Mortgage Credit Certificate (MCC): Home Buyers Tax Credit

Before the first-time home buyer’s credit program came out, one home buyers tax credit that has been around for quite some time is the mortgage interest credit (MCC).

The first-time home buyer’s credit is only good for tax years 2008 to 2010 but it offers a much higher one-time home buyers tax credit worth as much as $8,000 while MCC is ongoing and it is administered through your local agencies (county or city or state).

The Mortgage Credit Certificate (MCC) Program was authorized by Congress in the 1984 Tax Reform Act as a means of providing housing assistance to families of low and moderate income. The MCC home buyers tax credit reduces your federal income tax liability amount, thus, providing you more available income to qualify for a mortgage loan.

The MCC is available to homebuyers who meet household income and home purchase price limits established for the MCC Program as well as federal eligibility regulations. Depending on the agency’s program, some MCC are good for the life of the loan while others are only good for a specific number of years. In general, the mortgage credit rate is usually between 10% and 50%.

How does a mortgage credit certificate (home buyers tax credit) works?

• Tax Credit Vs. Tax Deduction – First of all, let me educate you about the difference between a tax deduction and a tax credit. As explained on the article Understanding Tax Credits, a tax credit is better than a tax deduction because the credit is a dollar for dollar reduction of your tax liability while a tax deduction will only reduce your tax liability (amount you owe to the IRS) by a percent equivalent to your tax rate.  As an example, if your tax liability is $3,000, a $2,000 tax credit means that your tax liability will be reduced by $2,000, thus, you only need to pay $1,000 to the IRS. However, if you have a $2,000 tax deduction and your tax rate is at 20%, your tax liability will not be reduced by $2,000. Instead, it will only be reduced by $400 ($2,000 x 20%). Thus, you would still need to pay the IRS, $2,600. In this scenario, by taking the $2,000 home buyers tax credit, you came up ahead by as much as $1,600 when compared to taking the tax deduction.
• Your mortgage interest paid will be split: a portion will become a home buyers tax credit while the rest will remain a tax deduction – When you own a home, the mortgage interest that you paid is considered a tax deduction and is reported on your itemized schedule on your tax return. However, when you have an MCC, a portion of your mortgage interest becomes a tax credit while the rest remains as a tax deduction. The amount of your mortgage credit depends on the amount of interest you pay on your mortgage loan. When you have an MCC, you can take the stated percentage of the MCC of your annual mortgage interest as a tax credit. The remainder of your annual mortgage interest will continue to qualify as an itemized tax deduction. For example, if your MCC rate is 15%, then you can take 15% of the mortgage interest as a tax credit while the remaining 85% will remain as a tax deduction. The 85% mortgage interest can be deducted on your Schedule A while the 15% mortgage interest credit will be deducted off your tax liability dollar for dollar.
• Mortgage credit reduces your effective monthly payment – When you are issued an MCC,  loan officers will take into account the amount of credit that you’ll received and will be treated as increase in income or reduction of mortgage payment. Thus, it may help you increase your chances of approval (since it will reduce your debt-to-income ratio) or it may help you qualify for a much higher home value. As an example, if your monthly payment is $2,000 and the monthly equivalent of your mortgage credit is $200, the loan officer will treat your monthly payment as just $1,800. To actually see the immediate benefit during the year instead of waiting until the end of the year when you file taxes, you have to adjust your w-4 employee’s withholding form.
• Limitations on the mortgage home buyers tax credit amount
  1. Mortgage Tax Credit Is Limited to the amount of your tax liability – One big restriction on the MCC home buyers tax credit is it is a non-refundable credit – meaning that you can only claim the credit up to the amount of your tax liability. So the big disadvantage of this tax credit is that if you do not have a tax liability for the year, you won’t be able to use the credit for that year. But do not be alarm because even if you cannot use the tax credit for the current year due to insufficient tax liability, you can actually apply the credit to reduce your future tax liability for up to three years. The IRS calls this process as carrying forward your tax credit to offset future tax liabilities.
     
  2. $2,000 Maximum Credit Per Year if MCC rate is greater than 20% – Per the IRS, if your MCC is greater than 20%, the maximum mortgage interest credit that you can claim for the year is only $2,000.
  3. Mortgage more than certified indebtedness – If your mortgage loan amount is larger than the certified indebtedness amount shown on your MCC, you can figure the credit only on the part of the interest you paid. To determine the mortgage interest amount you’ll need for the calculation, multiply the total interest you paid during the year on your mortgage by the following fraction:  Certification indebtedness amount of your MCC/Original amount of your mortgage. For example, your mortgage is $200,000 but your MCC certified loan is only $150,000. If your mortgage interest paid for the year is $10,000, the amount of mortgage interest that you can use to calculate the home buyers tax credit will be limited to only $7,500 ($10,000 x $150,000/$200,000). Thus, if your MCC rate is 20%, your mortgage credit will be only $1,500 (20% x $7,500) and not $2,000 (20% x $10,000).
  4. Limited to your share of the mortgage interest payment – If two or more persons (other than a married couple filing a joint return) hold an interest in the home to which the MCC relates, the credit must be divided based on the interest held by each person.

Example:

You bought a home and acquired a mortgage loan of $250,000 at 5.50% for 30 years with a monthly principal and interest payments of $1,419.47. You also obtained a MCC from your local county with a credit rate of 20%.

To Calculate the Mortgage Interest Credit and the Mortgage Interest Deduction:

• 1st Step: Determine the total mortgage interest paid for the year. You can figure this out when you receive your 1098 – Box 1 indicates how much mortgage interest you paid. For simplicity, let’s assume that the total interest paid for the year is $13,666.
• 2nd Step: Calculate the mortgage interest rate credit using the rate multiplied by the total interest paid. In this case, the total mortgage credit is $2,733 (20% x $13,266).
• 3rd Step: Determine your tax liability. After completing your taxes for the year and you have determined that your tax liability is more than credit, then you can claim the full $2,733 credit on your tax return. However, if your tax liability is less than the calculated home buyers tax credit, then the excess credit will be carried forward for the next three years. For example, if your tax liability is only $2,000, then you can only reduce your taxes by $2,000 when you apply the mortgage credit and the $733 unused credit will be carried forward for next tax year to reduce your future tax liability.
• 4th Step: Determine how much mortgage interest paid you can deduct on your Schedule A, Itemized deduction. In this case, your total mortgage interest paid is $13,666. When you claim a mortgage credit of $2,733, you can then deduct the remainder ($10,933) on your Schedule A, Itemized Deduction schedule.

You can also receive the immediate benefit of your MCC home buyers tax credit instead of waiting until the end of the year (when you file your taxes) by adjusting your W-4 withholding form with your employer. In this scenario, you can reduce the amount of federal tax withheld on your paycheck and increase your monthly take home pay by $228 per month (maximum credit of $2,733 divided by 12). By  doing this, you are essentially reducing your monthly mortgage payment by $228 because you can apply the immediate mcc tax credit towards your monthly mortgage payment. Thus, your effective monthly payment would be $1,191 ($1,419 minus $228). However, please keep in mind if you take the benefit early then you are essentially reducing your tax withholding monthly and may potentially underpay your taxes.

What are the requirements?

The requirements varies among the local agencies but this may include the following in most cases:

• The home you buy must be used as your principal residence after you obtain your mortgage. If it stops being your principal residence, your MCC will be automatically revoked and you will no longer be entitled to claim the mortgage home buyers tax credit.
• You cannot have had an ownership interest in a principal residence at any time in the last three years.
• The mortgage loan must be a new loan. You cannot be issued a MCC for the acquisition, replacement or refinancing of an existing mortgage loan. However, you may (on a case-by-case basis) be issued a MCC for the replacement of construction period loans, bridge loans, or similar financing of a temporary nature with a term of twenty-four months or less.
• The federal government considers the MCC tax credit to be a subsidy. As such, you may be subject to federal “recapture tax” if
  1. You sell your home within nine years of purchase
  2. You sell you home at a gain, and
  3. Your income increases above a specified level.

So if you are in the market to purchase your first home, it does not hurt to apply for this home buyers tax credit so you can save money on your taxes every year.