Your state may let you deduct savings for down payments

Some states help with homeownership

There is a small but growing number of states that are using their tax systems to encourage would-be homeowners to save for their down payments.

Is yours one of those that allow you to make deductions? And how much help might you get? Read on to find out.

Down payments and the problems they pose

When the Urban Institute published its “Barriers to Accessing Homeownership” report in November 2017, it concluded that saving up for a down payment was the biggest of those barriers. And more than half of renters surveyed said saving enough was their biggest obstacle.

In fact, many face less of a problem than they think, but overestimate the amount they need. It’s actually as little as 3.0 percent (or even zero percent for some) of the purchase price. Indeed, the National Association of Realtor’s “2017 Buyer and Seller Survey” found the average first-time buyer put down just 5 percent.

And most states have down payment assistance programs that can help would-be homeowners with grants or loans. Meanwhile, not-for-profits or other agencies also offer homeownership education, financial literacy, and help with down payments.

Complete guide to down payment assistance in the USA

But one form of assistance that has until recently sneaked under the radar is making down payment savings tax deductible at a state level. Maybe one reason for its low profile that so far only six states allow such deductions. Although one more has passed a bill that’s awaiting signature. And another five are actively exploring the idea.

Good and bad

However, to be fair, another reason for low awareness of these programs is that some of them are pretty rubbish. Minnesota’s, for instance, only lets you deduct only the interest you earn on your savings each year. That’s not much at today’s interest rates. And being able to deduct that isn’t going to be a major bonus.

But others programs let you deduct the amount you save each year, as well as the interest earned. And those are well worth exploiting.

For example, in Mississippi, you can deduct up to $2,500 a year each in down payment savings. So that’s $5,000, if you’re a couple.

Does your state have a program?

The New York Times recently explored this topic. And it identified the six states that currently have programs:

1. Colorado
2. Iowa
3. Minnesota
4. Mississippi
5. Montana (PDF)
6. Virginia

You can click through on the above links for more details of each program. And, according to The Times, these five states are considering implementing programs:

1. Alabama
2. Louisiana
3. Michigan
4. Missouri
5. Pennsylvania

New York pending

In addition, the New York Legislature passed a bill in 2017 creating a program for that state. But, at the time of writing, it is still sitting on the governor’s desk.

If signed into law, that should provide a worthwhile program. Because, as proposed, it provides state income tax deductions of up to $5,000 each on savings for down payments. And, yes: That’s $10,000 for couples.

Some conditions

Those who are lucky enough to live somewhere with one of these programs will likely have to comply with some terms and conditions. And the most common of these is you must be a first-time buyer.

However, some states say you’re eligible if you haven’t owned a home in the last three years. So those who need a second chance to get on the housing ladder may still get some help, providing they have a sympathetic state legislature.

And you might presume that some or all programs have mechanisms to claw back your deductions if you blow your savings on a wedding, a vacation or anything that isn’t a down payment.

Saving for down payments

But another condition that may apply in some places is that you designate a savings account with a bank or credit union within your state. And that raises another question: What sorts of accounts are the best places to save for down payments?

Because, as we’ve already noted, most savings accounts provide terrible yields. But the answer will depend on two main factors:

1. When you’ll need the money

Generally, the yield (interest rate) you’ll be offered will be tied to the length of time you commit to tying up your money. So, for example, you stand to get a significantly better rate with a five-year certificate of deposit (CD) than a one-year one.

But suppose you go for the longer term to get the higher return. And then find — and find you can afford — the home of your dreams after, say, three years.

You’ll likely pay a penalty for early withdrawal. And that loss might be greater than if you’d gone for the lower yield in the first place.

So you need to explore your options with savings accounts, CDs, and money market accounts. And then choose one that optimizes your return and the flexibility you need. For near-total security, make sure you invest with an institution that’s a member of the Federal Deposit Insurance Corporation.

2. Your tolerance for risk

At the time of writing, stock markets are regularly hitting record highs. So why not put your money into those and make a bomb, rather than put up with riduculous yields from boring old banks or credit unions?

Well, you would almost certainly have hit your savings goals sooner had you gone into stocks in recent years. But markets are inherently risky. And if you’re in one when a bubble bursts, you stand to lose much more than a bit of interest. You could see your net worth tumble.

Some people go for mixed portfolios when they’re saving for down payments. In other words, they come up with a blend of ultra-safe, low-return savings and higher-risk, higher-return investments.

And that certainly spreads the risk. But it doesn’t eliminate it. You’re the only one who can decide on the level of risk with which you are comfortable.

What are today’s mortgage rates?

Current mortgage rates are still moving within a narrow band, and still highly affordable. In general, the more money you put down, the better the terms and the lower your rate will be. Taking advantage of every program available to you can help you save a larger down payment, in a shorter time.