Beyond Paycheck to Paycheck

at June 30, 2009 in Carnivals and Housing. 5 Comments

So my wife and I are starting to shop for a home. We’ve never owned a home before. We almost did twice before, in two different states and in what seems like two different lifetimes ago. For a variety of reasons, it didn’t happen either time, but I’m pretty sure it will this time.

You: What makes you so sure?

As I said to a friend at a party recently: “If we don’t buy a house soon, you won’t hear about a divorce, you’ll read about a murder.”

You: Your wife really wants a house, eh?

Yes, quite perceptive of you.

You: You?

I’m ready, especially now that the bubble has become self-evident. Still, I’ve always been cautious about owning a home and remain so. Not that it’s going to stop me (remember, I like life), but an article featured in this week’s carnival of personal finance called The Other Costs of Home Ownership serves as an excellent reminder that owning a home has far greater costs than simply the monthly mortgage. Tough Money Love gives quite a list including:

Property taxes
Homeowner’s insurance
Lawn care
Internal maintenance
Keeping up with neighbors

and on and on.

So my question to you homeowners: What’s surprised you, financially speaking, about buying and owning a home?

To everyone, regardless of homeownership/renter status: are you interested in hearing about our progress towards home buying including the ups and downs, the negotiations, selecting and working with a realtor, the pro’s and con’s of various properties, and so forth? Which parts of the home buying process would you find to be the most interesting or educational?

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Friday Q & A: Where to Put Your Future House Down Payment Money Today

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at June 12, 2009 in General Financial Planning, Housing and Q & A. 1 Comment

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

Coincidentally, I received the following two questions less than five minutes apart:

You signed my book at the ING DIRECT cafe in Chicago some time ago. In your book you refer to an 8% savings rate in hypothetical scenarios in several places. Where/how does one get this rate? I have a high interest account (under 2%) at ING DIRECT. I’m considering seeking financial advise/money management at Charles Schwab, but thought I’d check w/you first to get any feedback. I have $60,000 that I think I should be able to grow at a better rate with little (or no) risk, but not in a cd. I’d like to buy my first home in 6 months (with most of this money as a down payment) and am wondering what options I have to safely grow this money. I’m saving maybe $3,000 a month. I’ve never invested. Thoughts?

– Becky B., Chicago, Illinois

I’m thinking of buying my first house some time in the next 4-5 years. And I know I should start saving now. But what is the best way of saving? Should I put my money in a High-Interest Savings account such as ING DIRECT, in a 3-year long CD, or invest in a mutual fund with Vanguard? How do I choose which is the best option? Thank you.

– Diana C., Los Angeles, California

Straightforward Answer: Your investment choices must match your time horizon.

More Detailed Explanation:

Whenever you choose save a dollar, you must choose how to invest it.

You: No, I could put it in the bank.

Putting your money in the bank is an investment decision. It’s called investing in “cash.” Broadly speaking your investment choices are:

Cash (includes savings accounts, checking accounts, money in your wallet, and change in the couch).
Fixed Income (includes savings bonds, municipal bonds, corporate bonds, and the stable value option at your retirement plan)
Equities (includes stocks)

You: What about mutual funds?

Mutual funds can fall into any of the three categories above.

You: Even cash?

Absolutely. A money market fund is actually just a mutual fund that is invested in ultrasafe assets like “cash and cash equivalents.” Furthermore, some mutual funds invest in more than one category.

You: They can do that?

Sure. A balanced fund, for example, will often have a large percentage invested in both fixed income and equities.

Your Risk Tolerance, Time Horizon, and Investment Choices

As covered in depth in the investing chapter of Beyond Paycheck to Paycheck, your risk tolerance should drive your investment choices. (Unfortunately, that’s often not how it works since choices are often revealed to having made:

Out of fear of losing it all and therby keep it all in the bank - also known as the “Depression Mentality”
Out of fear of missing out on the next good thing and thereby purchasing 17 condos in Miami, putting $1,000 down per unit.

But that’s a post for another day.

Your risk tolerance is based on both your personality and your time horizon. Both Becky and Diana have shared with us their time horizon as 6 months and 4-5 years respectively. Let’s first address Becky’s conundrum.

Becky Wants 8% And Has a 6-Month Time Horizon

Turns out Becky isn’t going to be happy.

You: Why?

Because she has two mutually exclusive objectives. The first is to earn an 8% rate of return on her money. The second is extreme safety for her money since she needs it for a home down payment in just 6 months.

You: Why can’t she have these two goals?

She can. Just not at the same time on the same money. In order to expect to earn about 8%, she’ll need to take the risk of investing her funds in the stock market. (For those of you skeptical that 8% is achievable or that it dramatically understates today’s opportunity, I say:

I really don’t know what’s going to happen in the near term and neither do you.

However, 8% is the long-term historical return of the stock market (Check out this cool little calculator at Money Chimp where you can plug in any pair of start and ending years and learn the historical performance of the S&P 500). Since 1900, we’re at over 9%. Since 1990, we’re still over 7%.) Indeed, even today 8% seems reasonable for long-term performance.

You: But what’s the big takeaway?

There’s a ton of volatility in the stock market.

You: Well, there’s a newsflash.

First off, to some people it is. And secondly, when times are good (which they will be again), many people forget about the risk. Or, more precisely, they redefine risk as “not making as much money as someone else did.” All along, in good markets and in bad, you can make money and you can lose money by investing in stocks.

The net impact to Becky is that no matter how aggressive she is (and she’s probably not that aggressive, being that she’s accumulated $60,000 and has “never invested,”) she must keep all of her down payment money in cash. That’s the only way to ensure she will absolutely have her money available to her when she needs it six months from now.

Only in a savings account or a money market fund can she be assured that she won’t lose her principal. Furthermore, only cash affords her the ability to refrain from timing the market. After all, where will the stock market be in six months?

You: I don’t know.

Me neither. You wouldn’t want to have to sell if we’re back down at 6,500, would you?

You: No. will it be back to 6,500 again?

I still don’t know.

You: Me neither.

I think you see my point.

You: Right. So Becky can’t get 8% without risking her principal?

Correct - and please don’t comment below about the sure thing in soybeans.

Gary: It’s actually frozen orange juice.

Whatever.

Becky, just keep your money in a high-interest savings account and you’ll be fine. If you’re absolutely certain you won’t need it for six months and you can get a better rate with a CD, feel free, but remember the first time home buyer tax credit. If you’d otherwise buy a house in December, buy it in November and get the free $8,000 (subject to income restrictions).

Diana Has More Time - Can She Take More Risk?

Diana’s time horizon is a bit longer: 4 - 5 years. But, from reading her letter, her risk is less so from a potential loss of principal than it is from a current lack of savings. Diana needs to get going on savings for this specific goal (a home) today. It takes along time to get a down payment of 20% of the price of the home in order to avoid costly and utterly unnecessary PMI - especially in California.

You: Why is PMI unnecessary? I thought it was required if you put down less than 20%.

It is required. It’s unnecessary because no one is putting a gun to your head saying buy a home you can’t afford to pay 20% down on.

You: But–

But nothing. Save longer or buy a less expensive home. Or, like Diana and Becky, start saving well before you actually go home shopping.

You: When Diana starts saving, where should she put her money she has earmarked for a home?

In the bank.

You: She shouldn’t invest in stocks?

Probably not.

You: Why not?

Because the risk of loss of principal is still too great.

You: But if the next three years prove to be stellar for the stock market, this would prove to be the wrong advice.

No, it would prove to be unlucky. It’s the right advice for that very reason: we simply don’t know. Many people have advocated investing in stocks for your long-term objectives like retirement. Count me among them. From my vantage point, stocks make sense for my retirement plan as much today as they did 15 years ago when I started investing. I still felt that way earlier this year when the Dow was down in the mid 6,000s.

Don’t get me wrong, it may have periodically caused some lower intestinal distress, but it was and is still the best way to go - for the long-term.

You: What’s long-term?

At least 10 years. Four or five years is just too short. Diana, put your money in something much safer. A CD (or more than one CD) could be attractive, but you shouldn’t be investing your home money in anything you could actually lose your principal by in. By definition, this includes stocks.

More aggressive and sophisticated investors could consider bond or other fixed income investing - but given where we are with interest rates at the moment, even those may prove to be overly risky - especially for someone new to the game.

Good News

All of this leads to a wonderful conclusion: savings will be the primary determinant for you getting you your first house someday. True discipline will give you the opportunity to become a homeowner and in a far different way than the buyers of 2005 and 2006 accomplished the feat.

Remember, however, do not be cheap - be fiscally responsible.

I’m beginning to go through the home buying process myself. When you call your banker and you tell them you’re going to be putting down 20% (or more) and they pull your impeccable credit history, you will feel rewarded when they tell you what you can afford and at what rate. This is the future for Becky and Diana.

You: And me?

That’s up to you.

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7 Things You Need to Know About the Home Buyer Tax Credit

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at June 4, 2009 in Housing and Media. 0 Comments

In conjunction with what has turned into what could be the world’s largest Q & A session on the first time home buyer tax credit (a fact I have not attempted to verify), I recently wrote about the 7 Things You Need to Know About the Home Buyer Tax Credit at Mint.com.

You may already realize that mint.com is a huge provider of online financial software with over one million users (It was also named the best online personal finance tool by Money Magazine.) What you may not know, however, is that they also have one of the most widely read personal finance blogs on the Internet (or anywhere else, since I really don’t think you can have a blog offline). Anyway, it’s a thrill to share some of my personal finance education with their audience. Plus, let’s be honest: the software is free and they disclose their compensation sources on their “About” page. What’s not to like?

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Friday Q & A: First Time Home Buyer Tax Credit

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at May 22, 2009 in Housing and Q & A. 2 Comments

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question. The questions about the first time home buyer tax credit keep coming so this week we’re including two on the topic. If you have your own, feel free to comment at the 2009 First Time Home Buyer Tax Credit.

I am a first time buyer BUT I was married in 2005 and lived with my husband for 3 months; after 3 months I moved back with my mother and have lived there every since which has been almost 4 years now. My estranged husband owned his house prior to the marriage and I am not on the loan or the deed and he has an FHA loan. I have been approved for a FHA loan can I take the $8,000 tax credit if he signs away his rights. We have no intentions on getting back together.

–Requested Anonymity

I have clients who live in another state and would like to purchase a home (in Colorado) for their son while he attends college here. If they purchase the home in son’s name, would he be able to take advantage of the First Time Homebuyers Credit? The home could either be a conventional loan or cash purchase. Your thoughts on the best way to go?

–Carly K., Colorado

Short Answers: A problem and no problem.

More Detailed Explanations: Anonymous hasn’t owned a home in four years. Since the definition of a first time home buyer is anyone who hasn’t owned a home in the last three years, she’s okay on that front. However, she can’t be married to someone who doesn’t qualify. She appears to still be married to her husbdand and, since her husband is a homeowner, she is disqualified. If she were divorced, the answer could be different.

Carly’s clients are considering purchasing a home for their son who has never been a homeowner before and who, we can safely assume, is well underneath the income limits described here. The source of financing is irrelevant (cash vs. mortgage) so long as it is the son who will own the home. Keep in mind that there may be gift tax implications if the parents are just giving him a huge amount of cash to assist with the down payment. (If less than $26,000, there’s no problem).

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Friday Q & A: First Time Home Buyer Tax Credit

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at April 10, 2009 in Housing, Q & A and Tax. 2 Comments

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

I was wondering if we qualify for a first time home buyer credit. We just bought our first house in Nov 2008. My husband purchased a home with his ex-wife more than 3 yrs ago, (his name is still on that one) but has not lived there in 4 yrs.

Thank you for your help,
Donna

I have been living in a trailer for 11 years. I co-own the trailer with my spouse. Can we take the first time homeowner credit?

-TMC

Straightforward Answers: Donna: Yes. TMC: No.

Detailed Explanation:

Both the 2008 version of the first time home buyer tax credit and the credit for 2009 first time home buyers have raised a ton of interesting questions (By far, they are the most widely read and commented on posts in the history of this blog.) Let’s take these two questions one at a time.

Impact of A Spouse’s Current of Former Home Ownership

One of the key constraints of this credit is that if either spouse is disqualified for any reason, than both spouses are disqualified. (The same is not true of unmarried taxpayers who jointly purchase a home. This is why engaged couples have an enormous tax planning opportunity. For example, if one fiancé owns a condo but they both plan to move in together into a home in the suburbs after the wedding, it’s best to buy the home before they get married. Details available throughout the comment section of the 2009 article.) In Donna’s case, the question is whether her husband’s previous ownership of a home with his ex-wife disqualified him and his current wife.

If he still owns the home with his ex-wife, you’re Donna and her husband are out of luck. However, if he moved out of that home more than three years ago and it became his ex’s home exclusively at that time, you’re in the clear. Take the credit.

The answer to TMC’s question is less a happy one. In Congress’ desire to be generous, the credit specifically applies if you are to purchase a trailer home as your first home. As such, a reasonable interpretation of the law says that previous (or current) ownership of a trailer similarly disqualifies you. So if you’re going to buy your first home and it is a trailer, you’re in good shape to take the credit. If you currently own a trailer and then seek to buy a first home on a permanent foundation, you’re apparently out of luck.

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First Time Home Buyer Credit - Your options if you buy after April 15

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at March 25, 2009 in Housing and Tax. 96 Comments

The IRS released a notice recently concerning an obvious contradiction:

The deadline to purchase a home and potentially qualify for the 2009 first time home buyer tax credit is November 30, 2009.
You can claim this $8,000 refundable tax credit on your 2008 tax return.
Your 2008 tax return is due April 15, 2009.

You: So how can I claim a credit on my 2008 tax return if I haven’t purchased a home by April 15?

Here are your options:

Extend your tax return. File Form 4868 and automatically receive a six-month extension to file. Note, this is not an extension of time to pay your taxes if you think you’ll owe. Then again, will you owe after factoring in that $8,000 tax credit?
File now. Amend later. Another option is to file your return on time and then file an amendment (using Form 1040X) after you close on your home. Presto: up to $8,000 back in your pockets!
Claim it in 2009. You don’t have to take the first time home buyer credit in 2008. Instead, you can choose to take it in 2009. For some people, this may actually be better.

You: But what about the time value of money? Better to receive a dollar today (or 8,000 of them!) than a dollar next year, right?

Absolutely. However, for some people the choice may be $5,000 today or $8,000 in a year.

You: How come?

If your income is too high in 2008 to receive the full credit and you think you might make less money in 2009, it may pay to wait to take the credit until then. Remember, the income limits for the full credit are $75,000 MAGI if filing as a single person and $150,000 if married, filing jointly.

You: What if I already filed my 2008 tax return, subsequently buy my first home before December 1, and want to take the credit on my 2008 tax return? Can I still do that?

Absolutely. See option number two above: amend.

Is it time to buy a home yet where you live?

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at March 13, 2009 in Housing. 3 Comments

I recently had lunch with several other random financial professionals. One, a realtor, spontaneously launched into a verbal tirade about how the media was making the economy out to be so much worse than it actually was and that this fact, more than anything else, was feeding potential home buyers unrealistic expectations. She continued that the first-time home buyer tax credit was something that, if ignored by a potential first-time home buyer, was just ludicrous. Since it expires on December 1 and “It’s $8,000 - hello what are you waiting for?!”

I had to bite my tongue to not suggest that it was certainly possible that the value of a particular home might go down by a mere $8,000 in light of the fact that homes nationally have gone down several times that over the last few months. This, after many people, especially realtors, had called a market bottom more than a year ago. But since we were all financial professionals and no one could get hurt, I left well enough alone. (Personally, I don’t think you can convince an average realtor that home prices periodically go down as part of ordinary market cycles.) This is because the average realtor started in the business during the boom. Of course a good realtor is an entirely different story.

Nonetheless, the entire episode got me thinking. With the widely reported decline, are home prices finally reasonable? Some of you may recall that my family and I rent a home in New Hampshire. I was very bearish as to real estate prices upon moving here from New Jersey in 2005 and decided not to buy. We nearly purchased a home last year upon the birth of our second child. I was set to give into non-financial concerns (primarily my wife’s happiness), but was bailed out by her real estate savvy uncle who convinved my wife to wait. (Thank you Warren. See, even non-bankers can get bailed out.)

Buy Now?

But with the local market finally showing some strains and with that $8,000 first time home buyer credit available, is now the right time?

There are many ways to assess whether homes are priced appropriately including multiples of rent prices and recent comps (what neighboring homes have sold for recently). (Comps, or comparisons, have always been a bit of a joke since it basically says your home is worth X because a similar home is worth X. As we’ve all learned recently, that works the same way on the way down as it did on the way up. Your home is no longer with Y, because your neighbor just had to get rid of his home in a fire-sale so now yours is worth 30% less than Y.)

Affordability as a National Proxy on Home Prices

My favorite approach on home price rationally is affordability. In my mind, this means the cost of the home to the buyer. I look at the median household income and the median home price to determine if a market fairly or over-valued. By 2005, almost no one could afford their homes based on traditional metrics, meaning a mortgage of approximately 28% of their gross income and a 20% down-payment. As we now know, people were buying homes and feeding this frenzy with no-money-down mortgages, teaser interest rates. Furthermore, many lied about their incomes simply to show lenders they could afford the teaser payment. As long as home prices went up and one could sell or refinance his property before his payments increased, all was blissful. But it didn’t take a brain surgeon to figure out that this wouldn’t work in perpetuity.

Is the United States Affordable?

So now we must return to affordability. Is the United States home market reasonably affordable? To me that’s the question for the blog. For me personally, the question is “Is the seacoast area of New Hampshire reasonably affordable?” If it is, it might be a good time for me to buy, especially with the incentive of the first time home buyer credit. For you, the best question is “Is your neighborhood affordable?” If it is, most people will be able to (and will choose to) make their monthly mortgage payments even if there home is worth less than their mortgage (the condition widely reported of being “under water.”) But if people can’t afford to make their payments regardless of market conditions, eventually they walk away from their properties and drag down the comps with them. (See, Las Vegas, Miami, Phoenix as notable examples of this sad phenomenon.)

One Approach to Calculating National Home Affordability

Here’s how I approached calculating home affordability nationally:

National Median Household Income rounded: $50,000

(Source: If I were Michael Scott, I’d say wikipedia, which lists it at $50,233. The census bureau file I found has it at $49,900 for 2007. So, $50,000 seems reasonable today. Note that the census bureau lists median household income by state. So a more useful exercise for you is to use this file. Find your state. Or, for extra credit, go crazy on google to find your county, city or town. The more local, the better.)

If the average household makes $50,000 gross, they earn $4,167 per month. Traditional metrics allow for between 28% (conservative) and 36% (aggressive) of your gross income to be used for your housing payments, including real estate taxes and homeowners insurance. I use 31%. The midpoint is 32% but lenders are tightening and then there’s the problem of all the other debt people owe.

When you multiply 31% by the $4,167 gross monthly income, you see that the average American, according to reasonable affordability standards, can pay approximately $1,292 a month in housing expenses. But remember, not all of that goes to the mortgage payment; some must be used for property tax and homeowners’ insurance. The 2007 median national real estate tax paid was $1,838. Sure, I’d like a more recent number but I’m pretty confident it isn’t too much less than this figure on a national basis. For a county by county analysis which shows shocking variability, view this file.

The median household homeowners insurance is $800, according to the Insurance Information Institute. Add $800 to the $1,838 annual real estate tax and you’ve got $2,638 in annual non-mortgage related housing expenses, or $220 per month.

Since I like round numbers, the homeowner’s number is a bit dated (we’ve had some hurricanes since then), and some states are still raising property taxes thanks to dated assessments, I’ll subtract a total of $292 from the $1,292 affordable figure. This leaves $1,000 a month for the median household to spend on their mortgage.

Bankrate.com currently lists a 5.1% average rate for a traditional 30 year fixed conforming loan. At 5% (since rates change daily and I like round numbers), this implies the median American can afford a mortgage of $186,000. With a down-payment, they can afford a bit more.

Guess what the median home sales price was for Q4 2008?

$180,100.

Are home prices affordable? I believe, on a national basis, that they are. Note: home prices aren’t on some crazy discount. Furthermore, homes can just as easily sell for far less than what people can afford the same way they once, quite recently, sold for far more. In my opinion, home prices have simply returned to being affordable.

Crazy?

2005 was crazy. 2008 was not. 2009? I’ll ll tell you about that when it’s over.

All Real Estate is Local

Make sure you look at your situation since, as any good realtor will tell you, all real estate local.

Here’s what I found for Rockingham County New Hampshire:

Median Monthly Income: $7,400

Median Real Estate Tax: $5,000

Average Homeowners Insurance: $700

Implied Amount available for mortgage: $1,800

At 5%, the amount of an affordable mortgage: $335,000

Median Home price in Rockingham County (as of Q3 2008): $270,000 and I know, anecdotally, that it’s fallen further since.

So it looks like we may have reached a good buying time here locally. Other cities and states may be less certain.

Do your research, follow the links above for your own county or state and share the results below. Let others know of valuable links and any ideas for improving this methodology!

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First Time Home Buyer Tax Credit - 2009 Version

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Update: Here are your first time home buyer tax credit options if you buy a home after April 15, 2009.

at February 18, 2009 in Housing and Tax. 365 Comments

After weeks of intense negotiation, the new first time home buyer tax credit of $8,000 was signed into law this week. Here are some first time home buyer tax credit FAQs:

Will I qualify for the credit?

You qualify for the full credit if:

You close on a home between January 1, 2009 and December 1, 2009 AND
You haven’t owned a home in at least three years AND
Your adjusted gross income is less than $75,000 (single) or $150,000 (married).

How much is the first time home buyer tax credit worth?

The credit is for 10% of the purchase price of the home, up to a maximum of $8,000.

What if I wouldn’t owe $8,000 in tax?

Not a problem. The first time home buyer credit is refundable, meaning that you get the money even if it exceeds what your tax liability would have otherwise been.

Do I have to pay back this money?

No. You keep the $8,000.

Really?

Yes, unless you sell the home within three years.

How is this different from the previous version of the home buyer tax credit?

In several ways. Read more about the 2008 version of the first-time home buyer tax credit and note that it

Has a maximum value of $7,500.
Must be paid back over 15 years.
Is applicable to homes purchased after April 9, 2008 and before July 1, 2009.

The new credit seems better. If I qualify for both, why would choose the old one?

You wouldn’t.

What other questions do you have? Comments? Happy to see this credit because you’re about to buy a home? Ticked off because you bought one in late 2008 or even 2007? Do ask. Do tell.

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First Time Homebuyer Tax Credit: When a credit isn’t a credit but it’s still free money

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at September 24, 2008 in Housing and Tax. 135 Comments

This article is about the initial first-time home buyer tax credit. It’s an important read if you bought your first home in 2008. If you haven’t purchased your home yet, be sure to read the 2009 First Time Home Buyer Tax Credit.

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!

"financial education"

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.