Shopping for a Mortgage

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A lower rate will not only result in a lower payment, it will amortize the loan quicker. A $250,000 mortgage at 4.5% for 30 years will have a $1,266.71 principal and interest payment. At 4%, the same loan will have $1,193.54 payment saving $73.18 a month and the unpaid balance would be $1,776 lower at the end of five years.

Mortgage lenders tend to price their mortgages based on the credit score of the borrower. The higher the credit score, the lower the mortgage rate. There is an inverse relationship that the lower the credit score, the higher risk and therefore, a higher rate is needed to balance the risk.

In order to get a valid rate that will be available to you with your credit score, you need to be pre-approved. The process of making a loan application before you find a home, allows the lender to verify your credit, income, and ability to repay the loan. Lenders usually only charge the cost of the credit report for this type of service. Be aware that pre-approval is not the same thing as pre-qualification which is simply a loan officer’s opinion.

When you shop for a mortgage with multiple lenders, the credit bureaus count them as a single credit inquiry if they are done within a two-week period. On the other hand, restrain yourself from applying for other credit such as cars, furniture or credit cards until after you have closed on the purchase of your home because those inquiries can negatively affect your credit score.

The Consumer Financial Protection Bureau recommends that you let lenders know that you are shopping the mortgage for the best rate and fees.

Instead of going to the Internet and Googling mortgage lenders, start with recommendations for a lender from your real estate professional. They see the good, the bad and the ugly and can save you a lot of time. Another reliable source would be from a friend who has recently purchased a home.

There are lenders who bait unsuspecting borrowers with lower rates and fees into making an application and after critical time has lapsed, try to switch them to a different program. By that point, many buyers feel they don’t have any choice but to accept what is offered.

Another confusing factor is the way that loans are priced to the public. They are usually quoted at a rate with a certain amount of points. A point is one percent of the amount borrowed. An example would be a quote for a loan at 4.5% with 1 point or at 4% with 2.5 points.

The points combined with the rate affect the yield the lender will earn, and you will pay. A simple way to make this an apple to apple comparison is to have the lender quote the loan as a “par-value” loan with no points involved. Then, the lowest rate will produce the lowest cost to you.

Another way to compare loans will be to uses a financial app called Will Points Make a Difference. You can plug in the rate and points to calculate the lowest yield over a projected holding period or the full term.

The lenders do not want to make it easy for you to compare. Mortgage money is a commodity and shopping will be worth the effort.

Get Ready to Garage Sale

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A well-planned garage or yard sale can give you extra space in your home, get rid of unused items and make some money but it needs some of the same considerations that any business needs to be successful.

  • Start early to research and plan
  • Promotion is key
  • Display items attractively
  • Price items right
  • Organize checkout

Determine the date of your sale, remembering that there are exceptions, but Saturdays are generally the best day. Experienced garage-salers believe that a well-planned one-day event will do as well as a multi-day event. Serious purchasers will look for the “new” sale and most people don’t come back multiple days.

Recognize that the first day of the sale will have the most people. Everyone will be looking for a bargain but some of them actually want to purchase things for them to resell at their own sales.

Advertise in local newspapers and free online classified sites like Craigslist. If several families are going together for the sale, mention that in the ad; it will be a big draw. Mention your bigger-ticket items like furniture, equipment and baby items.

Garage sale signs can be purchased or you could have them made at Office Depot or FedEx Office. Signs need large lettering so they’re easy to read without too many words on them. Remember that people will be driving when they see them. Most important info: Garage or Yard Sale, address, date and time. Directional signs are also important along with balloons and streamers to attract attention.

Consider using the service Square so that you can take credit cards. The cost is 2.6% + 10¢ per swipe and you can do it on your smartphone or iPad. You’ll need to sign up at least two weeks in advance to receive your reader.

You will be amazed at what sells and what doesn’t. If your goal is to get rid of some things regardless, put those items in the sale and at the end of the sale, donate what you can to Goodwill and the balance goes to the dump. If you can’t bear to do that, box them up and try again next year or possibly, at one of your neighbors’ sales.

Other supplies you’ll need will be:

  • Labels and markers for pricing items.
  • Newspaper and clean, grocery bags to wrap breakables.
  • Tables to display the items.

Unless you’re having an estate sale, keep your home locked. You don’t want people wandering through your home while you’re outside. If you start to accumulate a lot of money, take some of it inside. Don’t discuss how much money you’ve made during the sale or how successful it has been.

People will want to bargain; it’s the nature of the game. Consider this strategy: less negotiations early in the sale and possibly, more toward the end of the sale.

What kind of properties are these?

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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.

Why Put More Down

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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 (512) 501-3848.

Financing Home Improvements

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Home improvement loans provide a source of funds for owners to finance the improvements they want to make. These are usually, personal installment loans that are not collateralized by the home itself. Since there is more risk for the lender with this type of loan, the interest rate is higher than a normal mortgage loan.

In today’s market, the rates on home improvement loans could vary between 6% and 36%. A borrower’s credit score will determine the interest rate; the lower the score, the higher the rate and the higher the score, the lower the rate.

Smaller loan amounts are under $40,000 with larger loan amounts over $40,000 based on the extent of the improvements to be made. With all things being equal, a larger loan may have a lower interest rate.

Besides the interest rate being higher than a regular mortgage, the term is shorter. Similar to a car loan, the term can be between five and seven years. A $50,000 home improvement loan for a borrower, with good but not great credit, could have a 12% interest rate for seven years. That would make the monthly payment $882.64.

An alternative way to fund the improvements would be to do a cash out refinance. These types of loans are collateralized by the home. The current mortgage would be paid off with the new mortgage plus the amount for the improvements. Lenders will usually require that the owner maintain a minimum of 20% equity in the home.

Assuming a homeowner owed $230,000 on the existing mortgage and wanted $50,000 for improvements. The new loan amount would be $280,000 and the home would have to appraise for at least $350,000 for the homeowner to have a 20% equity remaining.

Another thing that occurs on a refinance is that the standard term for mortgages is 30 years which means the owner would be financing the improvements for 30 years instead of a shorter term. The advantage would be a smaller payment.

Let’s say in this example, the owner originally borrowed $250,000 at 4.5% for 30 years with a payment of $1,266.71. After 54 payments, the unpaid balance is $230,335. If they did a cash out refinance at 4.5% for 30 years for the additional $50,000 and financed the estimated closing costs of $8,700, the new payment would be $1,464.50.

Using the home improvement loan, the combined payments would be $2,149.35 which would be $684.85 higher. While the cash out refinance produces a lower payment, it adds $8,700 to the amount owed and stretches it out over a longer period. Home improvement loans have lower closing costs than regular mortgage loans.

Another alternative loan is a HELOC or Home Equity Line of Credit which can be explored and compared to the two options mentioned above. If a homeowner is going to finance improvements, a comparison of different types of loans and payments can be helpful in the decision-making process.

A trusted mortgage professional is a valuable resource to assist you with current and accurate information. If you need a recommendation, please call me at (512) 501-3848.

House-Hacking Rental Property

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House-hacking refers to buying a multifamily property on an owner-occupied mortgage, living in one unit and renting the others. If you’re thinking about becoming a rental mogul, starting early is an advantage. Not only will you have longer to accumulate a larger portfolio, you can increase the leverage on the first acquisitions if they are owner-occupied.

Leverage is the use of other people’s money to finance an investment. The higher the loan-to-value, the greater the leverage which can increase the yield.

A $200,000 rental property with an 80% LTV at 4.5% for 30 years producing a 16.88% before-tax rate of return would increase to a 23% return on investment by increasing the mortgage to 90%. A typical down payment on an investor property in today’s market is 20-25% but, in some cases, a higher loan-to-value is possible.

Owner-occupied, multi-unit properties, two to four units, allow a borrower to occupy one of the units and rent the others out. The cash flows from the rental units subsidize the cost of housing for the unit occupied by the owner. VA will guarantee 100% of the mortgage for eligible veterans, while FHA will loan up to 96.5% for qualifying borrowers.

Consider a four-unit property was purchased as owner-occupied and the other three units were rented for $800 each. If an FHA loan was obtained, the owner could live for roughly $355 a month after collecting the rent and paying the expenses. Assume the owner lived in it for two years and then, rented out the fourth unit for the same $800 per month. The cash flow would rise to $4,800 a year with a before-tax rate of return of 30% based on a 2% appreciation.

Occupy 1 unit Rent all 4 units
Gross Scheduled Income @ $800 monthly each $2,400 $3,200
Cash Flow Before Tax $4,59 $4,861
Before Tax Rate of Return 20.77% 30.56%

Rental properties offer the investor to borrow large loan-to-value mortgages at fixed interest rates for up to 30 years on appreciating assets with tax advantages and reasonable control that many other investments don’t enjoy.

Some people consider rental properties the IDEAL investment with each letter in the acronym standing for a benefit it provides. It provides income from the rent which many investments do not have. Depreciation is a non-cash deduction from income that increases cash flow. Equity buildup occurs as each payment is made by reducing the principal owed. Appreciation happens over time as the value of the property increases. L stands for leverage that was explained earlier in this article.

You may be able to buy another four unit as an owner-occupant before you need to start using a normal investor’s down payment. In the meantime, you could have eight units that are increasing in value while the mortgage balance is decreasing with every payment made. If there is sufficient equity in the properties by the time, you’re ready to buy more, you may be able to take cash out of the existing ones to use for the down payments.

This can be a great way to turbocharge your net worth by becoming an owner and a real estate investor at the same time. To learn more about rental properties, download the Rental Income Properties guide and/or contact me at (512) 501-3848 to schedule an appointment to meet to discuss the possibilities.

Take the Standard Deduction & the Home

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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.

Understanding Reverse Mortgages

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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.

Downsizing in 2020

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Approximately 52 million or 16% of Americans are age 65 and over. It is easy to understand that some of them are thinking of downsizing their home because they don’t need the same space they did in the past.

It can be liberating to divest yourself of “things” that have been accumulated over the years but are no longer needed. Moving to a less expensive home, could provide savings for unanticipated expenditures or cash that could be invested for additional income.

Savings can be realized in the lower premiums for insurance and lower property taxes, as well as, the lower utility costs associated with a smaller home.

Typically, owners downsize to a home to 2/3 to 50% of their current home’s size. In some situations, it is not only economically beneficial, but their interests may have changed so that a different style of home, area or city might fit their lifestyle better.

The sale of a home with a lot of profit will not necessarily trigger a tax liability. Homeowners are eligible for an exclusion of $250,000 of gain for single taxpayers and up to $500,000 for married taxpayers who have owned and used their home two out of the last five years and haven’t taken the exclusion in the previous 24 months.

Homeowners should consult their tax professionals to see how this may apply to their individual situation. For more information, you can download the Homeowners Tax Guide.

Call me at (512) 501-3848 to find out what your home is worth and what it would take to make the move to another home.

Another Source for a Down Payment

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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.