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 might not be 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 “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 advantage being gained by itemizing deductions.

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

Understanding Reverse Mortgages

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Reverse mortgage loans are like traditional mortgages that permit homeowners to borrow money using their home as collateral while retaining title to the property. But, 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 of the new reverse mortgage
  • 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 that 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 and don’t 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 are thinking of downsizing their home because they don’t need the same space as 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 utilities costs associated with a smaller home.

Typically, owners downsize to a home 1/2 to 2/3 the size of their current one. 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 for at least two of the last five years if they’ve not taken the exclusion within 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 (316) 337-5154 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 account, a 403b, or the cash value of a life insurance policy is a common financial strategy. While taxpayers are not allowed to 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 re-deposit 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.

Anticipating the Cost of a Home

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The largest expenditure a buyer has when purchasing a home is the down payment which can range from a minimum required amount of zero for veterans to 3-3.5% minimum for most everyone else. With mortgages come closing costs which can be another 2-4%, mostly connected with the buyer’s mortgage financing, and that cost must also be paid at settlement in cash by the Buyer (unless successfully negotiated in the purchase contract to be covered by the Seller).

Most mortgages require an escrow account to pay the property taxes and homeowner’s insurance premium when due. Generally, the lender will require one to three months of taxes and insurance placed into escrow at closing so those annual bills can be paid before the actual due date.

First-time buyers should be aware that they’ll need this amount of funds available to purchase a home. Unlike tenants who are not responsible for repairs, homeowners also need to be able to cover repairs cost when they arise.

Newer homes typically need repairs less often than older ones. At some point, components like the furnace, air-conditioner and appliances will need to be replaced, which can be a heavy burden if unanticipated. Homeowners should expect between one and four percent of the value of the home in annual repairs. The age and condition of the home and whether some of the items have been replaced will help assess the anticipated expenditures.

Components Estimated Life
Dishwasher 9-10 years
Refrigerator 13 years
Furnace 15-25 years
Air-conditioner 8-15 years
Stove top 13-15 years
Oven 15 years
Compactors 6 years
Water heater 8-12 years
Faucets 15-20 years

A $175,000 home with 2% estimated repair expenditures would be $3,500 a year or about $300 per month. Some years it may not run that much and other years maybe more. By anticipating the maintenance expenses, a homeowner is more likely to handle things when they arise.

Another way to handle the risk of unexpected major appliances and mechanical systems repair expenses would be to purchase a home warranty. For $500 -750 a year, warranted repairs or replacements can be handled by the protection plan.

Call me at (316) 337-5154 for a list of trusted protection plans available in our area or for help in determining whether or not a home warranty plan could provide you with good value for the cost.

Personal Finance Review

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Even if Benjamin Franklin never actually used the expression “a penny saved is a penny earned”, the reality is that it has been a sentiment for frugality for centuries. He did say: “Beware of little expenses; a small leak will sink a great ship.” At the end of the day, it is not about how much you make as much as it is about how much you keep.

The first step in a personal finance review is to discover where you are spending your money. It can be very eye-opening to have a detailed accounting of all the money you spend. Coffee breaks, lunches, entertainment, happy hour, groceries and the myriad of subscription services you have contribute to your spending.

This revelation can lead you to obvious areas where savings can be accomplished. The next step is to dig a little deeper to see if there are possible savings on essential services.

  • Get comparative quotes on car, home, other insurance.
  • Review and compare utility providers.
  • Review plans on cell phones.
  • Consider eliminating the phone line in your home.
  • Review plans on cable TV, satellite for unused channels and packages or receivers.
  • Consider entertainment alternatives for cable like Hulu or Netflix.
  • Review available discounts on property taxes.
  • Consider refinancing home … to lower the interest rate, shorten the term, or take cash out to pay off higher rate loans.
  • Consider refinancing cars.
  • Call credit card companies to ask for a lower rate.
  • Consider transferring the balance from one card to a new card with a lower rate and then, pay off the balance as soon as possible.
  • Review all the automatic charges on your credit cards … do you need or still use the service?
  • Review all bank charges for accounts and debit cards; determine if they can be reduced or eliminated.
  • Pay your bills on time and avoid all late fees.
  • Monitor your bank account and avoid over-draft charges.
  • Some companies have customer retention departments that can lower your rates to retain your business.

A strategy that some people use is to report their credit cards as lost so new cards will be issued. When they are contacted by the companies to get a valid credit card, they can determine if the service is still needed.

The money you save can ultimately help you in the future on “a rainy day”, for an unanticipated expense or a major life event, or retirement. Cutting back now gives you more later, possibly, when you need it even more. Tennessee Williams said “You can be young without money, but you can’t be old without it.”

an Investment Perspective on a Home

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Looking for an investment that will turn $10,000 into $80,000 in seven years? Sound too good to be true? What if I told you that you could live in it every day during that seven years? Would that sound even better?

A $300,000 home purchased today with a FHA loan would have a $10,500 down payment. If it appreciated at 2% annually, which is less than the U.S. average, the future value of the home would be $344,606 in seven years. The unpaid balance on the loan would be $256,350 based on normal amortization, which would make the equity in the home $88,256.

The annual compound rate of return on the down payment would be 35%. This number sounds so large, that you might start doubting the credibility of this example.

Looking at some alternative investments, a ten-year Treasury note is currently paying 1.73%. You can earn 2.1% on a ten-year certificate of deposit. If you could handle the volatility of the stock market and pick the right stock, you might earn 7-10%.

There really is no alternative investment that can earn the return that an owner-occupied home can offer while giving you the ability to live and enjoy the home during the holding period.

Even if you could find an investment that paid a good return, when you realize the gain, you’ll be required to pay income tax, either at long-term capital gains rates or as ordinary income. However, a person who has lived in a home for at least two of the last five years can exclude up to $250,000 of gain from their income if they are single and up to $500,000 of gain if the owners are married, filing jointly.

A home can certainly be a place of your own to feel safe and secure, to raise your family, share with friends and build memories. A home could be considered an emotional investment and one that pays big dividends. A home is also a financial investment, not just for the reasons mentioned above, but also because the equity can be accessed by doing a cash-out refinance or a home equity line of credit.

See what your investment might look like by using the Rent vs. Own. Please feel free to give me a call at (316) 337-5154.

Understanding the Mortgage Interest Deduction

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Mortgage interest paid on your principal residence is deductible today as it was in 1913 when the 16th amendment allowed personal income tax. The 2017 Tax Cut and Jobs Act reduced the maximum amount of acquisition debt from $1,000,000 to $750,000.

Acquisition debt is the amount of debt used to buy, build or improve a principal residence, up to the maximum amount. A common misunderstanding among taxpayers is that you are entitled to that much debt even if you refinance a home during your ownership years.

Acquisition debt is a dynamic number that changes over time. It decreases with normal amortization as the principal amount of debt is reduced. The only way to increase acquisition debt after a home is purchased is to borrow additional funds that are used for capital improvements.

Assume a person buys a home with a new mortgage and after the home has enjoyed significant appreciation, refinances the home for much more than is currently owed. Let’s also say that the refinance amount is less than $750,000 which might lead the borrower to an erroneous conclusion that all the interest will be deductible.

The current acquisition debt is transferred to the new mortgage. Only the portion of the funds used to pay for new capital improvements can be combined to equal the increased acquisition debt. The interest on that part of the mortgage is deductible as qualified mortgage interest.

The remainder of the refinanced mortgage is attributed to personal debt and the interest paid on that is not deductible.

Lenders are not generally concerned with making a homeowner a fully tax-deductible loan. Lenders are interested in making a loan which will make a profit and be repaid according to the terms. The annual statements that most lenders issue to borrowers indicate how much interest was paid in a calendar year as they are required to do by federal law.

Part of the confusion may be because homeowners believe they can deduct interest on debt up to $750,000 and this annual statement shows the interest paid for the year. It is up to each homeowner to keep track of their acquisition debt and only deduct the qualified mortgage interest.

Your tax professional can be very helpful in determining this amount. It is important to notify them that you have refinanced a home during the tax year for which the taxes are being reported. For more information, see IRS Publication 936 and Homeowners Tax Guide. Home equity debt has not been allowed since the beginning of 2018.

Title Insurance

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Most people who have car, home and health insurance have probably made claims and wouldn’t consider being without it. However, it might be difficult to find a homeowner who has made a claim on their title insurance which could lead a person to think that it may not be necessary.

Title insurance covers the largest investment most people have and if there was a loss, it could be devastating. Title insurance indemnifies the policy holder from financial loss sustained from defects in the title to the property. The policy holder is determined by their interest in the property.

An owner’s title policy protects the owner of the property from title issues that may arise other than the mortgages that are being placed on the property at the time of purchase. The title work for the property goes back in time to check that clear title (no unsatisfied liens or levies and no question of legal ownership) was passed from owner to owner up to the current seller.

A mortgagee’s or lender’s policy protects the lender by guaranteeing they have an enforceable lien on the property and that there are no legal claims from parties asserting they have a claim against the property. Lender’s generally require the borrower to provide this coverage.

The title search is an examination to determine and confirm legal ownership and whether or not there are clouds on the title, so the seller can pass a clear title. A cloud is defined as any document, claim, unreleased lien or encumbrance that might invalidate or impair the title to real property.

If a seller passes title to a buyer a title that has unsatisfied liens against the property, the buyer could become responsible for the money owed and it could affect their ability to sell the property in the future.

Unlike most insurance that has a specific term and periodic premiums, title insurance covers the insured for a single premium. An owner’s policy lasts for as long as they or their heirs have an interest in the property. It guarantees the title up to the date and time that the property was deeded to you and recorded in the public records.

The majority of homes purchased in America have title policies insuring the new owner. You could live in the home for five, ten or twenty years without an incident. Then, when you’re ready to sell the home, a title claim could happen. The title policy would still protect you at that point. It is peace of mind coverage that is part of the investment in your home.

7 Reasons to Buy a Home

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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 between 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 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 for a 30 year fixed rate loan 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, 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. While the current low interest rate environment has already persisted far longer than experts have predicted, bear in mind that over the much longer term historically an average rate is around 8%. 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% that payment increases to $1,434.53, or by $160.96 per month for the 30-year term. Check the Rent vs. Own to see how the numbers look in your situation.