Monday, February 24, 2020

What kind of properties are these?


It is the way the property is used that determines the type of property it is, not what it looks like.  Based on the intent of the owner, the property could be a principal residence, income property, investment property or dealer property.

A principal residence is a home that a person lives in.  There can be only one declared principal residence.  It is afforded certain benefits like deducting the interest and property taxes on a taxpayers' itemized deductions, up to limits.  Up to $250,000 of gain for a single taxpayer and up to $500,000 for a married couple filing jointly can be excluded from income if the property is owned and used as a principal residence for two out of the previous five years.

An income property is an improved property that is rented for more than 12 months.  The improvements can be depreciated based on a 27.5-year life for residential property or 39-years for commercial property.  This is a non-cash deduction that shelters income.  When the property is sold, the cost recovery is recaptured at a 25% tax rate.

An investment property could be an improved property or vacant land that does not produce income and is not eligible for depreciation or cost recovery.  The gain on both income and investment properties are taxed at a lower, long-term capital gain rate and are eligible for a tax deferred exchange.

Second homes are properties that a taxpayer primarily uses for personal enjoyment but is not their principal residence.  For IRS purposes, it is treated as an investment property in that the gain is taxed at preferential long-term rates if it is held for more than 12 months.   However, it is not eligible for exchanges because personal use properties are excluded from that benefit.

Properties that are built or bought to make a profit are considered inventory and are labeled dealer properties.  The gain is taxed at ordinary income rates and they are not eligible for section 1031 deferred exchanges.

The financing available differs considerably based on the intent of the owner which determines the type of property.  Owner-occupied homes, used as a principal residence, are eligible for low down payment mortgages like VA, FHA, USDA and conventional ranging from nothing down to 20%.

A second home, in most cases, requires a minimum of 10% down payment.  Investment and Income properties, generally, require 20% or more in down payment with some possible exceptions.  There is not any long-term financing available for dealer property. 

Monday, February 17, 2020

Why Put More Down



The least amount in a down payment is an attractive option when people are thinking of buying a home.  A common reason is to have cash available for furnishing the new home and  possible unexpected expenses. 

Some people don't have any options because they only have enough for a minimum down payment and the closing costs.  For those fortunate buyers who do have extra money available, let's look at why you'd want to do such a thing.

Most loans in excess of 80% loan to value require mortgage insurance to protect the lenders for the upper portion of the loan if the home were to go into foreclosure.  FHA requires an up-front premium of 1.75% of the amount borrowed plus a monthly amount of .85% on the balance.  FHA mortgage insurance premium must be paid for the life of the loan.

Mortgage insurance on conventional loans varies depending on the borrowers' credit and the amount of down payment being made.  Unlike FHA, when the unpaid balance reaches 78% of the original amount borrowed, the mortgage insurance is no longer needed.  If the home enjoys rapid appreciation, after a period, the lender may allow the borrower to get an appraisal to show that the unpaid balance is now less that 78% of the current appraised value.

The premium for mortgage insurance on conventional loans can be paid as a single premium upfront in cash or financed into the mortgage.  A second option would be monthly mortgage insurance included in the payment until it is no longer needed.  A third option could be lender-paid MI where the cost is included in the mortgage interest rate for the life of the loan.

VA loans do not require mortgage insurance but there is a one-time funding fee of 2.3% that can be paid in cash at closing or added to the amount borrowed.  Disabled veterans and Purple Heart recipients are not required to pay the funding fee.

Putting at least 20% down payment on a home not only will avoid the mortgage insurance, it could also help you to get a little lower interest rate.  Since the loan to value is lower, there is less risk for the lender.

A $350,000 with a 10% down payment at 4% interest could have a monthly mortgage insurance cost between $70 to $130.  A trusted mortgage professional can help you assess the options you have available.  It is always better to make some of these decisions before you start shopping for a home.

This is another reason it is good to start by getting pre-approved with a trusted mortgage professional.  If you need a recommendation, call me at  (785) 650-4370. 

Monday, January 20, 2020

Take the Standard Deduction & the Home


Now that the standard deduction is increased to $12,200 for single taxpayers and $24,400 for married ones, many homeowners are better off with the standard deduction than itemizing their deductions to write off their mortgage interest and property taxes.  There was some speculation that without the tax advantages, homeownership is not the investment it once was.

By looking at the other benefits, you can see that homeownership is still one of the best investments people can make.

A $275,000 home financed with a 4.5%, 30-year FHA loan would have an approximate total payment of $2,075.  The difference in the value of the home and the amount owed on the mortgage is called equity.  Two things cause equity to increase: the home appreciating in value and the principal loan balance being reduced with each payment made on an amortizing loan.

In this example, if the home were appreciating at 2% annually, the value would increase by $5,500 the first year which would be $458.33 per month.  At the same time, with each payment made, an increasing amount would reduce the unpaid balance which would average $363.00 a month in the first year.

The homeowner's equity would increase over $800 a month.  Instead of paying rent, the homeowner is building equity in their home.  It becomes a forced savings and lowers their net cost of housing.  In seven years, the homeowner in this example would have $80,901 in equity instead of seven years of rent receipts.

This example doesn't consider tax advantages at all.  If the homeowner would benefit from itemizing their deductions, it would lower their cost of housing even more.

The IRS recommends each year to compare the standard and itemized deductions to see which would benefit you more.  Items such as substantial charitable donations, mortgage interest, property taxes and large out-of-pocket medical expenses could increase the likelihood of itemizing deductions.

You can see the benefits using your own numbers without tax advantages by using the Rent vs. Own. 





Monday, January 13, 2020

Understanding Reverse Mortgages


Reverse mortgage loans are like traditional mortgages that permits homeowners to borrow money using their home as collateral while retaining title to the property.  Reverse mortgage loans don't require monthly payments.

The loan is due and payable when the borrower no longer lives in the home or dies, whichever comes first.  Since no payments are made, interest and fees earned are added to the loan balance each month causing an increasing unpaid balance.  Homeowners are required to pay property taxes, insurance and maintain the home, as their principal residence, in good condition.

Reverse mortgages provide older Americans including Baby Boomers access to their home's equity. Borrowers can use their equity to renovate their homes, eliminate personal debt, pay medical expenses or supplement their income with reverse mortgage funds.

Homeowners are required to be 62 years and older and meet the following requirements:

  • Own the home free and clear or owe very little on the current mortgage that can be paid off with the proceeds
  • Live in the home as their primary residence
  • Be current on all taxes, insurance, and association dues and all federal debt
  • Prove they can keep up with the home's maintenance and repairs

Payouts are based on the age of the youngest spouse. The younger the age, the less money can be borrowed. Reverse mortgages offer two terms ... a fixed rate or variable rate. Fixed rate HECMs have one interest rate and one lump sum payment. Variable rate loans offer multiple payout options:

  • Equal monthly payouts
  • A line of credit with access until the funds are gone
  • Combined line of credit and fixed monthly payments for a specified term 
  • Combined line of credit and fixed monthly payments for the life of the loan

Traditional reverse mortgages, also called Home Equity Conversion Mortgage, HECM, are insured by FHA. There are no income limitations or requirements and the loan funds may be used for any purpose. The borrower must attend a counseling session about the HECM, its risk, benefits, and how much can be borrowed. The final loan amount is based on borrower's age and home value. FHA HECMs require upfront and annual mortgage insurance premiums but can be wrapped into the loan.

Proprietary HECM loans are not federally insured. Lenders create their own terms, including allowing loan amounts higher than the FHA maximum. Proprietary HECMs don't require mortgage insurance (upfront or monthly), which may result in more funds available. Proprietary reverse mortgages typically have higher interest rates than FHA HECMs.

Advantages

  • Create a steady stream of income during retirement
  • The proceeds aren't taxed or risk borrower's Social Security payments
  • Title and rights to the home are retained by the homeowner
  • Monthly payments are not required

Disadvantages

  • The loan balance increases over time rather than decreases as with an amortizing loan
  • The loan balance may exceed the property value eliminating inheritance 
  • The fees may be higher than traditional mortgage loans
  • Any absence of the home for longer than 6 months for non-medical or 12 months for medical reasons makes the loan due and payable

More information is available about reverse mortgages from the Consumer Financial Protection Bureau or Federal Trade Commission or HUD.gov.


Monday, December 30, 2019

Another Source for a Down Payment


Borrowing from a 401k, 403b or the cash value of life insurance policy is a common financial strategy.  While taxpayers are not allowed borrow from either a traditional or Roth IRA, they can withdraw funds before age 59 ½ for specific purposes like a first home purchase, qualified higher education expenses or permanent disability without incurring a 10% penalty.

First-time home buyers can make a penalty-free withdrawal of up to $10,000 if they haven't owned a home in the previous two years.  This would allow a married couple who each have an IRA to withdraw a lifetime maximum of $10,000 each, penalty-free for a home purchase.

In many cases, the money would be used for a down payment or closing costs.  However, some buyers might consider this source to increase their down payment so they could qualify for a loan without mortgage insurance.

There is another condition where a taxpayer can withdraw money from their IRA without triggering the tax or penalty if it is returned to the IRA within 60 days.  This can only be done once in a 12-month period.  Unless you're certain you can redeposit the money in the strict time frame, the potential tax and penalties makes this a risky and expensive way to arrange temporary funds.

If the taxpayer qualifies for the penalty-free withdrawal, there may still be taxes due.  Contributions to traditional IRAs are made with before-tax dollars and the tax is paid when the funds are withdrawn.  Since Roth IRAs are made with after-tax dollars, there is no tax due when the funds are withdrawn.

Another interesting fact about this provision is that the taxpayer making the withdrawal can help a qualified relative which includes children, grandchildren, parents and grandparents.

Before withdrawing money from an IRA, taxpayers should get advice from their tax professional concerning their individual situation.


Friday, December 27, 2019

Renting vs Buying



It might seem like kind of an odd concept, but there are a number of companies that let you rent your home décor these days. Companies like Feather and CasaOne allow you to lease your furniture and other décor for a limited period or until you decide to buy it outright. Even some older rent-to-own companies have options to change furnishings after completing a portion of your lease. The big question is, how viable is this as a way to decorate your home?


Renting vs. Buying

With just about any situation where you have the option to rent or buy something, there will be proponents on both sides extolling why that option is the better deal. People will discuss markets when talking about renting or buying a home, or depreciation rates when discussing automotive lease options versus outright purchase. With furniture, however, the discussions have long been fairly one-sided due to the excessive cost associated with many rent-to-own furniture options. Unless you had another other choice, buying your furniture was the only way to avoid paying nearly twice as much in some cases.

The difference here is that these new options are intended as a way to provide flexibility in your décor instead of simply providing a path to purchase. While you do have an option to purchase, you also have the option to change your furniture options as your needs and tastes change. Because services like Feather are focused more on providing an actual service than simply selling furniture with installment plans, they have a larger focus on benefits than what you would get from a standard rent-to-own purchase.


Is It a Viable Option?

There are two questions to ask when trying to decide if renting home décor in this fashion is a viable option for you. The first concern is the cost: is it really worth it to you to have the sort of flexibility these services provide, versus owning your furniture outright? Feather, for example, has a $19/month service charge in addition to the monthly furniture payments for members on annual contracts. If you don't plan on taking advantage of all the services that Feather offers, it might not be worth paying this extra cost in your case. On the other hand, if you're the sort that would like to be able to reinvent your living space on a regular basis, then the discounts and annual free change that membership provides might be more than worth that added monthly fee.

The second thing to consider is how viable these companies are in the long term. If there's no market for this sort of a service, then you might find yourself without a service to use a few years down the road. This may not be a concern, however; the market has supported multiple more traditional rent-to-own services over the years, but companies like Feather aren't really competing with those. Instead, they're taking an updated version of their model and targeting a slightly higher income bracket. With reasonable pricing, some great style and a solid service model in place, these early movers into this new bracket could have significant staying power.


Nailing Your Décor

Regardless of whether you plan to rent or buy, it's a good idea to plan out your décor before you start decorating. This is especially important if you're using an online service like Feather where you'll be doing your planning and shopping online. This is where it can help to have a professional interior decorator or designer there to assist you in choosing the pieces that will work best together.




Tuesday, November 19, 2019

7 Reasons to Buy a Home


Some people don't need a reason to buy a home, they just want it.  That can be enough justification by itself.  Other people need some solid logic before they're ready to make the commitment.  The following reasons might help you to make a decision.

  1. Pride of ownership ... among the most popular reasons given by homebuyers is that they want a place they can call their own and decorate and improve it the way they want.  It is a place to feel safe and secure and a place for their family.  They can share it with their friends and enjoy living in it.
  2. Good investment ... Homeowners have a 80 times greater net worth than renters.  By investing in a home that appreciates over time, it contributes to an increasing equity.  The high loan to value mortgages that are available combined with the low mortgage rates also contribute to the investment through leverage which has been described as "using other people's money" to control an investment.
  3. Interest and property tax deductibility ... Homeowners can deduct their qualified mortgage interest and up to a maximum of $10,000 of their property taxes as itemized deductions on their federal income tax return.  In some instances, the standard deduction may benefit them more, but they can elect to choose either method each year, whichever helps them the most. 
  4. Capital gain exclusion ... A single homeowner can exclude up to $250,000 of capital gain and if married filing jointly, can exclude up to $500,000 of gain on their principal residence.  The need to have owned and occupied it as their home for two of the last five years.
  5. Cash out refinance ... Generally speaking, a lender will allow an owner with good credit and income to borrow the difference in their current unpaid balance and 80% of the fair market value.  This money can be used for any purpose and is not a taxable event.
  6. Equity buildup ...The difference in the value of the home and the unpaid mortgage balance is called equity and it increases with each payment made.  It is like automatic savings.
  7. No landlords ... Instead of dealing with landlords who may impose restrictions on things like painting, improvements and pets.  Owners are not concerned about rent increases and will have a fixed principal and interest payment for as long as they have a mortgage.

A bonus reason to buy a home now are the low mortgage rates available. The lowest rate recorded by Freddie Mac is 3.35% in December 2012.  Today's rates are 3.75% on a 30-year fixed rate mortgage and 3.21% on a 15-year fixed rate mortgage.  So, they are certainly very close to all-time lows.

The highest rate on a 30-year fixed rate mortgage was 18.45% in October 1981.  When you put today's rates in perspective, they are an incredible bargain.  Many industry experts expect that they will not remain as low as they are now.  Locking in a low rate can keep your housing costs low.

A $275,000 mortgage at 3.75% for 30 years has a principal and interest payment of $1,273.57.  If the rate goes up by 1%, the payment would increase to $1,434.53 or $160.96 per month for the 30-year term. Check the Rent vs. Own to see how the numbers look in your situation.