land on which the home was located.

This rule applies to your main home and to a second home that you treat as a qualified home. It also applies whether or not your home is in a federal disaster area.

You can treat a home you own under a time-sharing plan as a qualified home if it meets all the tests for a qualified home. If you rent out your time-share, it qualifies as a second home only if you also use it as a home. To know whether you meet that requirement, count your days of use and rental of the home only during the time you have a right to use it or to receive any benefits from the rental of it.

Married Taxpayers

If you are married and file a joint return, your qualified home(s) can be owned either jointly or by only one spouse.

If you are married filing separately and you and your spouse own more than one home, you can each take into account only one home as a qualified home. However, if you both consent in writing, then one spouse can take both the main home and a second home into account.

Note: If a divorce or separation agreement requires you or your spouse or former spouse to pay home mortgage interest on a home owned by both of you, the payment of interest may be alimony.

Special Rules

This section describes certain items that can be included as home mortgage interest and others that cannot. It also describes certain special situations that may affect your deduction.

Late payment charge on mortgage payment. You can deduct as home mortgage interest a late payment charge if it was not for a specific service in connection with your mortgage loan.

Mortgage prepayment penalty. If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan.

Sale of home. If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of the sale.

Example: John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Their mortgage interest deduction is $1,270 ($1,220 + $50).

Prepaid interest. If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. You can deduct in each year only the interest that qualifies as home mortgage interest for that year. However, there is an exception for points.

Mortgage interest credit. You may be able to claim a mortgage interest credit if you were issued a mortgage credit certificate (MCC) by a state or local government. If you take this credit, you must reduce your mortgage interest deduction by the amount of the credit.

Ministers' and military housing allowance. If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you can still deduct your home mortgage interest.

Mortgage assistance payments. If you qualify for mortgage assistance payments under section 235 of the National Housing Act, part or all of the interest on your mortgage may be paid for you. You cannot deduct the interest that is paid for you.

Rental payments before real estate closing occurs. If you live in a house before final settlement on the purchase, any payments you make for that period are rent and not interest, and therefore not deductible. This is true even if the settlement papers call them interest.

Mortgage proceeds invested in tax-exempt securities. You cannot deduct the home mortgage interest on debt used to buy securities or certificates that produce tax-free income.

Refunds of interest. If you receive a refund of interest in the same year you paid it, you must reduce your interest expense by the amount refunded to you. If you receive a refund of interest you deducted in an earlier year, you generally must include the refund in income in the year you receive it. However, you need to include it only up to the amount of the deduction that reduced your tax in the earlier year. This is true whether the interest overcharge was refunded to you or was used to reduce the outstanding principal on your mortgage.

Mortgage Interest Statement (Form 1098)

If you paid $600 or more of mortgage interest (including certain points) during the year, you will usually receive a Form 1098, Mortgage Interest Statement from the mortgage holder, showing the amount of interest you paid.

Tip: You should receive the statement for each year by January 31 of the following year. A copy of this form is also sent to the IRS.

The Deductibility of Points

This Financial Guide explains when and to what extent points paid on the purchase of a home or on a refinancing are deductible. It explains the rules for deducting points and discusses special circumstances and situations.

Note:For an explanation of the deductibility of home mortgage interest, please click here.

What Are Points?

The term "points" is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.

Points are prepaid interest and may be deductible as home mortgage interest, if you itemize deductions on Form 1040, Schedule A. Generally, if you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage. If your acquisition debt exceeds $1 million or your home equity debt exceeds $100,000, you cannot deduct all the interest on your mortgage and you cannot deduct all your points.

A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. See "Points Paid by Seller," later.

Tests for Deductibility

Generally, you cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you generally must deduct them over the life (term) of the mortgage.

However, you can fully deduct points in the year paid if you meet all of the following tests.

  1. Your loan is secured by your main home (the one you live in most of the time).
  2. Paying points is an established business practice in the area where the loan was made.
  3. The points paid were not more than the points generally charged in that area.
  4. You use the cash method of accounting (the method used by most individual taxpayers).
  5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
  6. You use your loan to buy or build your main home.
  7. The points were computed as a percentage of the principal amount of the mortgage.
  8. The amount is clearly shown on the settlement statement (such as the Uniform Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller's.
  9. The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.

Home improvement loan. You can also fully deduct in the year paid points paid on a loan to improve your main home, if statements (1) through (5) above are true.

Non-Deductible Amounts

Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:

  1. Appraisal fees
  2. Notary fees
  3. Preparation costs for the mortgage note or deed of trust
  4. Mortgage insurance premiums
  5. VA funding fees.

You cannot deduct these amounts as points either in the year paid or over the life of the mortgage.

Points Paid by Seller

The term "points" includes loan placement fees that the seller pays to the lender to arrange financing for the buyer. The seller cannot deduct these fees as interest. But they are a selling expense that reduces the seller's amount realized. The buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them. If all the tests explained earlier are met, the buyer can deduct the points in the year paid. If any of those tests is not met, the buyer deducts the points over the life of the loan.

Funds Provided Are Less than Points

If you meet all the tests referred to earlier; except that the funds you provided were less than the points charged to you (test 9), you can deduct the points in the year paid, up to the amount of funds you provided. In addition, you can deduct any points paid by the seller.

Example: When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the nine tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in the year paid. You spread the remaining $250 over the life of the mortgage.

Excess Points

If you meet all the tests except that the points paid were more than generally paid in your area (test 3), you deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the mortgage.

Points Paid on Second Home

The general rule of instant deductibility does not apply to points you pay on loans secured by your second home. You can deduct these points only over the life of the loan.

Mortgage Ends Early

If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan.

A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.

Points Paid on Refinancing

Generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them. This is true even if the new mortgage is secured by your main home.

However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first five tests listed earlier; you can fully deduct the part of the points related to the improvement in the year paid. You can deduct the rest of the points over the life of the loan.

Example: In 1999, Bill Fields got a mortgage to buy a home. The interest rate on that mortgage loan was 11%. In 2008, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan that has an interest rate of 7%. The mortgage is secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Bill paid the points out of his private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area, and the points charged are not more than the amount generally charged there. Bill's first payment on the new loan was due July 1. He made six payments on the loan in 2008 and is a cash basis taxpayer.

Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill's continued ownership of his main home, it was not for the purchase or improvement of that home. For that reason, Bill does not meet all the tests, and he cannot deduct all of the points in 2008. He can deduct two points ($2,000) ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) x 6 payments] of the points in 2008. The other point ($1,000) was a fee for services and is not deductible.

Example 2: The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Bill deducts 25% ($25,000 ÷ $100,000) of the $2,000 prepaid interest in 2008. His deduction is $500 ($2,000 x 25%).

Bill also deducts the ratable part of the remaining $1,500 ($2,000 - $500) prepaid interest that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180 months) x 6 payments] in 2008. The total amount Bill deducts in 2008 is $550 ($500 + $50).

Limits on Home Mortgage Interest Affect Points

You cannot fully deduct points paid on a mortgage that exceeds the limits on home mortgages for purposes of the home mortgage interest deduction.

Form 1098

The mortgage interest statement (Form 1098) you receive should show not only the total interest paid during the year, but also your deductible points.

The statement will show the total interest you paid during the year. If you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. However, it should not show any interest that was paid for you by a government agency.

As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. See the earlier discussion of Points to determine whether you can deduct points not shown on Form 1098.

Refinancing Your Mortgage: When and How

If you bought your home when mortgage rates were higher than today's rates are, or have an adjustable-rate loan and would like to change it to a fixed rate, then you are probably a candidate for refinancing your mortgage. Here are some factors to consider when deciding whether to refinance and how to get the best deal.

If you decide to refinance your mortgage, you can expect the process to be similar to what you went through in obtaining the original mortgage because in reality, refinancing a mortgage is simply taking out a new mortgage. You will encounter many of the same procedures and the same types of costs the second time around. In this Financial Guide, we will give you some pointers on how to get the best possible deal.

Who Can Benefit From Refinancing?

Refinancing does not make good financial sense for everyone. A general rule of thumb is that refinancing is worthwhile if the current interest rate on your mortgage is at least two percentage points higher than the prevailing market rate. This figure is generally accepted as the safe margin when balancing the costs of refinancing a mortgage against the savings. However, a rule of thumb is not ironclad: every individual's circumstances need to be analyzed. If your loan amount and the particular circumstances warrant it, you might choose to refinance a loan that is only 1-1/2 percentage points higher than the current rate.

Tip: Lenders may be offering zero point loans and low-cost refinancing. Therefore, even if your rate change is less than one percentage point, you may be able to save some money by refinancing.

Most experts say that it takes at least three years to fully realize the savings from a lower interest rate, given the costs of refinancing. You may find, however, that you could recoup the refinancing costs in a shorter time than three years. Again, every homeowner's circumstances should be analyzed individually. Generally, refinancing is a good idea if you:

  • Want to get out of a high interest rate loan to take advantage of lower rates. (This is a good idea only if you intend to stay in the house long enough to make the additional fees worthwhile.)
  • Want to convert to an ARM with a lower interest rate or more protective features (such as a better rate and payment caps) than the ARM you currently have.
  • Want to build up equity more quickly by converting to a loan with a shorter term.
  • Want to draw on the equity built up in your home to get cash for a major purchase or for your children's education.
  • Have an adjustable-rate mortgage (ARM) and want a fixed-rate loan in order to know exactly what the mortgage payment will be for the life of the loan.

Planning Aid: For information on fixed rates, see the Financial Calculator: Which Loan Is Better, Fixed or Adjustable?

Tip: If you decide that refinancing is not worth the costs, ask your lender whether you may be able to obtain all or some of the new terms you want by agreeing to a modification of your existing loan instead of a refinancing.

How to Go About Making the Decision

Talk to several lenders to find out what the current rates are and what costs are associated with refinancing. These costs (explained in more detail below) include appraisals, attorney's fees, and points. Once you know what the costs will be, determine what your new payment would be if you refinanced. You can then estimate how long it will take to recover the costs of refinancing by dividing your closing costs by the difference between your new and old payments.

Be aware that the amount of money that you ultimately save depends on many factors, including your total refinancing costs, whether you sell your home in the near future, and the effects of refinancing on your taxes.

If you are thinking of refinancing an adjustable rate mortgage (ARM), you should also consider these questions:

  • Is the next interest rate adjustment on your existing loan likely to increase your monthly payments substantially? Will the new interest rate be two or three percentage points higher than the prevailing rates being offered for either fixed-rate loans or other ARMs?

  • If the current mortgage sets a cap on your monthly payments, are those payments large enough to pay off your loan by the end of the original term? Will refinancing to a new ARM or a fixed-rate loan enable you to pay your loan in full by the end of the term?

You also might want to consider refinancing if you have an adjustable rate mortgage with high or no limits on interest rate increases. You might want to switch to a fixed-rate mortgage or to an adjustable rate mortgage that limits changes in the rate at each adjustment date as well as over the life of the loan.

How to Determine Your Refinancing Costs

When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With the new loan, you again pay most of the same costs you paid to get your original mortgage, including settlement costs, discount points, and other fees. You may also be charged a penalty for paying off your original loan early, called a prepayment penalty, if such a practice is not prohibited by your state.

The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required to obtain a loan. You should plan on paying an average of 3 to 6% of the outstanding principal in refinancing costs, plus any prepayment penalties and the costs of paying off any second mortgages that may exist.

Tip: When shopping for a lender, ask each one for a list of charges and costs you must pay at closing. Some lenders may require that some of these costs be paid at the time of application.

The fees described below are the ones that you are most likely to encounter in a refinancing. (Some of the costs are expanded on in the paragraphs that follow.) Because costs may vary significantly from area to area and from lender to lender, the following chart should be regarded only as an estimate. Your actual closing costs may be higher or lower than the ranges indicated below.

  • Application Fee $ 75 to $300
  • Appraisal Fee $300 to $700
  • Survey Costs $150 to $400
  • Homeowners Hazard Insurance $300 to $1,000
  • Lenders Attorney's Review Fees $500 to $1,000
  • Title Search & Title Insurance $700 to $900
  • Home Inspection Fees $175 to $350
  • Loan Origination Fees 1% - 2% of loan
  • Mortgage Insurance 0.5% to 1.0%
  • Points 1% to 3%

Tip: To save on some of these costs, check with the lender who holds your current mortgage. The lender may be willing to waive some of them, especially if the work relating to the mortgage closing is still current (such as the fees for the title search, surveys, inspections, and so on).

Let's look at some of these costs in greater detail:

Application Fee. This charge imposed by your lender covers the initial costs of processing your loan request and checking your credit report.

Title Search and Title Insurance. This charge will cover the cost of examining the public record to confirm ownership of the real estate. It also covers the cost of a policy, usually issued by a title insurance company that insures the policy holder in a specific amount for any loss caused by discrepancies in the title to the property.

Tip: Be sure to ask the title insurance company carrying the present policy if it can re-issue your policy at a re-issue rate. You could save up to 70% of what it would cost you for a new policy.

Lender's Attorney's Review Fees. The lender will usually charge you for fees paid to the lawyer or company that conducts the closing for the lender. Settlements are conducted by lending institutions, title insurance companies, escrow companies, real estate brokers, and attorneys for the buyer and seller. In most situations, the person conducting the settlement is providing a service to the lender. You may also be required to pay for other legal services relating to your loan which are provided to the lender.

Tip: You may want to retain your own attorney to represent you at all stages of the transaction, including settlement.

Loan Origination Fees. The origination fee is charged for the lender's work in evaluating and preparing your mortgage loan.

Points. Points are prepaid finance charges imposed by the lender at closing to increase the lender's yield beyond the stated interest rate on the mortgage note. One point equals one percent of the loan amount. For example, one point on a $75,000 loan would be $750. The total number of points a lender charges will depend on market conditions and the interest rate to be charged. To give you the lowest rate offered, most lenders will charge several points, and the total cost can run between three and six percent of the total amount you borrow. For example, on a $100,000 mortgage, the lender might charge you between $3,000 and $6,000. However, some lenders may offer zero points at a higher interest rate, which may significantly reduce your initial costs, although your payments may be somewhat higher.

Tip: In some cases, the points you pay can be financed by adding them to the loan amount. This means that the points will be added to your loan balance, and you will pay a finance charge on them. Although this may enable you to get the financing, it also will increase the amount of your monthly payments.

Tip: To decide what combination of rate and points is best for you, balance the amount you can pay up front with the amount you can pay monthly. The less time you keep the loan, the more expensive points become. If you plan to stay in your house for a long time, then it may be worthwhile to pay additional points to obtain a lower interest rate.

Appraisal Fee. This fee pays for an appraisal which is a supportable and defensible estimate or opinion of the value of the property.

Prepayment Penalty. A prepayment penalty on your present mortgage could be the greatest deterrent to refinancing. The practice of charging money for an early pay-off of the existing mortgage loan varies by state, type of lender, and type of loan. Prepayment penalties are forbidden on various loans including loans from federally chartered credit unions, FHA and VA loans, and some other home-purchase loans. The mortgage documents for your existing loan will state if there is a penalty for prepayment. In some loans, you may be charged interest for the full month in which you prepay your loan.

Miscellaneous. Depending on the type of loan you have and other factors, another major expense you might face is the fee for a VA loan guarantee, FHA mortgage insurance, or private mortgage insurance. There are a few other closing costs in addition to these.

How Does Refinancing Affect Your Tax Situation?

With a lower interest rate on your home loan, you will have less interest to deduct on your income tax return. That, of course, may increase your tax payments and decrease the total savings you might obtain from a new, lower-interest mortgage.

Interest (points) paid up front for refinancing must be deducted over the life of the loan, not in the year you refinance, unless the loan is for home improvements. This means that if you paid a certain number of points, you would have to spread the tax deduction for those points over the life of the loan. If, however, the refinancing is for home improvements (or a portion of the loan is for this purpose) you may be able to deduct the points (or a portion of the points) under certain circumstances.

If you are thinking about refinancing your mortgage, you might want to consider other types of mortgages. For example, you might want to look into a 15-year, fixed-rate mortgage. In this plan, your mortgage payments are somewhat higher than a longer-term loan, but you pay substantially less interest over the life of the loan and build equity more quickly. Of course, this also means you have less interest to deduct on your income tax return.

Tips for Getting the Best Deal

Here are some tips for getting the best deal when refinancing of your mortgage:

1. Shop Around

If you decide to refinance your mortgage, it pays to shop around by calling several lending institutions to find out what interest and fees they charge. This helps you get the best deal available. Also ask each about their "annual percentage rate" (APR) and compare them. The APR will tell you the total credit costs of the refinancing, including interest, points, and other charges.

Tip: You do not have to refinance your mortgage with the same lender that provided your original mortgage. However, to keep your business, some lenders will offer their original mortgage customers the incentive of lower mortgage interest rates, sometimes with reduced closing costs.

2. Obtain a "Lock-In" or Guarantee

If you decide to apply for refinancing with a particular lender, and if you do not want to let the interest rate float until closing, then get a written statement guaranteeing the interest rate and the number of discount points that you will pay at closing. This binding commitment, or lock-in, ensures that the lender will not raise these costs even if rates increase before you settle on the new loan. You might also consider requesting an agreement where the interest rate can decrease but not increase before closing. If you cannot get the lender to put this information in writing, you may want to choose one that will.

Most lenders place a limit on the length of time (60 days for example) that they will guarantee the interest rate. You must sign the loan during that time or lose the benefit of that particular rate. Because many people are refinancing their mortgages, there may be a delay in processing the papers. Therefore, contact your loan officer periodically to check on the progress of your loan approval and to see if additional information is needed

3. Review the Disclosure Form

When refinancing, the lender must give you a written statement of the costs and terms of the financing before you become legally obligated for the loan. This is required under the Truth in Lending Act. Typically, you receive this information around the time of settlement, although some lenders provide it earlier. Review this statement carefully before you sign the loan. The disclosure tells you the APR, finance charge, amount financed, payment schedule, and other important credit terms.

Related Guide: Please see the Financial Guide: MORTGAGE LOCK-INS: Questions To Ask.

4. Be Aware Of Your Right to Rescind

If you refinance with a different lender, or if you borrow beyond your unpaid balance with your current lender, you also must be given the right to rescind the loan. In these loans, you have the right to rescind or cancel the transaction within three business days following settlement, receipt of your Truth in Lending disclosures, or receipt of your cancellation notice, whichever occurs last.

5. Find Out If the Application Fee Is Refundable

When you apply for a mortgage, some lenders require you to pay a special charge to cover the costs of processing your application. The amount of this fee varies, but generally is in the range of $75 to $300. Usually, you must pay this charge at the time you file the application. Some lenders do not refund this application fee if you are not approved for the loan or if you decide not to take it.

If you elect to cancel the transaction within three business days after you close the loan, as discussed above, you are entitled to a refund of all costs and charges imposed for the credit transaction.

Tip: Before you apply for a mortgage, ask lenders whether they charge an application fee. If they do, find out how much it is and under what circumstances and to what extent it is refundable.

*   *   *   *

As you can see, there are many financial factors to consider when refinancing a mortgage, so you may want to think about getting professional guidance if you're considering your refinancing options.

Sample Refinancing Savings

The charts below illustrate the monthly and yearly differences in your mortgage payments if you refinanced to a 6 % or an 8 %, 30-year fixed-rate mortgage for $75,000. Remember, however, that the actual amount you may save by refinancing depends on many factors, such as your tax bracket and how long you plan to remain in your home.

Your Present Mortgage RateCurrent Monthly PaymentMonthly Payment at 8%Monthly Difference in Payment at 8%Annual Difference in Payment at 8%
Your Present Mortgage RateCurrent Monthly PaymentMonthly Payment at 6%Monthly Difference in Payment at 6%Annual Difference in Payment at 6%

Selling Your Home: How To Do It Effectively

This Financial Guide gives you suggestions that can increase the sales price and reduce the frustrations involved in selling a home. It discusses how to find a good agent, how to make your home more attractive to buyers, how to negotiate effectively, and how to handle the moving process.

Table of Contents


Here are some tips for getting the best possible price for your home and making the process as smooth as possible. By putting some time into choosing a real estate agent, for instance, you can avoid wasting unnecessary time on the market due to an ineffective or haphazard sales strategy. Further, there are actions you can take to make your home more saleable.

Finding A Good Real Estate Agent

To find a good real estate agent, gather a list of names of candidates you will interview. You may want to consider recommendations from colleagues, friends, and professionals, as well as names listed on posted "for sale" signs, especially for houses that have been sold. Once you have at least three names, schedule a telephone or in-person interview with the agent. You may encounter some resistance; if you run into a broker who refuses to take the time to answer your questions, just move to the next one.

TipTip: Although a popular practice in recent times (due to the savings on commissions paid to a broker), selling your own home without a broker is often more difficult unless you have a buyer in mind.

Be sure to ask potential agents the following:

  • What problems do you see in marketing our home? (The broker should be honest about potential problems in selling the home and able to think creatively about solutions.)

  • What would your plan be for marketing our home? What can we do to help you implement your plan? (Listen to the answer to find out whether the agent exhibits a willingness to think creatively in approaching whatever problems might exist with the selling process and whether he or she has a cooperative attitude.)

  • Will you include any ideas you have for selling the home in a listing agreement if we decide to sign with you?

  • Where do you live? (You want a broker who lives nearby, who knows the good and bad points about your area.)

  • How much is your commission? (The average commission is 6% or 7%. Although brokers sometimes take a cut in their commissions during the negotiation process-in order to move a sale along-there is no point in trying to bargain down a broker's commission at this point.)

  • Do you have a list of comparable homes? (Such a list is essential in helping you arrive at an asking price for your home.)

Reviewing The Listing Agreement

The listing agreement is a contract between the homeowners and the agent. It states how much the agent will be paid and what services will be provided.

The exclusive right to sell type of agreement gives the broker the exclusive right to sell your house for a limited period of time. Other types of listing agreements vary either the exclusivity or time period of the listing. No matter which of these agreements are signed, the listing agent gets 100% of the commission if he or she sells the house and part of the commission if another broker sells the house.

TipTip: Generally, try to limit an exclusive-right-to-sell agreement to a period of three months. This agreement will give the broker an incentive to sell the home, and it will still give you an out if you feel the broker is not doing enough for you. If you have substantial confidence in the broker, and you have seen and approved his or her plans for marketing the home, you may wish to sign a six month contract.
TipTip: If, at any time during the marketing process, you feel that your broker is not as effective as he or she could be, switch brokers. Do not waste time with a broker you have doubts about.

Speeding Up The Selling Process

There are various things you can do before and during the selling process to move it along-and make it less onerous. A good real estate agent may suggest the following:

  • Make cosmetic improvements to get the house looking as good as possible. For instance, patch damaged plaster and drywall, repaint, and re-wallpaper. Spruce up the exterior by replacing broken shingles or shutters or doing some minor landscaping to give your home more "curb appeal".

  • Increase your home's appeal to a wider range of potential buyers. Repair or replace any part of your home that's been modified that might not appeal to the general population.

  • Make your home cozy and inviting when potentials buyers come by. Make sure the interior and exterior are clean, neat, and well maintained. Have a fire burning in the fireplace, bake some cookies or an apple pie, or have a pot of coffee brewing. Put away toys and tools. Keep pets out of sight. Not everyone is as enamored of Fido as your family is. Try not to cook foods like fish with lingering odors.

  • Here are some ideas for working with your broker to speed up the sale of your home.

  • Offer a warranty. Sometimes offering a warranty on the roof, electrical system, or appliances can speed up a sale or smooth the negotiating process, particularly if it's causing buyers to balk at the asking price.

  • Create a home sale kit with your broker. A home sale kit consists of flyers that are distributed to potential home buyers and contain photos of your home's exterior, interior, and surroundings. The flyer should also list major selling points and include information about utility costs, taxes, and a floor plan.

  • Do not help the broker show the home. Allow the broker to do his or her job. Make yourself available for questions, but do not try to help sell to potential buyers who are looking at your home.

  • Offer a bonus to your broker. A bonus shouldn't be obvious to the buyer because the buyer will wonder if the house price has been bumped up to accommodate the real estate broker's bonus. Instead, offer the bonus in the form of an increased commission, say 3.5 percent instead of 3 percent.

  • Take it off the market and re-list it later. If your house has been on the market for a long time, it may be perceived as undesirable. Taking it off the market and re-listing it at a later time sometimes helps.

Negotiating Effectively

Although it is the broker's job to do the actual negotiating, the home owners should stay involved in the process. Here are some tips for negotiating with buyers, once they have made their first offer.

  • Find out as much as possible about the potential buyer. Try to find out, for example, whether the buyer needs to buy a home quickly or is in a position to take plenty of time to negotiate. This will help you to decide what type of negotiating stance to take. Knowing details about the buyer's family will help you point out how your home accommodates their needs. And, if you know that a buyer lives in an apartment and will need to buy appliances for their new home, then you can throw in deal-sweeteners such as refrigerators, washer and dryers, and furnishings.
  • On the flip side, try to reveal as little as possible about your own situation.

One final piece of advice is to avoid being confrontational, which can kill a potential deal during the negotiation process. The offers you receive will likely be 10 to 15% below your asking price. Do not be offended by this or by any "low-balling" techniques engaged in by buyers. Be willing to make some concessions. Make counter-offers to try to bring the offer closer to your asking price. If you feel that an offer is unreasonable, however, you can always reject it outright and wait for another buyer.

Planning Your Move

Once you have signed the contracts, it is time to start planning the move. The closing date, which is generally your moving date, will fall about two months after the contracts are signed.

Hiring A Moving Company

One thing you should do immediately after the contracts are signed-even though your moving date may be months away-is to begin calling moving companies. Try to get recommendations from friends or colleagues. Call a number of movers for estimates. You will have to provide them with the number of miles involved in the move and the approximate weight of your belongings. The mover will help you in making this estimate. Do not use a mover whose estimate seems too low. The services provided may be second rate. You get what you pay for!

Ask in advance about extra charges for heavy items, stairways, or pianos. Be aware that having the movers pack for you will increase your moving bill by about 30%. Also, you may pay a premium if you schedule your move during busy moving times, generally after the 25th of the month or before the 2nd.

Getting Ready For the Move

Right after you have scheduled your move, start taking care of the following items:

  • Start throwing away things you don't want to bring with you.
  • Decide which items you are leaving behind for the new owners, and tag them appropriately.
  • If your move is job-related, ask whether your employer will reimburse you for part of the cost. Save any receipts relating to the move, since part of the cost will be deductible.
  • Start shopping for a new bank in your new neighborhood. Open a checking account once you have found one with competitive fees and convenient branches.
  • Get a change of address kit from the post office, and start notifying everyone of your impending change. Note that you will need to follow the directions given by credit card companies, banks, and others to affect a change of address; sending them a change-of-address card will generally not be effective.
  • Call the schools in the new area to enroll your children.
  • Obtain enough packing supplies from your mover, and begin packing, unless the mover will be doing the packing for you.
  • Get copies of your medical and dental records (and veterinary records), so you can hand these to your new doctors after you move.
  • Be sure your move is covered by insurance: either the moving company's insurance, or your homeowner's insurance. Call your insurance company to determine whether the move is covered. Also, take care of transferring your homeowner's insurance to the new home.

Then, as you get closer to the date of your move, take care of the following:

  • Call the utility companies and tell them to turn on service in the new place. Schedule a date when they will terminate service in the old place.
  • Pack your belongings in boxes. Mark each box with its intended location in the new home, and with a summary of its contents. When you are close to moving day, pack a separate bag with items you will need right away, such as medications, toiletries and clothing.
  • Switch your direct payroll deposit, and any automatic payments, to your new checking account. You will have to fill out a form to accomplish this. Two or three days before you move, take the money out of your old account and transfer it to your new account.
TipTip: Leave the old account open until all outstanding checks have cleared. To avoid fees, you may need to leave in any minimum balance required. Be sure to leave your new address with the old bank.
  • If you are moving into an apartment building, discuss your moving plans with the landlord and make any necessary arrangements.
  • Shop for auto insurance in the new area (if moving out of state).
  • Confirm with the moving company. Write down directions to your new home.
  • Transfer your brokerage account to your new area.
  • Take valuables out of a safe deposit box and return the keys to the bank.
  • Obtain travelers' checks to cover the expenses of your move, and a cashier's check to pay the mover (unless they will accept a personal check).
  • Defrost your refrigerator.
  • Leave a mail-forwarding order with the Post Office.
  • On moving day, check your contract with the mover. Be sure the total cost of the move is clearly detailed. Make sure the moving date, location, and insurance information is correct.

Notifying People Of Your Move

Here is a list of people you should notify when you change your address and phone number. Although the list is not all-inclusive, it can be used as a starting point. You may need to notify these parties at both your old and new locations. Bear in mind that you may need to follow the instructions provided by banks, utilities, and credit card companies in order to make your address change effective. For instance, a phoned-in address change may not become effective with a lender if the lender's policy is to require written address changes.

  • The IRS (use Form 8822) and state and local taxing authorities
  • The U.S. Post Office
  • Home, auto, and life Insurance agents
  • Debtors and creditors, such as mortgage holders, car lien holders, other lenders, and people who owe you money
  • Credit card companies
  • Publications
  • Clubs and services to which you subscribe such as auto clubs, lawn mowing services, cleaning services, and book clubs
  • The Social Security Administration
  • Any organization that periodically mails you a check, such as a pension check or veterans' benefits
  • Banks
  • Employers
  • Doctors, dentists, veterinarians
  • Motor vehicle departments
  • Places of worship and non-profit agencies you are involved with
  • The registrar of voters
  • Utilities, telephone service, answering service, and trash collectors
  • Your professional advisors

Figuring The Tax

Your responsibilities do not end with the sale of the old home and the move to the new one. There are tax consequences, often complex, that need to be considered. How much is the gain? How much of it is taxable? How can you minimize the tax impact? Here, professional guidance is important.

Related GuideRelated Guide: To gain a better understanding of the tax consequences, please see the Financial Guide: SELLING YOUR HOME: How To Minimize The Tax On The Gain

Agents' Titles and What They Mean

When looking for a real estate agent, you may come across the following commonly used titles. Here is a basic definition of each:

  • Principal broker: This is a person who is licensed to operate a real estate office. He or she may either work alone or employ other agents. Several years of experience are required to obtain this licensure. Anyone selling realty must work under the supervision of a principal broker.

  • Realtor: A realtor is a member of the National Association of Realtors, along with a state realtors' association and a local board of realtors. Realtors are bound by a code of ethics. They are able to access a local computerized database of homes for sale known as the multiple listing service.

  • Agent: This is the general term for any licensed professional in the real estate sales business.

  • Listing agent: A type of agent who signs up the home seller and lists the home with the multiple listing service.

  • Selling agent: An agent who finds a home for sale (through the multiple listing service) and finds a buyer for it.

  • Buyer's agent: The buyer's agent is employed by the broker selected by the buyer.

Note: On a home sale, the listing agent and the selling agent split the commission with each other and with their principal brokers.

Improvements That Help The Most

The following improvements and additions may increase the re-sale value of your home. Of course, bear in mind that the value home buyers place on various improvements will vary regionally, and even from neighborhood to neighborhood. But the list might serve to give you some ideas.

  • Family room
  • Fireplace
  • Dining room
  • Linen closet
  • Garbage disposal
  • Wall-to-wall carpeting
  • Smoke detector
  • Two-sink vanity (bathroom)
  • Double-glass windows
  • Range hood and fan
  • Bathroom dressing area
  • Patio
  • New, stronger locks
  • Central air
  • Guest room
  • Bathroom exhaust fan

Selling Your Home: How To Minimize the Tax On the Gain

Many tax benefits are available to you when you sell your principal residence. However, the rules are complex and personal guidance is necessary to take full advantage of these benefits, so that you and your tax advisor can best work together to minimize the tax on the gain. This financial guide discusses the key rules so that you and your tax advisor can best work together to minimize the tax on the gain.

The IRS allows an exclusion of up to $250,000 of the gain on the sale of your main home ($500,000 if you are married and file a joint return. Most taxpayers can take advantage of the exclusion and will not have to pay any tax on the sale of a main home as long as they meet the IRS ownership and use tests (see below).

Note: If you do have a loss from the sale, it is a personal loss. You cannot deduct the loss.

If you don't qualify for exclusion, your gain exceeds the exclusion, or you used part of the property in business or for rent, you have a taxable gain and must report the sale of your main home on your tax return on IRS Form 8949 and Schedule D.

Principal Residence

Usually, the home you live in most of the time is your main home. In addition to a standard dwelling unit, your home can also be a houseboat, mobile home, cooperative apartment, or condominium.

Example: You own and live in a house in town. You also own beach property, which you use in the summer months. The town property is your main home; the beach property is not.

Example: You own a house, but you live in another house that you rent. The rented home is your main home.

Tip: Where a second residence has soared in value and you want to sell, some tax advisors have suggested moving to the second residence for the required period to qualify for exclusion on its sale. If this is your situation, please consult with a tax professional.

How to Figure Gain or Loss

Key information for determining gain or loss is the selling price, the amount realized, and the adjusted basis.

The selling price is the total amount you receive for your home. It includes money, all notes, mortgages or other debts assumed by the buyer as part of the sale, and the fair market value of any other property or any services you receive. Next, you deduct the selling expenses such as commissions, advertising, legal fees, and loan charges paid by the seller from the selling price.

The difference is the "amount realized". If the amount realized is more than your home's "adjusted basis," discussed later, the difference is your gain. If the amount realized is less than the adjusted basis, the difference is your loss.

However, it does not include amounts you received for personal property sold with your home. Personal property is property that is not a permanent part of the home, such as furniture, draperies, and lawn equipment.

Non-Traditional Sales

The following discussion covers how to determine your gain or loss if you trade one home for another, if your home is foreclosed on or repossessed or if you transfer a jointly owned home.

Jointly owned home. If you and your spouse sell your jointly owned home and file a joint return, you figure and report your gain or loss as one taxpayer. If you file separate returns, each of you must figure and report your own gain or loss according to your ownership interest in the home. Your ownership interest is determined by state law.

If you and a joint owner other than your spouse sell your jointly owned home, each of you must figure and report your own gain or loss according to your ownership interest in the home. Each of you applies the exclusion rules individual basis.

Trading homes. If you trade your old home for another home, treat the trade as a sale and a purchase.

Foreclosure or repossession. If your home was foreclosed on or repossessed, you have what the IRS calls a disposition and will need to determine if you have ordinary income, gain, or loss. The amount of your gain or loss depends on whether you were personally liable for repaying the debt secured by the home and whether the outstanding loan balance is more than the fair market value (FMV) of the property.

If you were not personally liable for repaying the debt secured by the home, the amount you realize includes the full amount of the outstanding debt immediately before the transfer. This is true even if the FMV of the property is less than the outstanding debt immediately before the transfer.

If you were personally liable for repaying the debt secured by the home and the debt is canceled, the amount realized on the foreclosure or repossession includes the smaller of the outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or the Fair Market Value (FMV) of the transferred property.

In addition to any gain or loss, if you were personally liable for the debt you may have ordinary income. If the canceled debt is more than the home's fair market value, you have ordinary income equal to the difference. However, the income from cancellation of debt is not taxed to you if the cancellation is intended as a gift, or if you are insolvent or bankrupt.

Example: You owned and lived in a home with an adjusted basis of $41,000. A real estate dealer accepted your old home as a trade-in and allowed you $50,000 toward a new house priced at $80,000 (its fair market value). You are considered to have sold your old home for $50,000 and to have had a gain of $9,000 ($50,000 minus $41,000). If the dealer had allowed you $27,000 and assumed your unpaid mortgage of $23,000 on your old home, $50,000 would still be considered the sales price of the old home (the trade-in allowed plus the mortgage assumed).

Transfer to spouse. If you transfer your home to your spouse, or to your former spouse incident to your divorce, you generally have no gain or loss, even if you receive cash or other consideration for the home. Therefore, the rules explained in this Guide do not apply.

If you owned your home jointly with your spouse and transfer your interest in the home to your spouse, or to your former spouse incident to your divorce, the same rule applies. You have no gain or loss.

If you buy or build a new home, its basis will not be affected by your transfer of your old home to your spouse, or to your former spouse incident to divorce. The basis of the home you transferred will not affect the basis of your new home.


You will need to know your basis in your home as a starting point for determining any gain or loss when you sell it. Your basis in your home is determined by how you got the home. Your basis is its cost if you bought it or built it. If you acquired it in some other way, its basis is either its fair market value when you received it or the adjusted basis of the person you received it from.

While you owned your home, you may have made adjustments (increases or decreases) to the basis. This adjusted basis is used to figure gain or loss on the sale of your home.

Cost as Basis

The cost of property is the amount you pay for it in cash or other property.

Purchase. If you buy your home, your basis is its cost to you. This includes the purchase price and certain settlement or closing costs. Your cost includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller in payment for the home.

Seller-paid points. If you bought your home after April 3, 1994, you must reduce the basis of your home by any points the seller paid, whether or not you deducted them. If you bought your home after 1990 but before April 4, 1994, you must reduce your basis by the amount of seller-paid points only if you chose to deduct them as home mortgage interest in the year paid.

Settlement fees or closing costs. When buying your home, you may have to pay settlement fees or closing costs in addition to the contract price of the property. You can include in your basis the settlement fees and closing costs that are for buying the home. You cannot include in your basis the fees and costs that are for getting a mortgage loan. A fee is for buying the home if you would have had to pay it even if you paid cash for the home.

Settlement fees do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

Some of the settlement fees or closing costs that you can include in the basis of your property are:

  • Abstract fees (sometimes called abstract of title fees),
  • Charges for installing utility services,
  • Legal fees (including fees for the title search and preparing the sales contract and deed),
  • Recording fees,
  • Surveys,
  • Transfer taxes,
  • Owner's title insurance, and
  • Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

Some settlement fees and closing costs not included in your basis are:

  • Fire insurance premiums.
  • Rent for occupancy of the house before closing.
  • Charges for utilities or other services relating to occupancy of the house before closing.
  • Any item that you deducted as a moving expense (settlement fees and closing costs incurred after 1993 cannot be deducted as moving expenses).
  • Fees for refinancing a mortgage.
  • Charges connected with getting a mortgage loan, such as mortgage insurance premiums (including VA funding fees), loan assumption fees, cost of a credit report, and fee for an appraisal required by a lender.

Real estate taxes. Real estate taxes for the year you bought your home may affect your basis, as follows:

If you pay taxes that the seller owed on the home up to the date of sale and the seller does not reimburse you, then the taxes are added to the basis of your home.

If you pay taxes that the seller owed on the home up to the date of sale and the seller does reimburse you, then the taxes do not affect the basis of your home.

If the seller pays taxes for you (taxes owed beginning on the date of sale) and you do not reimburse the seller, then the taxes are subtracted from the basis of your home.

If the seller pays taxes for you (taxes owed beginning on the date of sale) and you reimburse the seller, then the taxes do not affect the basis of your home.

Construction. If you contracted to have your house built on land you own, your basis is the cost of the land plus the amount it cost you to complete the house. This amount includes the cost of labor and materials, or the amounts paid to the contractor, and any architect's fees, building permit charges, utility meter and connection charges, and legal fees directly connected with building your home. Your cost includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller or builder. It also includes certain settlement or closing costs. You may have to reduce the basis by points the seller paid for you. If you built all or part of your house yourself, its basis is the total amount it cost you to complete it. Do not include the value of your own labor, or any other labor you did not pay for, in the cost of the house.

Cooperative apartment. Your basis in the apartment is usually the cost of your stock in the co-op housing corporation, which may include your share of a mortgage on the apartment building.

Condominium. Your basis is generally its cost to you. The same rules apply as for any other home.

Basis Other Than Cost

If your home was acquired in a transaction other than a traditional purchase (such as gift, inheritance, trade, or from a spouse), you may have to use a basis other than cost, such as fair market value.

Note: Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.

Home received as gift. If your home was a gift, its basis to you is the same as the donor's adjusted basis when the gift was made. However, if the donor's adjusted basis was more than the fair market value of the home when it was given to you, you must use that fair market value as your basis for measuring any loss on its sale.

If you use the donor's adjusted basis to figure a gain and get a loss, and then use the fair market value to figure a loss and get a gain, you have neither a gain nor a loss on the sale or disposition.

If you received your home as a gift and its fair market value was more than the donor's adjusted basis at the time of the gift, you may be able to add to your basis any federal gift tax paid on the gift. If the gift was before 1977, the basis cannot be increased to more than fair market value of the home when it was given to you. On the other hand, if you received your home as a gift after 1976, you would add to your basis the part of the federal gift tax paid that is due to the home's "net increase" in value (value less donor's adjusted basis).

Home received from spouse. You may have received your home from your spouse or from your former spouse incident to your divorce.

  • If you received the home after July 18, 1984, you had no gain or loss on the transfer. Your basis in this home is generally the same as your spouse's (or former spouse's) adjusted basis just before you received it. This rule applies even if you received the home in exchange for cash, the release of marital rights, the assumption of liabilities, or other consideration.
  • If you owned a home jointly with your spouse and your spouse transferred his or her interest in the home to you, your basis in the half interest received from your spouse is generally the same as your spouse's adjusted basis just before the transfer. This rule also applies if your former spouse transferred his or her interest in the home to you incident to your divorce. Your basis in the half interest you already owned does not change. Your new basis in the home is the total of these two amounts.
  • If you received your home before July 19, 1984, in exchange for your release of marital rights, your basis in the home is generally its fair market value at the time you received it.
  • Home acquired from a decedent who died before or after 2010. If you inherited your home from a decedent who died before or after 2010, your basis is the fair market value of the property on the date of the decedent's death (or the later alternate valuation date chosen by the personal representative of the estate). If an estate tax return was filed or required to be filed, the value of the property listed on the estate tax return is your basis. If a federal estate tax return did not have to be filed, your basis in the home is the same as its appraised value at the date of death, for purposes of state inheritance or transmission taxes.
  • Surviving spouse. If you are a surviving spouse and you owned your home jointly, your basis in the home will change. The new basis for the interest your spouse owned will be its fair market value on the date of death (or alternate valuation date). The basis in your interest will remain the same. Your new basis in the home is the total of these two amounts.

Example: Your jointly owned home had an adjusted basis of $50,000 on the date of your spouse's death, and the fair market value on that date was $100,000. Your new basis in the home is $75,000 ($25,000 for one-half of the adjusted basis plus $50,000 for one-half of the fair market value).

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), each spouse is usually considered to own half of the community property. When either spouse dies, the fair market value of the community property becomes the basis of the entire property, including the portion belonging to the surviving spouse. For this to apply, at least half of the community interest must be included in the decedent's gross estate, whether or not the estate must file a return.

Home received in trade. If you acquired your home in a trade for other property, the basis of your home is generally its fair market value at the time of the trade. If you traded one home for another, you have made a sale and purchase. In that case, you may have realized a gain.

Adjusted Basis

Adjusted basis is your cost or other basis increased or decreased by certain amounts.

Increases to basis include:

  • Additions and other improvements that have a useful life of more than 1 year.
  • Special assessments for local improvements.
  • Amounts spent after a casualty to restore damaged property.

Decreases to basis include:

  • Discharge of qualified principal residence indebtedness that was excluded from income (but not below zero).
  • Gain from the sale of your old home before May 7, 1997 on which tax was postponed.
  • Insurance payments for casualty losses.
  • Deductible casualty losses not covered by insurance.
  • Payments received for granting an easement or right-of-way.
  • Depreciation allowed or allowable if you used your home for business or rental purposes.
  • Residential energy credit (generally allowed from 1977 through 1987) claimed for the cost of energy improvements that you added to the basis of your home.
  • Adoption credit you claimed for improvements that you added to the basis of your home.
  • Nontaxable payments from an employer's adoption assistance program that you used for improvements you added to the basis of your home.
  • Nonbusiness energy property credit (allowed beginning in 2006 but not for 2008) claimed for making certain energy saving improvements you added to the basis of your home.
  • Residential energy efficient property credit (allowed beginning in 2006) claimed for making certain energy saving improvements you added to the basis of your home.
  • First-time home buyer's credit (allowed to certain first-time buyers in the District of Columbia--beginning on August 5, 1997).
  • Energy conservation subsidy excluded from your gross income because you received it (directly or indirectly) from a public utility after December 3l, 1992, to buy or install any energy conservation measure. An energy conservation measure includes an installation or modification that is primarily designed either to reduce consumption of electricity or natural gas or to improve the management of energy demand for a home.

Discharges of qualified principal residence indebtedness. You may be able to exclude from gross income a discharge of qualified principal residence indebtedness. This exclusion applies to discharges made after 2006 and before 2013. If you choose to exclude this income, you must reduce (but not below zero) the basis of your principal residence by the amount excluded from gross income.

Amount eligible for the exclusion. The exclusion applies only to debt discharged after 2006 and before 2013. The maximum amount you can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately). You cannot exclude from gross income discharge of qualified principal residence indebtedness if the discharge was for services performed for the lender or on account of any other factor not directly related to a decline in the value of your residence or to your financial condition.

Improvements. These add to the value of your home, prolong its useful life, or adapt it to new uses. You add the cost of improvements to the basis of your property.

Example: Putting a recreation room in your unfinished basement, adding another bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, or paving your driveway are improvements.

Here are some other examples:

  • Additions: Bedroom, bathroom, deck, garage, porch, patio
  • Lawn and grounds: Landscaping, driveway, walkway, fence, retaining wall, sprinkler system, swimming pool
  • Miscellaneous: Storm windows or doors, new roof, central vacuum, wiring upgrades, satellite dish, security system
  • Heating and air conditioning: Heating system, central air, furnace, duct work, central humidifier, filtration system
  • Plumbing: Septic system, water heater, soft water system, filtration system
  • Interior: Built-in appliances, kitchen modernization, flooring, wall-to-wall carpet
  • Insulation: attic, walls, floor, pipes, duct work
  • Improvements no longer part of home. Your home's adjusted basis does not include the cost of any improvements that are no longer part of the home.

Example: You put wall-to-wall carpeting in your home 15 years ago. Later, you replaced that carpeting with new wall-to-wall carpeting. The cost of the old carpeting you replaced is no longer part of your home's adjusted basis.

Repairs. These maintain the good condition of your home. They do not add to its value or prolong its life, and you do not add their costs to the basis of your property.

Example: Repainting your house inside or outside, fixing your gutters or floors, repairing leaks or plastering, and replacing broken window panes are examples of repairs.

Tip: The entire job is considered an improvement, however, if items that would otherwise be considered repairs are done as part of an extensive remodeling or restoration of your home.

Recordkeeping. You should keep records of your home's purchase price and purchase expenses. Furthermore, you should also save receipts and other records for all improvements, additions, and other items that affect the basis of your home.

Tip: You must keep records for 3 years after the due date for filing your return for the tax year in which you sold, or otherwise disposed of, your home. But if the basis of your old home affects the basis of your new one, such as when you sold your old home before May 7, 1997 and postponed tax on any gain, you should keep those records forever.

The records you should keep include:

  • Proof of the home's purchase price and purchase expenses;
  • Receipts and other records for all improvements, additions, and other items that affect the home's adjusted basis;
  • Any worksheets or other computations you used to figure the adjusted basis of the home you sold, the gain or loss on the sale, the exclusion, and the taxable gain;
  • Any Form 982 you filed to exclude any discharge of qualified principal residence indebtedness;
  • Any Form 2119, Sale of Your Home, you filed to postpone gain from the sale of a previous home before May 7, 1997;
  • Any worksheets you used to prepare Form 2119

Exclusion for Sales After May 6, 1997

If you sell your main home after May 6, 1997, you may qualify to exclude up to $250,000 of the gain ($500,000 if married filing jointly) on the sale of your main home; however, to claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

  • Owned the home for at least 2 years (the ownership test)
  • Lived in the home as your main home for at least 2 years (the use test)
  • During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home.
  • Exception. If you owned and lived in the property as your main home for less than 2 years, you can still claim an exclusion in some cases. However, the maximum amount you may be able to exclude will be reduced.

    If you sell the land on which your main home is located, but not the house itself, you cannot exclude any gain you have from the sale of the land.

    If you have more than one home, only the sale of your main home qualifies for excluding the gain. If you have two homes and live in both of them, your main home is the one you live in most of the time.

    Note: If you owned and used the property as your main home for less than 2 years, you may be able to claim a reduced exclusion.

    The two years of ownership and use during the five-year period don't have to be continuous. You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days during the five-year period. Short temporary absences, e.g., for vacations, are counted as periods of use, even if you rent out the property during that time.

    Example: From 1994 through August 2007, Anne lived with her parents in a house that her parents owned. On September 29, 2007, she bought this house from her parents. She continued to live there until December 15 of 2007, when she sold it at a gain. Although Anne lived in the property as her main home for more than 2 years, she did not own it for the required 2 years. Therefore, she cannot exclude any part of her gain on the sale, unless she sold the property due to a change in health or place of employment.

    Example: Professor Moore bought and moved into a house on January 4, 2005. He lived in it as his main home continuously until October 1, 2006, when he went abroad for a one-year sabbatical. During part of the leave, the house was unoccupied, and during the rest of the time he rented it out. On October 1, 2007, he sold the house. Because his leave was not a short temporary absence, he cannot include the period of leave to meet the 2-year use test.

    Ownership and Use Tests Met at Different Times. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale.

    Example: In 1996, Harry was 60 years old and lived in a rental apartment. When the apartment building went co-op, he bought his apartment on December 1, 1999. Harry then went to live with his daughter on April 14, 2001 because he became ill. On July 10, 2003, he sold his co-op while still living with his daughter. Harry can exclude gain on the sale of his co-op because he met the ownership and use tests. His 5-year period runs from July 11, 1998, to July 10, 2003, the date he sold the co-op. Even though, he only owned the co-op from December 1, 1999 to July 10, 2003--over two years, he lived in the apartment from July 11, 1997 (the beginning of the five-year period) to April 14, 2001 (over two years).

    Special Situations. There are a number of special situations that may result in exceptions to the general rules.

    Individuals with Disabilities. There is an exception to the 2-out-of-5-year use test if you become physically or mentally unable to care for yourself at any time during the 5-year period. You qualify for this exception to the use test if, during the 5-year period before the sale of your home:

    • You become physically or mentally unable to care for yourself, and
    • You owned and lived in your home as a main home for a total of at least one year during the 5-year period before the sale of your home.

    Under this exception, you are considered to live in your home during any time that you live in a facility (including a nursing home) that is licensed by a state or political subdivision to care for persons in your condition.

    If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion.

    Gain postponed on sale of previous home. For the ownership and use tests, you may be able to add the time you owned and lived in a previous home to the time you lived in the home on which you wish to exclude gain. You can do this if you postponed all or part of the gain on the sale of the previous home because of buying the home on which you wish to exclude gain.

    Tip: Also, if buying the previous home enabled you to postpone all or part of the gain on the sale of a home you owned earlier, you can also include the time you owned and lived in that earlier home.

    Previous home destroyed or condemned. For the ownership and use test, you add the time you owned and lived in a previous home that was destroyed or condemned to the time you owned and lived in the home on which you wish to exclude gain. This rule applies if any part of the basis of the home you sold depended on the basis of the destroyed or condemned home. Otherwise, you must have owned and lived in the same home for 2 of the 5 years before the sale to qualify for the exclusion.

    Members of the uniformed services or Foreign Service, employees of the intelligence community, or employees or volunteers of the Peace Corps. You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve on qualified official extended duty (defined later) as a member of the uniformed services or Foreign Service of the United States, or as an employee of the intelligence community.

    You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve outside the United States either as an employee of the Peace Corps on qualified official extended duty (defined later) or as an enrolled volunteer or volunteer leader of the Peace Corps. This means that you may be able to meet the 2-year use test even if, because of your service, you did not actually live in your home for at least the required 2 years during the 5-year period ending on the date of sale.

    Note: The period of suspension cannot last more than 10 years. Together, the 10-year suspension period and the 5-year test period can be as long as, but no more than, 15 years. You cannot suspend the 5-year period for more than one property at a time. You can revoke your choice to suspend the 5-year period at any time.

    Married Persons

    If you and your spouse file a joint return for the year of sale, you can exclude gain (up to $500,000) if either spouse meets the ownership and use tests.

    Example: Mary sells her home in June of this year and marries John later in the year. She meets the ownership and use tests, but John does not. Emily can exclude up to $250,000 of gain on a separate or joint return for this year.

    Example: Now assume that John also sells a home. He meets the ownership and use tests on his home. Mary and John can each exclude $250,000 of gain.

    Death of spouse before sale. If your spouse died before the date of sale, you are considered to have owned and used the property as your main home during any period of time when your spouse owned and used it as a main home.

    Home transferred from spouse. If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it.

    Use of home after divorce. You are considered to have used property as your main home during any period when you owned it and your spouse or former spouse is allowed to use it under a divorce or separation instrument. Such use is added to your own use before or after divorce.

    Special Exceptions Affecting Exclusions

    Home destroyed or condemned. If your home is destroyed or condemned after May 6, 1997, any gain (e.g., due to insurance proceeds) qualifies for the exclusion.

    Expatriates. You cannot claim the exclusion if the expatriate tax applies to you because you have renounced their citizenship and one of the primary purposes was to avoid U.S. taxes.

    More Than One Home Sold During the Two-Year Period. You cannot exclude gain on the sale of your home if, during the two-year period ending on the date of the sale, you sold another home at a gain and are excluding all or part of that gain. If you cannot exclude the gain, you must include it in your income.

    However, you can claim a reduced exclusion if you sold the home due to a change in health or place of employment or experienced unforeseen circumstances such as natural disasters, death, or unemployment (eligible unemployment compensation). When counting the number of sales during a two-year period, do not count sales before May 7, 1997.

    The $250,000 (or $500,000) exclusion is reduced according to a formula whose numerator is the number of days of qualified ownership or use (or between sales of the homes) and the denominator is 730 days (for 2 years). If married filing jointly, duplicate the same calculation for your spouse's ownership and use (or days between sales).

    Example: You owned and used your main home for 400 days before selling it at a $150,000 gain following your move to a new job location. Your exclusion is $136,986, that is, 400/730 x $250,000.

    Change in Place of Employment. You may qualify for a reduced exclusion if the primary reason for the sale of your main home is a change in the location of employment of a qualified individual.

    Health. You may qualify for a reduced exclusion if the sale of your main home is because of health if your primary reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness, or injury.

    Unforeseen Circumstances. You may qualify for a reduced exclusion if the sale of your main home is because of an unforeseen circumstance if your primary reason for the sale is the occurrence of an event that you could not reasonably have anticipated before buying and occupying that home. You are not considered to have an unforeseen circumstance if the primary reason you sold your home was that you preferred to get a different home or because your finances improved.

    Home used in business. So long as the business use takes place in the same dwelling unit as your main home, the exclusion is not affected by business use, with this exception: You cannot exclude the part of your gain that is equal to any depreciation allowed or allowable for the business use of your home after May 6, 1997. The 2 out of 5 year use-as-the-main-home test is not applied to deny exclusion for gain allocable to business use in the same dwelling unit, except for allowable depreciation.

    Example: You bought a home in 1997 and used it throughout 3/4 as your residence and 1/4 as your home office. On December 30, 2002 you sold it. The gain qualifies for exclusion except that you cannot exclude the part of your gain that is equal to any depreciation allowed or allowable for the business use of your home after May 6, 1997.

    Recapture of Federal Subsidy

    If you financed your home under a federally subsidized program (loans from tax-exempt qualified mortgage bonds or loans with mortgage credit certificates), you may have to recapture all or part of the benefit you received from that program when you sell or otherwise dispose of your home. You recapture the benefit by increasing your federal income tax for the year of the sale. You may have to pay this recapture tax even if you can exclude your gain from income under the rules discussed earlier; that exclusion does not affect the recapture tax.


    Adjusted basis: This is your basis in the property increased or decreased by certain amounts. See Adjusted Basis, earlier in this Guide, for a list of items that increase or decrease your basis in the property.

    Amount realized: This is the selling price of your old home minus your selling expenses.

    Basis: Your basis in the property is determined by how you got it. If you bought or built the property, your basis is what it cost you. If you got the property in some other way, your basis will be determined differently. See Cost as Basis and Basis Other Than Cost earlier in this Guide for more information.

    Date of sale: If you received a Form 1099-S, Proceeds From Real Estate Transactions, the date should be shown in box 1. If you did not receive this form, the date of sale is the earlier of (a) the date title transferred or (b) the date the economic burdens and benefits of ownership shifted to the buyer. In most cases, these dates are the same.

    Fair market value: Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.

    Fixing-up expenses: These are costs you pay for decorating or repairing your home to make it easier to sell. You may be able to deduct fixing-up expenses from the amount realized on the sale of your old home.

    Gain: Your gain on the sale of your home is the amount realized minus the adjusted basis of the home you sold.

    Improvements: These add to the value of your home, prolong the life of the property, or allow the property to be used for new purposes. The cost of improvements increases your basis in the property.

    Main home: This is the home you live in most of the time. It can be a house, houseboat, cooperative apartment, condominium, etc.

    Repairs: These maintain your property in good condition. They differ from Improvements in that they do not add much to the value or life of the property and their cost does not increase your basis in the property.

    Seller-financed mortgage: This is a mortgage from the buyer of your home. The buyer makes mortgage payments to you.

    Selling expenses: Selling expenses include items such as sales commissions, and advertising and legal fees you pay to sell your home. Selling expenses also usually include loan charges you pay on the buyer's behalf as an aid in selling your home, such as loan placement fees or "points."

    Settlement fees (or closing costs): These are amounts paid in purchasing your property in addition to the contract price. Some of these amounts are added to the basis of the property and some are deductible as itemized deductions. Certain amounts are neither deductible nor added to the basis of the property. See Settlement fees or closing costs under Basis, earlier in this Guide, for more details.

Which Moving Expenses Are Deductible?

Moving expenses are deducted as an adjustment to income on Form 1040, but you cannot deduct any moving expenses covered by reimbursements from your employer that are excluded from income. If you meet the requirements of the tax law for the deduction of moving expenses, you can deduct the following types of moving expenses, as long as they are "reasonable":

  1. Moving your household goods and personal effects (including in-transit or foreign-move storage expenses), and
  2. Traveling (including lodging but not meals) to your new home.

Note: The rules applicable to moving within or to the United States are different from the rules that apply to moves outside the United States. These rules are discussed separately.

Qualifying for Moving Expenses

If you moved due to a change in your job or business location, or because you started a new job or business, you may be able to deduct your reasonable moving expenses; however, you may not deduct any expenses for meals. If you meet the requirements of the tax law for the deduction of moving expenses, you can deduct allowable expenses for a move to the area of a new main job location within the United States or its possessions. Your move may be from one United States location to another or from a foreign country to the United States.

Note: The rules applicable to moving within or to the United States are different from the rules that apply to moves outside the United States. These rules are discussed separately.

To qualify for the moving expense deduction, you must satisfy three requirements.

Under the first requirement, your move must closely relate to the start of work. Generally, you can consider moving expenses within one year of the date you first report to work at a new job location. Additional rules apply to this requirement. Please contact us if you need assistance understanding this requirement.

The second requirement is the "distance test"; your new workplace must be at least 50 miles farther from your old home than your old job location was from your old home. For example, if your old main job location was 12 miles from your former home, your new main job location must be at least 62 miles from that former home. If you had no previous workplace, your new job location must be at least 50 miles from your old home.

The third requirement is the "time test". If you are an employee, you must work full-time for at least 39 weeks during the first 12 months immediately following your arrival in the general area of your new job location. If you are self-employed, you must work full time for at least 39 weeks during the first 12 months and for a total of at least 78 weeks during the first 24 months immediately following your arrival in the general area of your new work location. There are exceptions to the time test in case of death, disability and involuntary separation, among other things. And, if your income tax return is due before you have satisfied this requirement, you can still deduct your allowable moving expenses if you expect to meet the time test.

Note: If you are a member of the armed forces and your move was due to a military order and permanent change of station, you do not have to satisfy the "distance or time tests".

What Are "Reasonable" Expenses?

You can deduct only those expenses that are reasonable under the circumstances of your move. For example, the cost of traveling from your former home to your new one should be by the shortest, most direct route available by conventional transportation. If during your trip to your new home, you make side trips for sight-seeing, the additional expenses for your side trips are not deductible as moving expenses.

Nondeductible expenses. You cannot deduct as moving expenses any part of the purchase price of your new home, the costs of buying or selling a home, or the cost of entering into or breaking a lease. Don't hesitate to call us if you have any questions about which expenses are deductible.

Reimbursed expenses. If your employer reimburses you for the costs of a move for which you took a deduction, you may have to include the reimbursement as income on your tax return.

Travel by Car - How to Calculate the Deduction

If you use your car to take yourself, members of your household, or your personal effects to your new home, you can figure your expenses by deducting either:

  1. Your actual expenses, such as gas and oil for your car, if you keep an accurate record of each expense, or
  2. The standard mileage rate is 23.5 cents per mile for miles driven during 2014 (24 cents per mile in 2013).

Tip: If you choose the standard mileage rate you can deduct parking fees and tolls you pay in moving. You cannot deduct any general repairs, general maintenance, insurance, or depreciation for your car.

Member of Your Household

You can deduct moving expenses you pay for yourself and members of your household. A member of your household is anyone who has both your former and new home as his or her home. It does not include a tenant or employee, unless you can claim that person as a dependent.

Moves Within or to the United States

If you meet the requirements of the tax law for the deduction of moving expenses, you can deduct allowable expenses for a move to the area of a new main job location within the United States or its possessions. Your move may be from one United States location to another or from a foreign country to the United States.

Household goods and personal effects. You can deduct the cost of packing, crating, and transporting your household goods and personal effects and those of the members of your household from your former home to your new home. If you use your own car to move your things, compute the deduction under the rule discussed above under "Travel by Car."

You can deduct any costs of connecting or disconnecting utilities due to the moving your household goods, appliances, or personal effects.

Tip: You can deduct the cost of shipping your car and your pets to your new home.

You can deduct the cost of moving your household goods and personal effects from a place other than your former home. Your deduction is limited to the amount it would have cost to move them from your former home.

Example: Paul Brown is a resident of North Carolina and has been working there for the last 4 years. Because of the small size of his apartment, he stored some of his furniture in Georgia with his parents. Paul got a job in Washington, DC. It cost him $300 to move his furniture from North Carolina to Washington and $1,100 to move his furniture from Georgia to Washington; however, if Paul had shipped his furniture in Georgia from North Carolina (his former home), it would have cost him $600. He can deduct only $600 of the $1,100 he paid. He can deduct $900 ($300 + $600).

Note: You cannot deduct the cost of moving furniture you buy on the way to your new home.

Travel expenses. You can deduct the cost of transportation and lodging for yourself and members of your household while traveling from your former home to your new home. This includes expenses for the day you arrive. You can include any lodging expenses you had in the area of your former home within one day after you could not live in your former home because your furniture had been moved. You can deduct expenses for only one trip to your new home for yourself and members of your household. However, all of you do not have to travel together. If you use your own car, calculate your deduction as explained under Travel by Car, earlier.

Moves Outside the United States

To deduct allowable expenses for a move outside the United States, you must be a United States citizen or resident alien who moves to the area of a new place of work outside the United States or its possessions. You must meet the requirements of the tax law for deducting moving expenses.

In addition to the expenses discussed earlier, the following may be deductible for moves outside the United States.

Storage expenses. You can deduct the reasonable expenses of moving your personal effects to and from storage. You can also deduct the reasonable expenses of storing your personal effects for all or part of the time the new job location remains your main job location. The new job location must be outside the United States.

Moving expenses allocable to excluded foreign income. If you live and work outside the United States, you may be able to exclude from income part of the income you earn in the foreign country. You may also be able to claim a foreign housing exclusion or deduction. If you claim the foreign earned income or foreign housing exclusions, you cannot deduct the part of your allowable moving expenses that relates to the excluded income.

The Deduction For Real Estate Taxes

There are two primary deductions for homeowners: real estate taxes and home mortgage interest. This Financial Guide explains which expenses you can and cannot deduct as a homeowner, and explains useful aspects of the real estate tax deduction. The mortgage interest deduction is discussed in a separate Financial Guide.

Note: Click here for the discussion of mortgage interest deductions.

Preliminary Note: Nondeductible Items

If you took out a mortgage to finance the purchase of your home, you are probably making monthly house payments. This house payment may include various costs of owning a home. The only costs you can deduct are real estate taxes actually paid to the taxing authority and interest that qualifies as home mortgage interest.

Here are some nondeductible items that may be included in your house payment.

  • Fire or homeowner's insurance premiums.
  • FHA mortgage insurance premiums.
  • Any amount applied to reduce the principal of the mortgage.

Note: Members of the clergy or of the uniformed services who receive a nontaxable housing allowance can still deduct real estate taxes and home mortgage interest. They need not reduce their deductions by the nontaxable allowance.

What Is Meant by "Real Estate Taxes"?

Most state and local governments charge an annual tax on the value of real property. This is called a real estate tax. You can deduct the tax if it is based on the assessed value of the real property and the taxing authority charges a uniform rate on all property in its jurisdiction. The tax must be for the welfare of the general public and not be a payment for a special privilege or service you receive.

Deductible Taxes

You can deduct real estate taxes imposed on you. You must have paid them either at settlement or closing or to a taxing authority (either directly or through an escrow account) during the year. If you own a cooperative apartment, special rules apply to the deduction, which is generally available to you.

Purchase or Sale of Realty: How the Deduction Is Divided Up

Real estate taxes are generally divided so that you and the seller each pay taxes for the part of the property tax year you owned the home. Your share of these taxes is fully deductible, as long as you itemize your deductions.

For tax purposes, the seller is treated as paying the property taxes up to, but not including, the date of sale. You (the buyer) are treated as paying the taxes beginning with the date of sale. This applies regardless of the lien dates under local law. Generally, this information is included on the settlement statement you get at closing.

Tip: You and the seller each are considered to have paid your own share of the taxes, even if one or the other paid the entire amount. You can each deduct your own share, if you itemize deductions, for the year the property is sold.

Delinquent taxes. Delinquent taxes are unpaid taxes imposed on the seller for an earlier tax year. If you agree to pay delinquent taxes when you buy your home, you cannot deduct them. You treat them as part of the cost of your home.

Caution: Many monthly house payments include an amount placed in escrow (put in the care of a third party) for real estate taxes. You may not be able to deduct the total you pay into the escrow account. You can deduct only the real estate taxes that the lender actually paid from escrow to the taxing authority. Your real estate tax bill will show this amount.

Refund or rebate of real estate taxes. If you receive a refund or rebate of real estate taxes this year for amounts you paid this year, you must reduce your real estate tax deduction by the amount refunded to you. If the refund or rebate was for real estate taxes paid for a prior year, you may have to include some or all of the refund in your income.

Items Not Considered Real Estate Taxes

The following items are not deductible as real estate taxes.

Charges for services. An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing authority. You cannot deduct the charge as a real estate tax if it is:

  1. A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use),
  2. A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged for trash collection), or
  3. A flat fee charged for a single service provided by your local government (such as a $30 charge for mowing your lawn because it had grown higher than permitted under a local ordinance).

You must look at your real estate tax bill to decide if any nondeductible itemized charges, such as those just listed, are included in the bill. If your taxing authority (or lender) does not furnish you a copy of your real estate tax bill, ask for it.

Assessments for local benefits. You cannot deduct amounts you pay for local benefits that tend to increase the value of your property. Local benefits include the construction of streets, sidewalks, or water and sewer systems. You must add these amounts to the basis of your property.

You can, however, deduct assessments (or taxes) for local benefits if they are for maintenance, repair, or interest charges related to those benefits. An example is a charge to repair an existing sidewalk and any interest included in that charge.

If only a part of the assessment is for maintenance, repair, or interest charges, you must be able to show the amount of that part to claim the deduction. If you cannot show what part of the assessment is for maintenance, repair, or interest charges, you cannot deduct any of it.

An assessment for a local benefit may be listed as an item in your real estate tax bill. If so, use the rules in this section to find how much of it, if any, you can deduct.

Transfer taxes (or stamp taxes). You cannot deduct transfer taxes and similar taxes and charges on the sale of a personal home. If you are the buyer and you pay them, include them in the cost basis of the property. If you are the seller and you pay them, they are expenses of the sale and reduce the amount realized on the sale.

Homeowners association assessments. You cannot deduct these assessments because the homeowners association imposes them rather than a state or local government.

Special Rules for Cooperatives

If you own a cooperative apartment, some special rules apply to you, though you generally receive the same tax treatment as other homeowners. As an owner of a cooperative apartment, you own shares of stock in a corporation that owns or leases housing facilities. You can deduct your share of the corporation's deductible real estate taxes if the cooperative housing corporation meets certain conditions.

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