Homeownership remains a key part of the American Dream. Maybe that's why there are a host of things—federal and state grants, tax credits, and other options—that are designed to make it easier for first-time homebuyers to afford a place. In fact, even if you’ve owned a home in the past, you may qualify for these programs if you meet certain guidelines.

Key Takeaways

  • A host of options ease the path for first-time homebuyers (which can actually include past owners of property).
  • HUD-issued grants and state programs both exist to assist first-timers.
  • First-time homebuyers can withdraw IRA funds for housing-related costs penalty-free.
  • Like all homebuyers, first-timers can take advantage of tax deductions on mortgage interest and energy credits.

First-Time Homebuyer Definition

According to the U.S. Department of Housing and Urban Development (HUD), a first-time homebuyer is someone who meets any of the following conditions:

  • An individual who has not owned a principal residence during the three-year period ending on the date of purchase of the property (and the spouse of such an individual)
  • A single parent who has only owned a home with a former spouse while married
  • A displaced homemaker who has only owned with a spouse
  • An individual who has only owned a principal residence not permanently affixed to a permanent foundation in accordance with applicable regulations
  • An individual who has only owned a property that was not in compliance with state, local, or model building codes—and which cannot be brought into compliance for less than the cost of constructing a permanent structure

As long as you qualify as a first-time homebuyer as delineated above, the following options can help make your dream of buying a new home a reality.

First-Timer Benefits

Hone in on HUD

The first place to look for grant assistance is HUD. Although the government agency itself does not make grants directly to individuals, it does grant funds earmarked for first-time home buyers to organizations with IRS tax-exempt status. The HUD website has details.

Look to your IRA

Every first-time homebuyer is eligible to take up to $10,000 out of a traditional IRA or Roth IRA without paying the 10% penalty for early withdrawal. Like HUD, the IRS' “definition of a first-time homebuyer is someone who hasn’t owned a personal residence in three years,” says Dean Ferraro, a Mission Viejo, Calif., enrolled agent authorized to represent taxpayers before the Internal Revenue Service (IRS). So even if you owned a home in the past, if you meet the federal criteria, you’re eligible to tap these funds for a down payment, closing costs, etc.

The first-time homebuyer exclusion only exempts you from the 10% penalty. If you have a traditional IRA, you will still have to pay income tax on the money you withdraw. Roth IRA accounts will not be subject to additional taxes, as they are funded with money that’s already been taxed.

Because that penalty-free $10,000-lifetime withdrawal is per individual, a couple could withdraw a maximum of $20,000 (from their separate IRAs) combined to pay for their first home. Just be sure to use the money within 120 days, or it does become subject to the 10% penalty, Ferraro cautions.

Size up state programs

Many states—for example, Illinois, Ohio, and Washington—offer down payment assistance for first-time homebuyers who qualify. Typically, eligibility in these programs is based on income and may also have limits on how expensive a property can be purchased. Those who qualify may be able to receive financial assistance with down payments and closing costs as well as costs to rehab or improve a property.

Know about Native American options

Native American first-time homebuyers can apply for a Section 184 loan (in fact, all Native Americans can). “Next to the no-money-down VA loan, this is the best federal-subsidized loan offered,” says Ferraro. This loan requires a 1.5% loan up-front guarantee fee and only a 2.25% down payment on loans over $50,000 (for loans below that amount, it’s 1.24%).

Unlike a traditional loan’s interest rate, which is often based on the borrower’s credit score, this loan’s rate is based on the prevailing market rate. Section 184 loans can only be used for single-family homes (one to four units) and for primary residences.

Feel out the feds

If you're game for a fixer-upper, the Federal National Mortgage Association's (FNMA) HomePath ReadyBuyer program is geared toward first-time buyers. After completing a mandatory online homebuying education course, participants can receive up to 3% in closing cost assistance toward the purchase of a foreclosed property owned by Fannie Mae, as FNMA is affectionately known.

Other federal or government-sponsored enterprises offer programs and assistance that, although not exclusively for first-timers, favor those with less money or less of a credit history. Best-known among these are Federal Housing Administration (FHA) loans and Dept. of Veterans Affairs (VA) loans.

Tax Benefits for All Homebuyers

Buying a first home also makes you eligible for the tax benefits afforded to every homebuyer, whether they're on their first or fifth residence.

Home mortgage interest deduction

Home mortgage interest used to be one of the biggest deductions for those who itemize. However, the Tax Cuts and Jobs Act (TCJA) has limited this deduction to the interest paid on $750,000 or less ($375,000 or less for those married filing separately). At the same time, it has nearly doubled the standard deduction for a married couple filing jointly from $12,700 to $24,400 in 2019 and $24,800 in 2020 ($6,350 to $12,200 in 2019—$12,400 in 2020—for single filers), making it less likely that people will have enough deductions to itemize them. Still, mortgage interest is deductible, and you should be advised of interest paid to your lender on a 1098 form sent out annually in January and/or early February.

Points or loan origination fees deduction

The fees you pay to obtain a home mortgage may be applied as a deduction, according to Greene-Lewis. “Points will also be reported on Form 1098 from your lender or your settlement statement at the end of the year,” she says, adding that the rules for how you deduct points are different for a first purchase or a refinancing. 

Property tax deduction

Property tax deductions are available for state and local property taxes based on the value of your home. The amount that’s deducted is the amount paid by the property owner, including any payments made through an escrow account at settlement or closing, but the TCJA has put a $10,000 cap on the deduction.

“You may find property taxes paid on your 1098 form from your mortgage company if your property taxes are paid through your mortgage company,” says Greene-Lewis. “Otherwise, you should report the amount of property taxes you paid for the year indicated on your property tax bill.”

Residential energy credit

Homeowners who install solar panels, geothermal heat systems, and wind turbines—or energy-efficient windows or heating and air-conditioning systems—may receive a tax credit worth up to 30% of the cost. Check the IRS’s energy incentive list to see if you qualify.

Bear in mind the difference between a tax deduction and a tax credit, says Lisa Greene-Lewis, a certified public accountant in San Diego, Calif. “A tax deduction reduces your taxable income, but your actual tax reduction is based on your tax bracket. A tax credit is a dollar-for-dollar reduction in the taxes you owe.”

That means a credit saves you a lot more. “A tax credit of $100 would reduce your tax obligation by $100, while a tax deduction of $100 would reduce your taxes by $25 if you are in the 25% tax bracket,” says Greene-Lewis.

The Bottom Line

Homeownership costs extend beyond down payments and monthly mortgage payments. Be sure to consider how much home you can actually afford before you begin to hunt—not just for the home, but for a mortgage lender.

“Make sure you factor in closing costs, moving costs, the home inspection, escrow fees, home insurance, property taxes, costs of repairs and maintenance, possible homeowner’s association fees, and more,” says J.D. Crowe, president of Southeast Mortgage, a Georgia lender, and president of the Mortgage Bankers Association of Georgia. 

Knowing you can afford the home you choose gives you the best chance of being able to live there for years to come.