Beyond Paycheck to Paycheck

at September 24, 2008 in Housing and Tax. 2 Comments

Not surprisingly, government has found another way to make something that could be so simple so very complicated.

You: How so this time?

The relatively new first-time homebuyer tax credit.

You: Did this just come out because of the most recent financial crisis?

Actually, it came out a few months ago before the most recent financial crisis. But it was definitely added in response to falling home prices. Here’s what you need to know:

Qualification

In order to be eligible for the first-time homebuyer credit, you must meet the following conditions:

You must buy a principal residence (not an investment property or a second home) after April 9, 2008 and before July 1, 2009.
If you file single or as head of household, your modified adjusted gross income must be less than $95,000 to receive any credit (and less than $75,000 to receive a full credit). If you’re married, those two numbers increase to $170,000 and $150,000 respectively.
You must not have owned a principal residence during the last three years. Same is true for your spouse, if you are married.

Provided you meet all of the conditions above, here’s what the credit means for you:

Show Me The Money

Since the credit is 10% of your home’s purchase price but is subject to a maximum of $7,500, anyone who purchases a house costing $75,000 or more and meets the criteria above receives the same $7,500 credit. Note, however that the credit is refundable. That’s huge.

You: Why?

The fact that the credit is refundable means that you can get the full $7,500 even if your total tax liability was less (or even zero). Many other credits are only actually payable if you would otherwise have a tax liability.

You: Okay, now in English.

Say your tax liability for the year is $1,500 and you had $2,000 withheld. Ordinarily, you’d receive a $500 refund.

You: Easy enough.

Now, say that you’re eligible for the first-time homebuyer tax credit but that the credit was non-refundable.

You: But it is refundable.

Yes, but I’m trying to provide an example so you can understand the importance of the “hugeness.”

You: Right.

If it were non-refundable, your tax refund would increase to $2,000 because the credit would reduce your income tax liability to zero, providing you with a full refund of the entire amount you had paid through withholding.

You: But since, it’s refundable . . .

You get more. In fact, you get the whole $7,500 credit. The first $1,500 of it wipe away the tax you’d otherwise owe and the next $6,000 becomes “refundable.” Plus, since you already paid $2,000 through withholding, the refund you’d actually receive would be $8,000.

You: That’s a huge refund.

Pun intended?

Then, The Government Takes It Back. Slowly.

You: I don’t like the sound of that.

You shouldn’t. What happens next makes the credit not really a credit and more of an interest-free loan:

Over the 15 years starting two years after you claim the credit, you have to pay 1/15 (or $500) back to the government each year.

You: What? How?

You have to pay the credit back through a $500 reduction in your refund or a $500 increase in the amount due on each of 15 consecutive tax returns.

You: That doesn’t sound like a credit - it sounds like an interest-free loan.

It is. It’s just like the interest-free loan some people give to the government every year because of consistent over-withholding on their paychecks. But this interest-free loan is a good thing because it’s you are the one who is not paying interest. To be sure, an interest-free loan is not as good as a pure credit that you get to keep forever, but $7,500 is still a nice chunk of change in the form of an “interest-free advance” for the nominal effort of claiming it, if you are eligible.

Note, if you sell your home before the 15 years are over, you owe the remaining balance when you next file. If, however, you sell your home for a loss, the government eats the remaining balance. Same thing is true if you die before the 15 years are up.

You: They actually considered my potential death that when writing the law?

I wouldn’t say your death specifically but death in general: yup

According to the web site Federal Housing Tax Credit, you could save over $8,000 in interest payments compared to likely alternative of financing the full $7,500 over 30 years One last thing: if you know you’re going to qualify, don’t wait until April to get your money. Adjust your W4 at once or you’ll be giving the government an interest-free loan on the interest-free loan they are trying to give you!

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Using Home Equity

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at June 2, 2008 in Debt management, Housing and Media. 0 Comments

During the long-ago period of ever-rising home prices–

You: Wasn’t that, like, three years ago?

Indeed. Crazy, right? Seems like most people forget that prices haven’t been going down for that long. Anyway, one interesting phenomenon of the boom period was the homeowners nearly real-time use of that appreciation.

You: How is that even possible? How do you spend the increase in the value of your home without selling it? Besides, even if you sold it, wouldn’t you need another home, which presumably would require just about all of the money you made on the home you just sold?

Easy. Just borrow against it. You can do this via a home equity loan or a home equity line of credit.

You: Is doing so a good idea?

Glad you asked. James Geary wrote an extensive and entertaining primer on this topic, titled “How to Handle Home Equity” for which I was interviewed. I think you’ll find it informative and occasionally thought-provoking. Feel free to share your thoughts below, especially if you have an opinion on using home equity, either from personal experience or based on your future intentions.

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Bull market on housing market related articles

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at March 13, 2008 in Housing. 0 Comments

Lately, everyone’s writing about the housing market.

You: Why?

It’s nearly spring.

You: Nearly? It’s March. Are you a little down?

I live in New Hampshire. It snowed today. For me, nearly spring is actually being optimistic!

You: Oh. Today, our high was –

CAN’T HEAR YOU!

Anyway, I recently compared the housing market opinions of Time Magazine and Bankrate.com. I also saw a great piece on the WSJ online a couple of days ago that presented the challenges and opportunities for potential first-time home buyers.

Wednesday, one of the most preeminent financial journalists in the country, Jonathan Clements of The Wall Street Journal, weighed in on the topic. As usual, Mr. Clements’ advice is both very traditional and very solid. Well caveatted, Clements feels it might be a very good time to increase your real estate exposure. Still, he emphasizes the importance of being realistic going forward with comments like: “. . . if you view the (second home) purchase as a bet on rising home prices, I would hold off for now. “

But personally, I found the following paragraph, in the middle of the article, the most eye-catching of all:

“That said, I wouldn’t think of this move (to a more expensive home) as an investment. Your new home will probably mean not only a bigger mortgage, but also higher ongoing costs, including homeowner’s insurance, property taxes and maintenance expenses. These ongoing costs will offset a large chunk of any future home-price appreciation.”

Did he just say that? In The Wall Street Journal? That, even in an environment where home prices are falling almost daily, you shouldn’t expect the long-term price appreciation of your new home to exceed the housing expenses you’ll incur living there? I’m not saying I disagree, but I can’t believe I just read what I’ve been wondering to myself.

If he’s right, this really is a new world. In the nearly expired environment of quickly rising housing prices, no one cared about the ever increasing expenses related to the incessantly growing home sizes and mortgage payments. Now, the media is saying “Hey, it may be a good idea to buy a house, but it’s not like you’re going to make any money on it. At least not after you factor in all the costs associated with home ownership.”

Think about that. If it’s true now, even after prices have fallen, it was certainly true when home prices peaked a couple of years ago. But no one was warning anybody of anything back then, were they? No, what I remember hearing was “Buy the biggest house you can afford,” and “They’re not making any more land. Prices may slow down but they’re not going to go down.” When it came to carrying costs, property taxes or mortgage rates, people ignored them or told you how you would have a bigger tax write-off!

No one can predict the future with certainty, so I’m not going to go there. But, with reasonable confidence, you can be sure that we have entered a new long-term reality with regard to house appreciation expectations. Has the world of today’s prices adjusted to this new reality? We’ll only know in a few years looking back. The best thing to do, therefore, is follow the old new rules of housing.

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How home affordability has changed now that the boom is over

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at March 6, 2008 in Debt management and Housing. 1 Comment

When I recently wrote about whether now was the right time to buy a home, I argued that the price of the home was more important than the interest rate you received. Assuming you maintain good credit, you should have the opportunity to refinance a high interest rate downwards at some point in the future. On the other hand, you can never lower a high purchase price. You paid what you paid and now that’s what you owe.

While you’re better off paying a lower price, no one knows when prices will hit bottom until after they have started rising again. By then, it’s too late. Trying to buy a home at the exact right time is no different that trying to time the stock market. It’s a losing bet.

Therefore, nothing’s really changed for a potential homebuyer. The considerations are no different in this kind of market than those questions you’d ask in a booming real estate market. But, my, how the answers have changed! Here’s how the housing market traditionally works (and, for the most part, is working now) compared to the recent housing boom:

Key Consideration
Do you plan to live in this neighborhood and this home for at least the next five years?

Boom Guidelines
“You’ll just need to be here three years” was often the minimum bantered about. And that was from the more responsible folks. With housing prices skyrocketing, you actually only needed about seven minutes to make money by selling, but there aren’t too many people feeling that confident today. Just ask someone in the Miami condo market (a buyer or a seller) of his current expectations.

The Way It Is and Ought To Be
Do you have the job security and the job satisfaction to be confident in the five-year minimum? Or have just moved to the area? How well do you know this town? For that matter, how well do you know your employer?

Ideally, you’ll want to possess not only the desire, but also the confidence that you’ll be satisfied and capable of living in any home you purchase for at least five years. Even in a stable housing market, short time frames could mean you lose money on your home after you factor in the transaction costs of buying and selling it. Plus, if you’re only in a home a year or two, the odds that it will be worth less than you paid for it go up dramatically.

Net: Five years means five years.

Key Consideration
Do you have an appropriate downpayment?

Boom Guidelines
Those loose coins in your car and in your couch? That’s plenty! Seriously, “no money down” loans were common. The lenders weren’t concerned that you had no equity in your home because shortly after you left the room (again, about seven minutes), your house was up several thousand dollars and, presto, you had equity.

The Way It Is and Ought To Be
You should be able to put at least 20% down. So folks, if the home you’re looking at costs $250,000, you should have $50,000 of cash ready. You’ll borrow the remaining $200,000. That $50,000 you’re handing over is the equity you have in your home.

Even if you can get a loan from a bank without putting in 20%, you’ll most likely be charged primary mortgage insurance, or PMI. While some insurance is a good idea, this one . . . not so much. You pay the premiums, but the insurance isn’t actually for you. Instead, the insurance is for the lender. In the event you default on your mortgage, the PMI somewhat protects your lender from your difficulties.

Because you’re not putting in 20%, you’re a higher risk to default. Think about PMI as an extra cost that gets you nothing. Sort of like another utility bill except without the electricity bill, you’re using a lot of blankets and Sterno. Without the PMI bill, you’re being financially savvy.

Key Consideration
Can you afford the monthly payment?

Boom Guidelines
If you could answer yes to the question “Do you intend to one day consider going back to work?” the loan was yours! Seriously, you didn’t have to show proof of anything. Such loans are now known as NINJA-loans: No Income, No Job, No Assets.

True. And scary.

The Way It Is and Ought To Be
To determine what you can truly afford, you’ll need two pieces of information and then understand two rules:

Two Pieces of Information
1. What’s your gross income?
2. How much monthly debt do you have?

First Rule:

Your monthly home payments should cost no more than 28% of your grossly monthly income.

Let’s talk about what that means. Remember, despite what it says on the real estate web sites, your monthly home payment is not just your mortgage. Although the mortgage is the biggest part, your monthly housing payment also includes 1/12 of your annual real estate taxes and the monthly cost of homeowner’s insurance.

Second Rule:

Your total monthly debt shouldn’t exceed 36% of your gross income.

For this calculation include not only the housing costs, but also any payments you make each month for your student loans, car payments, credit card balances not paid off entirely, and the amount you owe Vinny because of the outcome of Super Bowl XLII. (How did Tyree catch that ball?)

Here’s an example:

If your gross income is $60,000 per year, your monthly gross income is simply 1/12 of that amount, or $5,000. Multiply your monthly gross income by 28% to calculate the maximum amount you can afford for your housing expenses each month: 0.28 x $4,166 = $1,400. If you have no other debt, you’re done (and also, perhaps, a liar).

However, if you also have a $249 monthly car payment and $200 you owe each month on a student loan, then you have $449 in other monthly loan payments. Since the most you can afford to carry in total debt is 36% of your gross income (0.36 x $5,000) = $1,800 and you must subtract $449 from that total, the most you can borrow under the second rule is $1,351.

Your maximum monthly housing payment is the lesser of the amounts calculated by the two rules. Since $1,351 is lower than the $1,400 figure calculated under the first rule, $1,351 is the most you can afford. Said another way, what you pay each month shouldn’t exceed $1,351. (Of course, it is possible that you might be able to borrow more assuming an even higher monthly payment. Depending on your credit score, it could also be less.)

We’ll get into how your monthly payments translate into an estimate of a house you can afford, but, by traditional standards, those two rules tell you the most you’d ever want to pay each month. Especially if you like the idea of sleeping well in a house you can afford while living Beyond Paycheck to Paycheck.

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Time magazine vs. bankrate.com on the housing market

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at March 4, 2008 in Debt management and Housing. 2 Comments

Housing prices have decreased significantly over the past year or two. So say people like Fed Reserve Chairman Bernanke, numerous articles in The Wall Street Journal, and my brother—who just bought a house for quite a bit below an already dramatically reduced asking price.

Although I’ve also read about specific locations which are “protected” or still “doing great,” I’m somewhat skeptical of those claims. It seems like the only people quoted in those articles are those with a vested interest in seeing the perception of housing market optimism stay high: typically local real estate agents and lenders. These articles never seem to quote people who actually have their home for sale.

Despite near universal agreement that home prices have declined, no consensus has formed as to what to do about it, especially for those who have not yet owned a home.

From bankrate.com’s “Is the time right for first-time homebuyers? (whose short answer is “. . . for most millennial homebuyers, the risks outweigh the benefits. . . ”) to Time magazine’s “Ignore the headlines!” which argues that even in an environment of falling home prices, buying now makes sense because interest rates may rise.

Personally, I’m with bankrate.com on this one, and not just because their article quotes real live homebuyers, a finance and real estate professor, and a real estate agent. (By contrast, the Time article, although recalling the past wisdom of legends such as Peter Lynch and John D. Rockefeller, only actually sources Lending Tree and one of its executives. Gee, what’s Lending Tree’s motivation on this issue?)

Time tries to make the case that even if you knew that a home you were about to purchase would go for 10% less 12 months from now, you’d still be better off buying it now rather than waiting. This relative advantage come from the hypothesis that certain macro events (which no one can predict with certainty) will cause interest rates to rise by half a percentage point over the next 12 months. (Turns out there was an error in their comparison calculations, so the online version of the article now hypothesizes a full one-point interest rate increase, conveniently once again “proving” their theory that renting for the year while home prices fall 10% is a bad strategy.)

That’s absurd.

By that logic, would it make even more sense to buy a new car which would lose 20% of its value as it’s driven off the lot? After all, if you pay full sticker price, you might be able to lock in a low interest rate on the car loan! But this is just silly. Intentionally buying a depreciating asset is always a bad idea from a financial perspective.

In addition, who’s to say that rates won’t go down (and not up) over the next 12 months? I can find as many economists predicting rates will fall as Time can find who say the opposite. But even if rates are higher at the time I choose to buy the house at a lower cost, I can refinance later when interest rates fall once again. On the other hand, those who purchase a house at a higher price can’t refinance their purchase price. What they paid is what they owe.

Can you imagine a successful real estate professional buying a property he feels is certain to be available in 12 months for 10% less? Of course not. His current financing opportunities don’t even enter the equation. I’d recommend ignoring the Time headline. Still, as the bankrate.com article says, “For young buyers . . . with good credit, a down payment and the intention to stay put, the time might just be right.” But there’s still no reason to pay more than you have to.