A Lower Payment is Your Choice

Mortgage acquired 250.png94% of purchasers last year opted for a fixed-rate mortgage at some of the lowest rates in home buying history. Yet, some of them will pay more in interest than necessary based on the time they’ll own the home.

If a person only plans to be in the home a few years, the adjustable-rate can offer significant savings.

Not only is the interest rate on the adjustable-rate lower than the fixed in the initial period, amortization on a lower interest rate amortizes faster than a higher interest rate.

In the example shown below, a $200,000 mortgage for 30 years is compared using a 4.25% fixed-rate to a 3.25% 5/1 FHA adjustable rate. The first five years of the ARM generates a $113.47 a month savings which accumulates to $6,808.20. In addition, due to faster amortization on lower interest rate loans, the unpaid balance at the end of five years will be $3,001 lower on the ARM for a total savings of $9,801.

Assuming the adjustable-rate mortgage was to escalate the maximum allowed at each period, the breakeven would occur in 8 years and 6 months. If a person were to sell the home prior to this point, the ARM would provide a lower cost of housing for the homeowner.

For some people, the uncertainty of how the interest rate may change is not acceptable. On the other hand, for the risk tolerant individual who may be more confident in financial matters or who may know when they’ll be moving next, the ARM can be a smart choice.

To make projections using your individual numbers, see the Adjustable Rate Comparison.

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An Exchange Means More to Reinvest

Section 1031 exchange for rental and investment real estate is a tool that allows investors to move the gain from one property to another without immediate income tax consequences.

An instant benefit is to postpone the tax due which gives the investor a larger amount of proceeds to invest. In the example shown, the investor has 21% more proceeds to invest and grow over time than if he had paid the taxes due instead of exchanging.

A legitimate long-term goal might be to make qualified exchanges from one property to another until the investor dies. The heirs would then receive a stepped-up basis on the property based on the market value at the time of the decedent’s death and possibly avoiding taxes altogether.

There are specific requirements to be met in order for the exchange to qualify. For more information on exchanges, see IRS publication 544. In addition to enlisting the services of a real estate professional familiar with investment property, seek the help of Qualified Intermediary to facilitate the intricacies of the exchange. Your real estate agent can help you locate one.

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Is the Window Closing?

iStock_000011016597Small 250.jpgWith interest rates lower than they’ve been in over 40 years, it may be difficult to think of a “window of opportunity” closing. However, it isn’t difficult to understand that it may very probably cost more to live in a home in the near future due to rising interest rates and prices.

Zillow recently reported results from a nationwide study that home values are expected to appreciate by 4.5% through the end of the year. Coupled with Freddie Mac’s projection that rates are going up, the cost of housing for buyers by the end of the year will be higher than it is now.

While uncertainty of the future can stagnate some people, the fear of loss can be much more devastating when a person realizes that the amount they pay to live and enjoy a home could have been considerably lower had they acted when prices and mortgage rates were lower.

The following example considers a $250,000 purchase today with a FHA mortgage compared to what it might be at the end of the year with a higher price and interest rate as discussed earlier. The net effect is that it will cost $191.87 more each month to live in the very same home based on the cost of waiting to buy.

To see what the cost might be for your price range, use this Cost of Waiting to Buy spreadsheet.

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Looking for the Largest Deduction

Standard Itemized.pngIRS allows taxpayers the option to take the standard deduction or the itemized deduction. The astute taxpayer will compare to see which one will result in the greatest deduction and the election can be made each year.

The 2013 standard deduction for a married couple filing jointly is $12,200 and $6,100 for a single taxpayer. It doesn’t require any proof of actual expense and has no requirement for home ownership.

Items that can be included on Schedule A for itemized deductions include:

  • Certain taxes paid for state and local income tax, general sales tax, real estate property taxes, personal property taxes or other taxes paid
  • Qualified home mortgage interest, investment interest or possibly, mortgage insurance premiums
  • Charitable contributions
  • Casualty or theft losses
  • Medical and dental expenses that exceed 7.5% of adjusted gross income if born before 1/2/49 or 10% if born after 1/2/49
  • Job expenses and other miscellaneous deductions that exceed 2% of adjusted gross income

A non-homeowner taxpayer who has been taking the standard deduction needs to consider that it isn’t just the ability to deduct the mortgage interest and property taxes.

While the standard deduction might be the obvious choice for a non-homeowner, the combination of the mortgage interest and the property taxes plus other allowable deductions not recognized previously such as charitable contributions, now makes taking the itemized deductions significantly more advantageous.

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What’s the Point?

Prepaid interest, sometimes called “points”, is generally tax deductible when a person pays them in connection with buying, building or improving their principal residence. When points are paid on a refinance, they are not a current deduction but have to be taken prorata over the life of the mortgage.DEDUCTIBILITY.png

For instance, if $3,000 in points were paid on refinancing a 30 year mortgage, a deduction of $100 per year is allowed. When the loan is paid off or replaced by refinancing again or the home is sold and the mortgage paid off from the proceeds, the balance of any un-deducted points may be taken in that tax year.

Your tax professional needs to be made aware of any of these situations so that he or she can accurately reflect the deductions in your return. Currently, the most common situation is homeowners may be refinancing their home for the second, third or even, fourth time. If there are points that have not been completely deducted, they need to be treated in the year of refinancing.

For more information, see points in IRS Publication 936; there is a section on Refinancing in this publication. For advice considering your specific situation, contact your tax professional.

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How’s Your IQ on the QM?

Qualifying Guidelines.pngThe Qualified Mortgage Rule came into effect on January 14, 2014 as one of the results to the Dodd Frank Reform Act to protect consumers from predatory lending practices. This will affect the underwriting standards that the majority of lenders will use to qualify borrowers.

The ability to repay rule states that financial information must be supplied by the borrower and verified by the lender. The borrower must have sufficient assets or income to pay back the loan which limits the maximum debt-to-income ratio of 43%. In an effort to present a more accurate picture of the costs to the borrower, teaser rates can no longer hide a mortgage’s true cost.

A maximum of 3% in upfront points and fees can be paid on behalf of the borrower. There can be no negative amortization, interest-only or balloon payments and the loan term limit cannot exceed 30 years.

While there are more requirements, most deal with good underwriting practices that are followed by reputable lenders such as considering and verifying things that affect the ability to repay the mortgage like income, assets, employment status, simultaneous loans, debt, alimony, child support and credit history.

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Every Homeowner Needs One

water meter key.jpgA water meter key is like insurance; buy it before you need it.

Imagine a pipe has burst and there is water flowing like a river through your home. There may a cut-off valve to each sink if it works and if that’s where the leak is coming from. Your home may have a master cut-off valve but if you haven’t used it before, you might not know where it is. The last resort is to cut off all the water to your house at the meter.

In most cases, you’ll need a key to get into the meter. With water starting to rise in your home, concern over the damage being done may add to your anxieties. You don’t have time to call a plumber or even go the store to buy a water meter key.

Emergencies are handled much better when you plan for them in advance and practice, even though you hope you’ll never need it.

1. Determine what kind of key you need to open your water meter.
2. Purchase it at the home improvement or hardware store.
3. Practice opening the meter to be able to do it quickly and easily.
4. If your meter key doesn’t have a wrench on one end, you need a wrench to turn the water valve.
5. Practice turning the water off just to see how it works and feels.
6. Put the key in an obvious and conspicuous place.
7. Have the phone number of an emergency plumber, just in case you need it.

While you’re planning for the unexpected, it might be a good idea to show some of the other family members how it works and where you keep the key.

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Reasonable Expectations

fortune cookie2.pngCoffee should be hot. Beer should be cold. Mexican food should be spicy. However, if these things are less than the standard that you expect, there are not any lasting consequences.

As the value of the object in question rises, either in price or gravity, the expectations usually increase and decisions become progressively more important. Marriage, children, health and careers are certainly a few of the more important items that bear careful consideration.

The sale of the largest asset that most people own, their home, also merits having reasonable expectations. A homeowner should expect to get the market value for their home in a reasonable period of time with as few inconveniences as possible.

According to the latest Home Buyers and Sellers Survey, more homeowners are entrusting the sale of their home to real estate professionals. Owners can increase the likelihood of a favorable outcome by sharing their expectations with agents prior to listing their home for sale.

Challenge your agent to explain what they intend to do to:

  • Price the home correctly
  • Prepare the home to make a good impression
  • Position the home in the marketplace

It is reasonable for a seller to expect the agent will work hard to sell the home; will tell the truth and represent the client’s interests to the best of their ability. Agents exemplify remarkable service when they exceed the seller’s expectations.

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Making Room in Your Rooms

retain remove.jpgThe more things you have, the more you have to take care of. And in this case, the more that you have to store that gets in the way of finding the things that you actually use. Periodically, you need to go through every closet, drawer, cabinet and storage area to get rid of the things that are just taking up space in your home and your life.

Every item requires the decision to retain or remove. Consider these questions as you examine each item:

• When was the last time you used it?
• Do you believe you’ll use it again?
• Is there a sentimental reason to keep it?

You have four options for the things that you’re not going to keep. If you know someone who needs it or will appreciate it, you can give it to them. You can sell it in a garage sale or on Craig’s List. You can donate it to a charity and receive a tax deduction or you can discard it to the trash.

Start with your closet. If you haven’t worn something in five years, get rid of it. Then, go through the things again and if you haven’t worn it in two years, ask yourself the real probability that you’ll wear it again.

Another way to do it is to move it from your active closet to another closet. If a year goes by in the other closet, the next time you go through this exercise, those clothes are on their way out.

If the items taking up space are financial records and receipts, the solution may be to scan them and store them in the cloud. There are plenty of sites that will offer you several gigabytes of free space and it may cost as little as $10 a month for 100 GB at Dropbox to get the additional space you need. It will certainly be cheaper than the mini-storage building.

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Rate/Payment Relationship

Rate Payment Relationship 2 small.pngA ½% increase in interest rate may not sound like much but it is roughly equivalent to a 5% increase in price. It becomes obvious when you compare the payments.

If you financed 100% of the cost of a $250,000 home at 4.5% interest for 30 years, the payment would be $1,266.71 per month. If the mortgage rate went up to 5%, the payment would be $1,342.05. If the home increased 5% in value, the $262,250 loan at the lower 4.5% rate would have payments of $1,330.05.

The two payments are close enough to justify the statement that a ½% change in interest is approximately equal to 5% change in price.

Each time interest rates go up, fewer people can qualify to buy a seller’s home. The mortgage rules that went into effect this year require buyers to meet specific payment to income ratios. As demand picks up for the seasonal market, most experts expect rates to increase.

Buyers will be doubly challenged in the current market because prices are rising (NAR reports 11% last year) along with the anticipated mortgage rates. Buyers who wait will inevitably be paying more to live in the same home had they acted sooner.

Check out on how Interest Affects Price for a home in your price range.

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