Getting Personal
Housing Archives
Payoff Mortgage?
Question: I now have saved $50,000 and my husband has saved $40,000 in the bank. We pay mortgage each month about $1,000 and we still have more than $120,000 to pay for 29 years.
My question is: should we pay off our mortgage within the next year? If not, what should we do or invest with our savings? How will we plan for the future? We have no kids. I have a retirement plan, 403 with my employer but my husband has nothing. My husband plans to retire next year but I'll keep working. Thank you very much. Sue, Grand Fork, North Dakota
Answer: I think in the heart of every homeowner burns an intense desire to say goodbye to the bank for the last time and own a home free and clear. It's a wonderful moment, and if you have the money there's nothing wrong with paying off the mortgage to live debt free.
That said, I'd like to throw a couple of cautions against your getting rid of the mortgage right away. For one thing, you're putting most of your financial eggs in one basket -- a home. That's another way of saying that your financial health is now dependent on how one asset performs in coming years and, as we are witnessing right now, home prices can go down as well as up. I'd prefer that you build up a well-diversified portfolio in cash, stocks, bonds, commercial real estate, commodities, and international equities. Your home will then shrink as a percentage of your net worth. Once you've built up a well diversified portfolio, then by all means pay off the mortgage.
What else could you do with the money? I'm glad to see that you're participating in your retirement plan at work. One idea is to create a long-term portfolio in a taxable account. This way you can access the money without paying the 10% penalty you have to fork over if you tap into your retirement account under the age of 59 1/2. To keep your annual tax bill down, I'd recommend investing a chunk of the money into broad-based equity index funds. For example, with an equity index fund that mirrors the Standard & Poor's 500 or the Wilshire 5000 you'll pay very little capital gains tax every year since there isn't a professional money manager churning the portfolio every couple of weeks. You will, however, pay taxes on dividend payments and when a company is taken out of the index, say, through a merger or acquisition.
Another tax saving tip is to put the fixed income portion of this investment into I-bonds. Inflation is every saver's nightmare. Even if inflation averages a low annual rate of, say, 2% to 3% over the next quarter century, that's still enough to depreciate the value of a today dollar by nearly half. The I-bond is a savings bond, and it shares many of the same attractive investment features as its better-known cousin, the Series EE savings bond. There are no commission costs imposed when buying or selling I-bonds. I-bonds are sold at face value (up to $30,000 a year) and earn interest for 30 years, although you can sell after five years with no penalties. You don't pay any taxes on the investment until you cash in the bonds. There's no credit risk since the I-bonds are backed by the federal government. Its value adjusts to take into account changes in the Consumer Price Index, and you're also paid interest on your money. (You can get much more detail about I-bonds at www.savingsbonds.gov.)
A final point: It seems to me that you're at a major transition point with your husband retiring and you continuing to work. It's at times like this that a fee-only certified financial planner (CFP) can help you create a financial blueprint for the next stage of life. The planner would help you look at your whole portfolio, your stream of income and savings, and match your finances to your lifestyle goals. And you can run by the CFP the ideas I've suggested to see if they will really work for you. Good luck.
12/14/07 by Chris FarrellThe Bi-Weekly Mortgage Payment
Question: I have a monthly mortgage of $786.33. I've been offered a deal where I pay $394.17 every 2 weeks, or $1 more per month. They state I'll save $33,039.25 and knock off 8 years and 11 months. It sounds like a wonderful deal. Is there something I'm missing? Why would the mortgage company want to save me this money? Thanks, Mark
Answer: I can think of two reasons. The benign reason is that lenders are responding to the desire of many customers to shorten the life of their loan, and this is one among several options. Taking out a 15-year mortgage is another common tactic. The other reason for the service is that it's profitable. Lenders have made a nice sideline business setting up this kind of program, and they usually charge an initial registration fee and a stream of ongoing charges.
Since you're paying back principal faster through a bi-weekly payment plan, the life of a traditional 30 year fixed rate mortgage is typically shortened by about 10 years (with the program the mortgage will last somewhere between 18 and 22 years depending on the interest rate). Now, the mathematics of a bi-weekly payment means that it's the equivalent of writing 13 mortgage checks during the course of a year.
I prefer that people interested in this strategy do it themselves. It's a perfectly acceptable D.I.Y financial maneuver with no extra fees or additional charges. The easiest way to accomplish your goal is to make a 13th monthly payment on your own. (You can divide the money into a couple of payments if that eases the strain on cash flow strain.) In either case, put a note with the payment saying it's to go toward paying down principal only. By the way, another advantage of this approach is if money does get tight during the year you can always skip the extra payment.
That said, several years ago I got a similar question from a listener on the radio, and I gave a comparable answer. The next week I got a call from a woman who strongly disagreed with me. If I remember the details right, she was a single mother with a demanding job. She wisely turned as many financial obligations as possible into automatic payments. Otherwise with her hectic schedule it was far too easy to forget a bill or to put money aside in savings. She signed up with her bank's bi-weekly mortgage program because it was one less thing to worry about. It worked for her.
01/04/08 by Chris FarrellPayoff Mortgage Early?
Question: I plan to retire most likely sometime next year. I have a 30 year fixed at about 6.5%. I'm 5 years into the payments. If I have the liquidity to do so, should I pay off my mortgage?
Answer: One of my favorite financial advisors, Henry "Bud" Hebeler, recently sent me his answer to this question. I've answered this question on the blog so I thought I'd like to share his response to give you another perspective.
Bud was president of Boeing Aerospace, and when he retired he was disgusted with much of the financial advice offered to future and current retirees. He now runs a website--www.analyzenow.com--that's full of good advice.
Here's his answer: The technical answer is that IF the after-tax earnings on your investments is more than the after-tax interest on the debt, you shouldn't pay down the mortgage.
The problem is that you have to guess at returns over the next 20 to 30 years and hope that there are no huge market drops. Also, you have to guess whether you'll be able to deduct mortgage interest over a long period. For those reasons, many financial planners believe you should pay off the mortgage early. I think you also have to consider the amount of money you have left after paying off the loan, and whether you could get as good a deal on a new loan should you ever need one considering such things as the future interest rates and paying closing costs again. You might want to make a side-by-side comparison of your two alternatives using one scenario starting in 1948 (a very good year to retire) and then changing to a 1965 (a very bad year to retire) comparison using the Dynamic program on www.analyzenow.com.
When things are uncertain, I'm often in favor of a compromise. Perhaps you could pay off half of your loan or accelerate payments should you be able to do this without loan penalties.
I like the compromise idea. Too much of personal finance is divided into an either/or construction when compromise is often the best solution.
Refinancing Mortgage
Question: Hi, I have an ARM which is just adjusted to 5.75% (and it'll increase to 8.5% next December). I owe $120,000 on this. I have a 2nd mortgage which has an 8.5% interest rate. I owe $23,000 on this. I want to get out of my adjustable rate and into a fixed rate but do not know the best way to do this. My mortgage broker told me to sit tight and advised this is not the time. However, I really feel I need to refinance before December 2008. Also, I paid about $163,000 for my condo 3 1/2 years ago. At that time it was appraised at $173,000, but the mortgage broker believes the appraisal value now may only be $145,000 - $150,000. What should I do? Please HELP. Thank you, Jeanie
Answer: Ignore your mortgage broker. He's probably correct that the value of your condo is down. But you're right to be aggressive about your mortgage situation. The same goes for anyone who's stressed out about their future mortgage payments.
For one thing, the recent cut in interest rates by the Federal Reserve may make it more practical for many homeowners to refinance. The conventional fixed rate mortgage is currently at 5.7%. It's at the lowest rate since the fall of 2005. For another, banks and other financial institutions are under a lot of federal, state, and regulatory pressure to work with financially stressed homeowners. It pays to reach out now when they have every incentive to treat you right (at least compared to the past).
I have a couple of suggestions. Do some of your own research and familiarize yourself with the mortgage market at a couple of online portals, such as www.hsh.com. HSH has a good articles library, and for a fee you can get the loan terms of lenders in your area.
Next, while I'm a big believer in doing research online, it always pays to talk to people in person when it comes to money. If you have a checking or savings account at a brick-and-mortar bank or credit union, introduce yourself to the loan officer. Spend time with her (or him). Let her run some numbers for you. If the numbers don't quite add up, stay in touch and work with her. In other words, develop a professional relationship.
Lastly, there are non-profit institutions in most metropolitan areas that specialize in helping troubled or confused homeowners cope with their mortgage issues. Contact them.
Refinance?
Question: I purchased my house three years ago with a 5-year ARM and a second mortgage to cover the down payment. My credit was (and is) good, and the interest rates and payments on both loans are low (about 5%-6% on the loans). I purchased my house just before property values climbed here, so the value has appreciated and the market has not crashed as in other places. When I purchased my home, my job was only supposed to last two years, so I expected to move long before the interest rate started to adjust. My job has now lasted 3 years, and it is no longer certain that I will move out of town before the 5 year mark. Should I refinance the house now just in case I don't move, or wait to see what happens with interest rates and lenders? The interest rate will start to adjust in October of 2009 and I have heard that 2009 might be a better time to refinance a home because the market is expected to have stabilized. Thank you.
Answer: Clearly, you have a good rate and the time to decide. By the way, I'm also a fan of 5-and 7-year adjustable rate mortgages. The rate is usually attractive and you buy time to decide on your next move.
Of course, I have no idea where interest rates will be in 2009. I do think the recent drop in mortgage rates makes refinancing over the next couple of months an attractive proposition for anyone with a good credit score and borrowing record--like you. The rate on a 30-year fixed rate mortgage has dropped to 5.54% (the last posting I saw). If I were you, I'd be running some numbers now to see whether you can 1) get rid of the second mortgage and 2) calculate the point where it makes sense for you to buy an "insurance" policy and long-term piece of mind by refinancing into a conventional 30-year fixed rate mortgage.
Of course, I don't have the answer, but my guess is that it's sooner rather than later.
01/29/08 by Chris FarrellSelling A Home
Question: My husband and I own a one-bedroom condo in Brookline, Massachusetts which has a pretty strong real estate market, but has dwindled some with the recent downturn. We currently have a 5/1 arm at a 3.75% interest rate and have lived in our home for 2.5 years. We are not yet sure if we will sell in the next couple of years or if we will keep the home, refinance to a fixed-mortgage and then pull out some equity to buy a larger home and rent this one-bedroom out.
With the recent lowering of interest rates do you think we should consider refinancing now even if it increases our current monthly payment, or do you think we should wait until we are closer to selling? Thanks! Adrienne
Answer: For people in circumstances like you, without any immediate pressure to refinance, a big part of the answer comes from your need or desire to take out an "insurance" policy. Of course, I have no idea where interest rates will be in two to three years. I can just as easily make the case that they will be lower or higher or the same (mostly depending on the outlook for inflation).
Instead of an answer, I have a bunch of questions. Probably the most important is: Will you sleep easier at night locking in today's low rates, even if it turns out two years from now that you would have come out ahead financially by standing pat? Is the price of that interest rate insurance policy worth it to you? Or will you be filled with regret? In the past, I've stuck with my 5-year adjustable rate mortgages and I was comfortable with the gamble (and in each case I got lucky). However, considering all the turmoil in the economy and financial markets I might act differently this time if I were in similar circumstances.
Other factors that can influence your decision: How stable are your jobs? And how realistic is it for you to become landlords? When you look at all of your assets and liabilities, where are you comfortable taking risks with your money and where would you like to buy some stability? And, of course, will you be moving in two-to-three years?
I realize it's often annoying to have a good question answered with a string of additional questions. But hopefully they'll lead you and your husband to an answer.
02/05/08 by Chris Farrell
Selling A Home in a Down Market
Question: My family lives in a 107-year-old house. We have dreams about a slightly newer home with more yard and more practical family space. We've talked about selling for about two years now, but have watched the market get worse and worse, and our home value drop from near $400,000 to maybe $300,000. And our friends fret as their houses sit on the market for months.
We're tired of being stuck in limbo, but I'm completely freaked out by the idea of living with two little boys in a house that needs to be market-ready 24-7 for the months it may take to sell.
Still, we're talking about biting the bullet and placing the house in the market this spring. Should we get a bridge loan and move out of our house before we ready it for the market? If not, what kinds of resources can you recommend as we get ready to sell? And how do you recommend we find out the true market value for our home? Thanks! Maria
Answer: I wouldn't take out a bridge loan, especially in this market. Bridge loans are expensive, and you could end up holding it for far longer than expected. There's always the risk that potential buyers don't bid on your home. Then what?
Now, it can be a pain keeping a home clean and presentable with two young, active children. But that pressure is nothing compared to the pressure of a bridge loan gone awry. It would be far better--and cheaper--to hire a cleaning service for the time your home is on the market. I would also find a realtor who's used to working with couples with young children, and can work with you on scheduling buyer viewings. You can structure visits by potential buyers to your home. No need for it to be ready for "show" all the time.
The value of your home is a moving target, as everyone wonders "Where is the real estate market bottom?" But you can get a good sense by spending time on websites like zillow.com. Real estate agents will also print you a list of prices for comparable home sales in your neighborhood in recent months.
In the next several years, I expect more families in your situation to opt for remodeling over moving. Homeowners are in a much better bargaining position with contractors. Remodeling prices should be much better than even a few years ago with the downturn in the housing market and the economy. With business falling off, contractors should be more willing to negotiate and strike a reasonable deal. I don't know if that works in your situation, but it's an alternative to research.
A Home Equity Line of Credit
Question: Hi - I have a $10,000 home equity line of credit (HELOC), which was essentially a 2nd mortgage when I bought my home 4 years ago. The balance of my HELOC is now $0; I do not plan to make any future HELOC withdrawals as I have a substantial "emergency" cash fund. (My primary mortgage balance is $190,000.)
Is there any reason to keep the HELOC open, such as for tax or credit score reasons? Or, am I better off officially closing the HELOC account? I may sell this home in 1-2 years. Thanks for your guidance. Stephanie
Answer: As far as I am concerned there are two good reasons for keeping a home equity line of credit open. The first is that it acts as an emergency store of funding. The second reason is to pay for renovation projects over time. In your case, neither reason applies. Another factor to check out: Some banks charge "inactivity" fees. You don't want to pay for that.
That said, here's why most people would advise you not to close it: Your credit score. When it comes to credit scores the longer you've been doing business with a lender--and making your payments on time--the more you're rewarded with a high score. It's a numerical calculation that bothers me for two reasons. First, I do worry about keeping unused accounts in an age of identity theft. And secondly, financial common sense says if you're no longer tapping into a product, end the relationship. The only beneficiaries of this credit score formula are lenders who can always hope that by keeping the account open, you'll eventually start using it again.
Here's a way out of the conundrum. If you aren't going to be taking out a new mortgage, a mortgage refinancing, a car loan or some other big ticket borrowing for a couple of years, go ahead and close the account. The dip in your credit score won't matter, and with time by maintaining payments on other debts your credit score will climb back up. However, if there is a major transaction in your future, I'd keep the account open. In your case, I'd leave it alone for now since you may sell your home in a year or two.
Saving for a Home
Question: I am 27, married with my fourth kid on the way. I'm currently a full time student and working 30hrs a week at Starbucks, and my wife is a stay at home mom. Within this situation, we do not make a lot of money, but I do receive quite a few scholarships and grants that more than cover school and bills, and we don't have any debt. We'd like to start saving some of this extra cash for our future home, which we plan on buying in about 5-7 years. I have looked at putting the money into CDs, but I want to know if there is a better way of maximizing a return on the money. Thanks for your time, Glen
Answer: I think you and your wife could teach all of us a lesson or two about the art of living well with little money--without taking on debt. In your situation and with your homeownership goal, there's nothing wrong with parking cash in bank certificates of deposit. And as long as the value of the CD is under $100,000 there is no credit risk, either, since they're FDIC insured. I'd would look at the after-tax yield you're earning on the CDs to the aftertax yield you could earn on a comparable Treasury security. I would put my savings into whichever one is paying you a better aftertax yield.
But let me toss out a couple of other options for you to consider.
First, in this period of uncertainty, when the Fed is combating recession while crossing its fingers when it comes to inflation, putting money into a brand-name, conservatively run money market mutual fund can pay. The reason for putting money in "cash" is if inflation stirs and interest rates go up, the money market fund will start paying you those higher interest rates quickly.
Another option is a short-term bond index fund. Fees are low with bond index funds, and the portfolio itself is well diversified. You should earn a slightly higher yield in a fund like this, but at the cost of increased volatility.
My last idea is to consider adding a thin stock market layer to your savings, say, through a broad-based equity index fund. My thought is that quality stocks are getting progressively cheaper (they'll probably head even lower in the months ahead). Your time horizon is long enough to justify taking on some extra risk to meet a specific goal. If everything works out, the finances of home buying will be that much easier. But if the market is down when you're putting together a down payment--and it doesn't make sense to sell stocks--the stock market portion of your portfolio won't be big enough to prevent you from becoming a first time homebuyer.
02/20/08 by Chris Farrell
The Hike in Mortgage Loan Limits
Question: I understand that the stimulus package includes a provision to raise the cap on conforming loans (i.e. when loans become jumbo). When can we expect to get loans at the new rate? Thank you.
Answer: You're right about the provision. The Department of Housing and Urban Development still has to determine the final loan limits by region. The new temporary limits will go into effect in early March and the idea is for them to last until the end of the year. The limits involve mortgages backed by giant mortgage securities firms such as Fannie Mae and Freddie Mac.
The problem was that the credit crunch and housing market debacle made lenders wary of writing jumbo mortgages. The conforming mortgage limit for Fannie Mae and Freddie Mac was a ceiling of $417,000. Any mortgage above that was considered a jumbo. The interest rate gap between a conforming mortgage and a jumbo is normally 0.25%, but thanks to the housing market nightmare it had widened to about 1.0%.
The new legislation changes the conforming loan limit to 125% of an area's median home price, with a new upper limit of $729,750. Clearly, the new limit was picked with San Francisco, Los Angeles, New York, Washington D.C., Miami, and other high-priced coastal cities in mind. The idea for the temporary hike in conforming loan limits is to make it easier for owners of expensive homes to refinance and for would-be buyers to get a better interest rate.
However, the impact of the change has been muted so far. A conventional 30-year fixed rate mortgage is currently 6.05% while a comparable jumbo mortgage is 6.94%. I'm skeptical the shift in loan limits will make much of a difference in the housing market over the next several months.
Interest-Only Mortgages--No
Question: My husband and I recently attended a workshop on optimizing real estate assets. The program presented information on how to create a debt and cash flow management strategy, optimizing real estate assets to build wealth. In other words, they recommend taking the asset of your home, and have that money work for you to build income. One of their recommendations is to obtain an interest-only loan, which will allow you to take greater tax benefits and spread your mortgage over the longest term so that you can invest money that you would put towards a shorter term (15 yr vs 30 yr.) What do you think of this idea? Thanks, Susan, Boulder, CO
Answer: No. No. No. It's by following financial advice like this that a number of homeowners have fallen into dire financial straits. Interest-only mortgages are highly risky. Stripping out the equity in your home to invest in other (risky) assets is very hazardous to your wealth.
From CDs to Mortgage?
Question: I have a $240,000 fixed rate mortgage at 5.75%. My monthly PITI payment is a little under $1,900/month. And I get by OK on my retirement and cash flow from a rental. I'm 58 and single, and I'm able to file an itemized return.
Now that CD rates are falling, I was wondering if it made sense to divert some of the expiring CDs' funds into the mortgage. My mortgage is recastable, so I can lower my payment for every $10,000 I chunk into it. What's more, I can't get anything like 5.75% on any safe investments. I'm gun shy of The Market right now. What's more, I have also been turned off by most stocks' stingy dividends. I do have some mutual funds and some utility stocks.
I could throw-in up to $100K and still have around $200K in cash left in CDs (not including IRAs). That amount would take the mortgage down by around $700/month. Basically, that extra money would provide me with extra spending money or money to pay off the mortgage principal. I have around 25 years left on the mortgage.
Does this make sense from the perspective of "tax savings?" I would have less taxable income at non-preferential rates from the CDs, but I would have a smaller interest deduction. Is this deduction worth it? Anonymous.
Answer: I think you have already answered your question. There is nothing wrong with paying down your mortgage early and, you're absolutely right, you lock in a 5.75% rate of return. And while the tax deduction helps, it isn't that valuable compared to the what you will save in interest. If you scroll through my previous answers on this question you'll see that I worry about homeowners putting too much of their savings into one asset--their home--and not enough into stocks, bonds, international securities, and cash. But you have accumulated a good amount of savings, and accelerating payments on a mortgage (or any debt) is a sound strategy for the risk averse--especially in this market.
04/03/08 by Chris Farrell
A Big Downpayment?
Question: I am searching for a new home (main residence) and was wondering whether I should use a huge downpayment and dent my assets or take a large loan and keep some assets, considering inflation, decreasing mortgage rates, and current turmoil. Thank you -- I love you show. Thank you for not printing my name. Anonymous.
Answer: I wonder what you mean by a "huge downpayment"? The traditional figure of a 20% downpayment is good benchmark. I wouldn't strap myself for cash--a home take money to maintain--to far beyond that percentage. And with the economy is recession or near-recession I'd want to have a healthy cash emergency safety net. Call it your "just-in-case" money. You can always accelerate principal payments on your own if it makes sense.
04/08/08 by Chris FarrellDownsizing
Question: My wife and both turn 50 this year. Our son is graduating college and our daughter enters college this fall. We are downsizing into a smaller home, purchasing with cash. We'll then sell our current home. I've looked forward to being "mortgage-free" for some time, but several of our friends suggest losing the tax advantage is a bad financial move. Chris, what is your opinion? Tom, Charlotte, NC.
Answer: First of all, from a financial point of view it's really smart to make a downsizing move while you're still working. You'll save a lot of money--no mortgage, lower property taxes, cheaper utility bills, and so forth--and you can salt away at least some of that money for later on. In a sense, it's a smart savings strategy. Secondly, I don't think the mortgage deduction is all that important to your bottom line. Sure, it helps. But it's far better to enter your Golden Years owning a home without a mortgage. This way you have a solid equity foundation for your overall portfolio. Go for it
Remodel Home?
Question: We are currently faced with a dilemma. My wife and I bought a home years back with the eventual assumption that we would outgrow it and have to move into a larger place. Since that time, we have had two kids and fallen in love with the neighborhood. Our kitchen is outdated, with buckling countertops, our furnace is over 30 years old, and we've got no room to store clutter that comes along with kids. (Legos can be particularly painful to bare feet.) We'd really like to stay put and get an addition and replace the dated things that need replacing, and have a place for storing everything. Our worry is now the best time to do these things? The economic down turn... or recession has us concerned. We have very little debt, other than the current mortgage. We are able to pay our bills and save a little for retirement and college for the kids. Are we making the right decision to add on to the house? Rob, Bel Air, MD.
Answer: Whew, I can relate to the pain of walking on Legos. I think the current housing turmoil means more people in circumstances like yours will pick remodeling over moving. (Plus, as you say, you love the neighborhood.) The remodeling industry boomed along with the surge in real estate prices, according to Harvard University's Joint Center for Housing Studies. The remodeling market in 2007 breached $290 billion, up from an annualized $85.3 billion in the final quarter of 1997. It's during these boom years that remodeling horror stories became common currency among homeowners, from contractors doing shoddy work to walking away from incomplete jobs. Although the remodeling market has held up well compared to the housing market, activity will slacken if history is any guide. While the cost of drywall, composites, and other materials is up, labor is plentiful and many contractors are eager to keep their crews working. There is more room to negotiate than before, but I think the real gain is better work for the price paid.
That said, if you do go the remodeling route remember that it will only "pay" as a long-term investment. You'll lose moeny if you end up moving soon. The general rule on renovations is that you will only recover about 40% of the cost of any work done, with kitchens and bathrooms having the highest return on your money and luxuries like swimming pools the least. I'm sure you've already gone over the details with your contractor, but you can check out the numbers at Remodeling Online . Again, it's clear you don't want to end up with too much debt, so prioritize the project and figure out what you might want to do later. So, assuming you stay conservative with your finances, owning a remodeled home in a neighborhood you love will add to the quality of your family's life. And that's worth a lot.
Mortgage Accelerator Programs?
Question: My husband & I are both retired. We have parent loans for our 3 children's college expenses. We have a $20,000 home equity loan but no other debt. Recently we were approached by a friend to look into u1stfinancial as a way of paying them off sooner and decreasing interest. Do you have any information or advice regarding this company? Carol, Pine City, NY
Answer: We've been getting a lot of questions about United First Financial and its Money Merge Account. Full disclosure: I'm not a fan of the product.
Here's how the company describes the money merge account on its website.
The Money Merge Account system is a powerful tool that enables homeowners to pay off a 30-year mortgage in as little as one-third of the time, without refinancing their existing mortgage or increasing minimum required monthly payments. The system incorporates the homeowners' checking and savings accounts with an advanced line of credit (ALOC), then helps to strategically and incrementally position their money where it provides much more financial benefit than "sitting stagnant" in a standard checking or savings account until it is otherwise needed. Complex financial details programmed into the Money Merge Account software help to better educate the homeowners and assist in some of the greatest time and interest savings possible.
Got that? There are a number of comparable products on the market. The bells and whistles may differ, but it looks like the basic idea is the same. You set up a special home equity line of credit off the value of your home (which is getting harder to do and more expensive these days, thanks to the credit crunch. As I understand it, you could use a personal line of credit or a credit card, but the latter at least sets off all kinds of alarm bells.) When you get your paycheck it goes into the line of credit, decreasing your mortgage balance and, after paying your bills from the account, the remaining money keeps your mortgage balance down. The software costs for $3500 for the Money Merge Account, and other programs also charge for their software.
Carol, as I mentioned above, I'm not a fan. In essence, I think these programs boil down to a complicated and expensive way to keep a household to a very tight budget. If that's what you want to do there are other, cheaper ways to map out and maintain a frugal lifestyle. Perhaps more important, I worry about homeowners pouring so much of their discretionary income into their home. It's nice to own your home free and clear, but it's also important to build up a well-diversified portfolio with a well-funded emergency cushion.
And if it makes sense for you to pay off your mortgage early, well, you can do it on your own without paying for special software. Just make extra payments to pay down principal. A classic approach is to make an extra monthly payment a year. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal. Last, Carol, these mortgage loan accelerator programs seem to violate a time-honored financial motto: Keep It Simple.
Points?
Okay, I've learned the hard way that I can't stay in a hotel without a good Internet connection just to save a few bucks, It isn't worth the time and aggravation. Anyway, since I couldn't post yesterday, here's an extra one for today.
Question: How do I see whether it's a better deal for us to refinance, say, at 5.8% with closing costs of, say $5,000 or to go with an offer with no closing costs but at 6.5%? It has to do with time to recoup the closing cost expense and time we plan to be in the home...? Are there amortization schedules (is that what you call them?) that can be run to show me the comparisons? Thanks much for any help! Johan, Ocoee, FL
Answer: Yes, there are a number of calculators on the web. For instance, you can go to www.dinkytown.net. In its mortgage calculation section there is a "mortgage points calculator." This way you can weigh the trade-offs. In general, the big advantage of a no-points mortgage is that it's cheaper if you end up refinancing at a lower rate within a reasonable period of time (or end up moving within a few years). The advantage of paying a point or two is that you buy down the interest rate, which can pay off over the long run. The mortgage calculators will give you concrete numbers to work with.
Mortage Paydown and Baby Boomer Retirement
Question: I am 55 years old, earn $62,000/year and I have a mortgage on my condo slated to pay off in six years (2014). My current mortgage balance is about $35,000 @ 5.25% APR. I have an account with a major brokerage house with a current value of approximately $54,000 and could sell some securities to pay off the balance on the mortgage now. (I have a 403B and an IRA in addition to the stocks I refer to above for my retirement.) I am wondering if the market might be in for a real bust as us baby boomers begin to retire. Should I pay off my mortgage now by some of selling my stock, and forfeit my mortgage interest tax deduction? I enjoy listening to your program. I am a member of my local NPR affiliate, WUOM, 91.7 Ann Arbor, MI. All the best, Mark
Answer: There is a popular idea that consistently pops up. Call it Malthus Visits Wall Street. Simply put, the notion is that there are too many baby boomers, and they will overtax the economy's resources. Home prices adjusted for inflation will fall for a long time with hordes of elderly home sellers and not enough young home buyers. When they retire and draw down their private pensions, the massive asset sale will depress stock and bond values, leaving boomers with less money in their golden years.
I don't think that investors should fear the march of time. For one thing, an aging population in a computer-dominated economy is working longer than previous generations. Far more important is the move toward market economies around the world. The spread of private property rights and openness to the world economy is encouraging vast amounts of capital to flow across borders. By the time boomers need to sell, markets will be far more international. Baby boomers will sell their stocks and bonds into a global economy full of Indian, Chinese, Brazilian, and other foreign investors.
When it comes to real estate, the picture is a bit more complicated. We're going through a tough downward cycle after the decade-long boom. But the market will eventually stabilize. Overall, I expect housing will remain an appreciating asset. However, here is one wrinkle to think about. I wouldn't be surprised if a surprising number of aging boomers decided to downsize. The demand for smaller homes could soar (since first time homebuyers will compete for the same properties) while the demand for McMansion type homes will lag. Overall, housing should be a healthy asset, but smaller homes could enjoy stronger demand than bigger ones (with the exception of the true luxury market).
For most people, I think it's important to be debt free in retirement (i.e. no mortgage). But it's also critical to enter your golden years with a well-diversified portfolio. There's nothing wrong with paying off your mortgage early. But you shouldn't feel that you have to. You have a good rate, and time is on your side.
A Wedding and a Mortgage
Question: Hi Marketplace, I've got a couple good things going for me right now. I just got a new job that pays a lot more than my old one, and I'm about to get married. Instead of having a regular registry for pots and pans, we're asking our guests for donations towards our "Mortgage Fund" to try to put a down payment on a place to live. Now, we're not quite ready to get a house...but we're thinking within the next year or so we'd start looking (pending, of course, what the market does).
My question is this: what's the best way to "park" our money for a year while we wait to buy a house? Is there a "Mortgage-specific" type of savings account that might yield a better return than a CD? Thanks for your time, Iseri, Chicago, IL
Answer: Congratulations on all the good things happening to you. I wonder if your idea is a sign of the times? A lesson of the housing boom and subsequent bust is that first-time homebuyers should buy themselves a margin of safety by putting in a greater downpayment than was necessary during the go-go years. It's an intriguing idea.
Yields are razor thin these days. But I wouldn't reach for yield with this "home" money. (For a harsh lesson on the cost of reaching for yield just look at the busted auction rate market. The stuff was marketing as safe, but higher yielding short-term debt, and now investors can't get their money out.). I would stick with a brand-name money market mutual fund with very low fees and no charges for putting the initial investment in and adding sums later into the fund. I would pick a conservative money market mutual fund option, one that invests heavily in U.S. Treasury bills, short-term federal agency debt, and blue-chop commercial paper.
Good luck.
05/28/08 by Chris FarrellHome Equity Loans?
Question: A) Love the show. B) In these uncertain economic times, am I better off getting a Home Equity Loan, or a Home Equity Line of Credit? Oh, and, what the sam-hell is the difference? Joel, Milwaukee, WI
Answer: I'm glad you love the show. Let's do the definitions first. A home equity loan (also called a second mortgage) is a lump sum of money. You pay it back on a regular basis over time, just like a mortgage. A home equity line of credit allows you to write a check (or use a special credit card) whenever you need to borrow against the equity in your home. The interest rate is typically fixed with a home equity loans, and the rate fluctuates (depending on the market environment) with a home equity line of credit. In both cases the equity in your home acts as collateral.
In general, a fixed-rate home equity loan is tailor-made for major remodeling projects, such as a new kitchen or bathroom. The variable-rate home equity line of credit is better for smaller projects that are accomplished over a longer period of time.
Now, I'm in the camp that says the money borrowed against the equity in your home should go toward improving the value of your home and the joy you get from living in it. This isn't money you tap for expensive vacations.
However, one additional advantage of a home equity line of credit is that it can be part of your emergency savings. In case of a financial emergency, say a major medical bill or a lost job, you can use the line of credit to help tide you over.
06/05/08 by Chris Farrell
Questions answered on air for June 7-8
In this edition of Getting Personal, Chris and Tess talk about private mortgage insurance, 457s vs. 403(b)s, removing a co-signer and borrowing from a 401(k).
Continue reading "Questions answered on air for June 7-8" »
06/07/08 by Richard CoreBuy A Home--Or Wait?
Question: My daddy taught me that rent is a waste of money, and my family has been renting for a year after relocating from NC. I'm ready to buy a house by September 1st at the latest. I think I'll be happy with the balance between falling prices and favorable interest rates (before they head up even more) by September. My husband thinks we should wait another year and continue to rent. Our price range is low in this market, between 450,000 and 550,000 and we've seen some homes in which we'd be comfortable with our two boys, 2 and 4 years old. Also, I want to move close to the school I've chosen for my oldest for kindergarten. I'd hate to move to another apartment. Is it too soon to buy? Will I regret jumping into the market in September, possibly before the prices hit rock bottom? One more thing--we can put down between 10 and 20%. Does it matter if we put down 10%? Thanks for any input you can provide. Jeri, North Hollywood, CA
Answer: Here's the safe forecast: You know once you buy a house prices will come down some more. Hitting bottom is a matter of luck. I also don't think you should feel any financial pressure to move. My own guess is that that the downward pressure on home prices isn't over, and there won't be any financial penalty for any potential homeowner that waits. (But that's a guess, of course.)
Lifestyle reasons may push you toward moving sooner. For instance, you already know what neighborhood you want to live in, and the kind of house you'd like to own. So, I would work with a real estate agent to really dig into the neighborhood. I would talk with a banker to see what kind of loan and rate you will get in this environment. I would be choosy and tough in any negotiation. In other words, be willing to walk away. But even if you miss bottom--which is highly likely--that may be okay for lifestyle reasons and assuming this is a long term investment. Put somewhat differently, both you and your husband are right, so use that knowledge in your favor when looking to buy a home.
The 20% vs. the 10% is really a number crunching exercise. You'll get the best rate on a 30-year fixed-rate mortgage with 20% down in the current environment. And, if you can do it, 20% is usually preferable. The reason to put in less than 20% is not to tie up all your savings in one asset. I'd run the numbers, look at the trade-offs, and then decide what works best for your family finances. You will pay PMI or private mortgage insurance with less than a 20% downpayment.
06/16/08 by Chris FarrellAdjustable Rate Mortgage
Question: Is there a source to which you can refer me that would state the average interest rate of the One Year T - constant maturity, over the past decade or two? We currently have an adjustable rate mortgage tied to the 12 Month Average of the One Year T, Constant Maturity. At present, the rate is not so bad, but we are all too aware it goes up and down. I am wondering if there may be an advantage to sticking with what we have, knowing that sometimes it will take a bigger bite out of our budget than others. In essence, if you can weather the peak interest rates, is it worth sticking with an adjustable rate for the valleys that are also part of the ride. Thanks. Brian, Pacific Grove, CA
Answer: The data is produced by the Federal Reserve Board. You can find both current and historical data at www.federalreserve.gov/Releases/H15/. Another data source with some nice tables is at www.moneycafe.com/library/cmt.htm.
I don't dislike adjustable rate mortgages. I've had two, and both worked out well. But I now prefer the certainty that comes with a fixed rate mortgage. I think it's a better financial product for most people. But not all.
In essence, the question about an adjustable rate mortgage comes down to 1) how healthy is your cash flow and 2) if the financial world conspires against you and interest rates go up sharply over several years how deeply will the higher mortgage payments affect you? You're weighing the advantages of lower interest rate payments against the risk of higher payments. Is that a reasonable gamble for you to take?
The big advantage of a fixed rate mortgage is that you always know what your payment will be. It doesn't matter if interest rates go up. However, if rates do tumble, you can always refinance at a lower rate.
A Bigger Mortgage?
Question: Hi Chris! (please withhold my name if you use - thanks!)... I am 36 years old and about to marry for the first time (my fiancé is also 36). He owns a teeny home which he purchased 4 years ago (a duplex) that he will sell and we would use the equity to purchase a larger home since we feel we'll soon outgrow his place if we have a child, and it's actually quite tiny for even the two of us. I am strugging with whether or not we should buy. The mortgage payment (with taxes, etc) on the house that we are interested in purchasing would be about 30% of our combined gross incomes. I have heard that 25-30% is what you shoot for. Everyone tells us to "stretch" and buy more house that we think we can afford, assuming that our income will increase over time. Here's the catch -- I am self-employed, and so if I have a child and stay home for even just 6-8 weeks, I will lose money as I don't have any "paid time off." Plus, being self-employed, my salary can potentially vary (though it hasn 't over the last 2 years that I have been doing this full-time). Is it a mistake to take this on when we know that my income will *decrease*? My fiancé will probably get annual raises of 5-6%.... Thanks so much! Alexandria, V.
Answer: Don't do it. DON'T DO IT. Among the worst pieces of conventional financial wisdom is to "stretch" to buy a bigger home. It's a recipe for money trouble.
You have a lot going on in your life. Getting married. Starting a family. You're self-employed. What if your husband-to-be doesn't get 5% to 6% raises, but only 2% to 3% during a recession--or even no raise? Why add mortgage stress into the mix?
What's more, when you buy a bigger house you take on more than a larger mortgage. Property taxes, heating bills, air conditioning, and all the other costs that go into running and maintaining a home are higher. I'd rather that you put more money into savings--from cash to stocks and bonds--rather than into bigger mortgage payments.
No, I would stay financially conservative so that you can focus on married life and your work. If your incomes go up, you and your husband can always move to a bigger home. But by then you'll have built up the strong foundation of a healthy balance sheet.
A DIY MOrtgage?
Question: Dear Mr. Knows-a-lot-about-financial-stuff,
My niece and her new hubby are looking to buy a house, and are well-qualified for a mortgage. She does not like the idea, however, of all of their payments going to a bank and would rather "keep it in the family" by arranging a private mortgage with me. Are there established reliable brokers who can manage the loan as if it were an arms-length standard mortgage that just happens to use me as the lender? How much work would I personally have to do in the long run? ;-)
I can well afford the up-front loan amount and have good confidence in their financial discipline to pay. Also, I have an excellent accountant who is professionally conservative but used to goofy financial arrangements. Sincerely, Noelie. Austin, TX.
Answer: It isn't a goofy financial arrangement if you have the money and you trust your niece. However, there's the wisdom of the financial ages behind the standard caution of don't lend substantial sums of money to family members. It can lead to a lot of heartbreak.
That said, if you're still determined to go ahead with the loan, it's easy to do. There's no need to work with an outside broker. Instead, hire a knowledgeable real estate lawyer to both draw up a legally binding loan contract, and to make sure that the title and other ownership issues are dealt with properly. Charge your niece a market rate of interest on the mortgage (so you don't get into any trouble with the IRS). Have her set up automatic monthly payment from her checking account into yours. The home is your collateral if she ever stops making payments. Good luck.
Keep or Sell Vacation Home?
Question: Hi, Chris. Perhaps you can help solve a debate between me and my husband. Here's the background: In 2000, we bought a vacation home in the Catskills, 3 hours outside of New York City (where we live). We refinanced in 2004 and got a 4.75% 15 year mortgage and our payments are affordable for us. The home is now valued at 2-3 times what we paid for it, but I'm worried that the real estate market in second home areas won't hold up under prolonged high gas prices and I'm thinking about selling (we could use the money for other things, such as buying a primary residence). My husband wants to hold on to the place indefinitely, thinking that our mortgage rate is very low and high gas prices might actually help vacation spots that are close to big metro areas, since people will still want to vacation but might want to stay closer to home. There does still seem to be plenty of wealth in New York City and prices in its ring of vacation-home areas seem fairly stable so far. Is there any historical precedent you're re aware of or advice you could give that could help us think through what might happen to the second home market over the next few years? Thanks, Erin. Brooklyn, NY
Answer: This is a truly intriguing question for the new world of high-priced energy. I hope Getting Personal readers weigh in with their thoughts.
I do think that high energy prices will impact real estate values over time. For instance, although it's commonplace for financial advisors to recommend that retirees downsize, few do. One reason may be that families often pay almost as much for a smaller home. A two bedroom condominium in an attractive part of a city with all the amenities typically sells for nearly the price tag of a comfortable four-bedroom home in a tony suburb. The same economics hold for moving from a McMansion to a villa.
That may be true, but I think the calculation will change. Large homes cost significantly more to maintain, and are subject to higher property taxes. The savings from running a smaller home compound over time. The combination of high energy costs and an aging population could signal a fundamental shift in the retirement home market toward small is beautiful. Bud Hebeler, who runs the website www.analyzenow.com, believes that over the next decade small homes are going to be relatively pricier than large ones, at least on a dollars-per-square-foot basis."
With that type of thinking in mind, I do think that vacation spots nearer a major metropolitan area like New York will do well, especially as fuel efficient cars become more commonplace. Demographic trends, such as the aging of the population, suggest that vacation homes will continue to attract buyers (once the current downturn reaches the history books). The problems with housing and energy will lie more with exurb developments and larger homes.
So, on this side of the investment ledger I am with your husband.
However, let's say you really want to own your own place. If you can find a good value in today's market (it's better to be a buyer than a seller these days) and you can end up with a conservative financing by selling your vacation home, then I'd sell. It's partly a question of how much you actually use your vacation home, and how much you want to own your own place near to where you work. If the answer is yes--we want to own a home--I'm with you. Sell.
In other words, you're both right. The answer then depends on what is a greater priority for you--a vacation home as an investment or owning a primary residence?
By the way, the vacation market isn't doing well after several years of hype and speculation. Last year, according to the National Association of Realtors, vacation home sales fell by more than 30% in 2007. Weakness in the market was also reflected in a 2.5 percent decline in the median price to $195,000. It's a pretty safe bet that the market is doing worse in 2008. Nevertheless, surveys consistently show that vacation homes are alluring to an aging population.
Anyone else have thoughts on thinking through this question?
Rent--Or Buy?
Question: My husband is 52 and I am 51. He works and I retired in 07 taking my pension in a lump sum which I now take small amount from each month. Husband earns $73,000/yr and stows away 20% in his 401k. He has a chronic degenerative disease which will necessitate him going on disability within the next 5-7 years. A substantial amount of his income goes toward his medical copays, Dr, visits and massive amounts of prescriptions. We sold our SoCal home in December 07 and feel fortunate to have lost just $1,000 on it. With prices continuing to slide, we now rent a home, but rent costs us much more each month than what our former mortgage payment was. I put the $154,000 equity from the sale of the home into CD's and savings for the short term. We can easily find a nice home for $250,000. by putting down our $154,000, we would then have money left each month to spend on other things like traveling, which my husband won't be able to do in the future after he can no longer work. When he does quit working, we will move back closer to family in the upper midwest. What is your opinion on buying in a SoCal market which is still falling; or should we find a more affordable apartment and pay to store our furniture and save some money? Even the nicer apartments rent for higher rates than what a mortgage payment would be. We have no debt of any kind and excellent credit scores. M. Yucaipa, CA.
Answer: Bloomberg recently ran an article suggesting that California could be the first state to hit bottom. "California led the U.S. into the worst housing recession since the 1930s," write reporters Dan Levy and Daniel Taub. "Now the most populous state may be the first to find the bottom." Sales are picking up, with about 40% of sales foreclosed homes. In the article, Mark Zandi, chief economist at Moody's Economy.com, estimates that nearly $1.3 trillion of homeowner equity was lost in California since home prices peaked in December, 2005. ``California is having a wrenching decline in wealth, but this is a cathartic event that will lay the foundation for a recovery,'' says Zandi. ``This signals the beginning of the end.''
It's a good article and Zandi is smart. He knows real estate and credit markets. Still, the downward pressure on home prices doesn't seem to be letting up, and it could still get a lot worse, especially when option ARMs come due later this year and next in California. Even the Bloomberg article expects home price discounts of up to 50% will extend into 2010.
Rather than trying to predict the direction of the real estate market, what struck me in your note was that your husband won't be able to travel in the future. He faces a disability. I say "buy" if owning a home frees up cash flow to travel and do things together while you can. So what if you buy too early and miss bottom? You'll be accumulating experiences and memories while you can. Assuming you're right on the finances and quality of life, I think you already know the answer to your question.
When you look to buy I'd focus on homes that are designed for ease of use when your husband is disabled. In other words, everything should probably be on one floor, with wide doorways (in case he needs a wheelchair), a shower without a lip (again in of a wheelchair or walker), and other so-called "universal design" features that are geared toward making it easier to age in place and deal with a disability.
Borrow to Fund 529s?
Question: My wife and I have no debt except for $23,000 from a home-equity line. This year, she took some time off, reducing our income and meaning that we might not be able to save into our 529s for two sons, ages 6 and 4. (We will save $36,000 for retirement this year.)
My question: Should I borrow $10,000 from our Home Equity line to fund these 529s? My argument is that I immediately get the NYState 6% tax reduction for that whole $10,000 ($600), that the Home Equity interest rate is small (4.75%) and deductible so effectively even smaller (3.5%), and that there is a lot of upside with the market at about 11,500. My wife's argument is that I am completely nuts. Thank you for your (gentle) reply. David, Amherst, NY.
Answer: No, I'm not going to say you're nuts. And you can make the numbers work if you use the stocks market's average annual rate of return of some 7% (after taking inflation into account). Problem is, the flaw with using averages is that Lake Erie never freezes and stock market returns don't fluctuate.
We get variations of this question all the time. What's unusual about your query is the timing. Usually people want to borrow and put the money into whatever asset is flourishing at the time--Internet stocks, residential real estate, and so on. Right now, it seems that just about everything is weak: The economy, the job market, homes, stocks, even commodities.
Leverage is risky. Borrowing to invest in stocks and bonds can backfire badly since you need to make those interest and principal payments even if the assets you've bet on cratered. So I wouldn't do it.
To put it somewhat differently, I don't think the potential rewards justify the risk. It's wonderful that you are saving for your children's college education. But they'll still be able to go to college even if you don't save in their 529s for a year or two. Maybe they'll have to borrow a bit more to pay for college. But that's the biggest downside I can see.
Under One Roof?
Question: After the death of my father, my siblings and I discussed one of us living closer to mom. She lives in SoCal and the cost of living is much higher there (duh). One option is going in on a place with my mother as co-owners, and I would live there. I am guessing I will need to locate some sort of contract, or meet with a real estate attorney to draw this up. Can you provide any advice on this topic, or just outline some of your thoughts? Andrew, Boise, ID
Answer: What you're thinking of doing could become increasingly common with the aging of the population. Indeed, many members of the "sandwich generation," who now find themselves responsible for the welfare of both their parents and children, are embracing such living arrangements that were more common a few generations ago. And even if young children aren't involved, living under the same roof offers less expensive independent living for older people and their adult children. It can be very good from a family perspective.
That said, the move represents a big financial and emotional commitment for an extended family. To make it work often takes many hours coming up with the right financial arrangement that not only are good for you and your Mom, but also take into account your siblings. You will need a lawyer to draw up legal documents, and in cases when substantial assets are involved working with a financial planner is common.
Among the questions to ask: How will you divide utility and other bills. Will you share co-ownership? Will you pay rent to your Mom or vice-versa. Who gets the tax deduction on the mortgages? Questions along those lines. All of this is routine in this market, and there is a fair amount of flexibility in making financial arrangement, but everything should be laid out and well-understood.
Family dynamics came into play, too. How will your siblings react to the financial arrangement?. Will they support you and your Mom? And what are the implications of living under one roof for the division of her estate?
Last, you will at some time in the future be the point person for dealing with disability and death. It's a good idea to talk them through, since you'll be living in the same place. You have to really think about the endgame, more than a lot of people are comfortable doing. That said, I do believe that this kind of arrangement can work for everyone.
Buying a retirement home
Question: My girlfriend and I are both in our mid 50s and thinking ahead to where we want to live when we retire. Here's a summary of our current financial situation. We each own our own homes and don't have any mortgages, car loans, or credit card debt. Her house has a tax appraised value of about $150K and mine is $390K..... She plans to retire in 5 years, receiving a pension from the state. But I will probably wait till full retirement age.
We'd like to buy a house about an hour North of us in a small New England resort town. The property taxes are low, and it will be an interesting place to live. I enjoy doing remodeling work, so we'd like to get something that is older that we'll be able to rehab to our liking, in particular making the property as energy efficient as possible, as well as completely handicap accessible. (We're able bodied now, but...) We're looking for properties in the range of $150K to $250K, although our hope is to keep it at the lower end to keep our future property taxes lower. (NH has no sales or earned income taxes, but property taxes can be a problem for retired folks.)
What I can't decide is how to finance the new property and budget for the renovations. Would it be better to finance the bulk of the new property, reserving my cash for the renovations. Or would it make more sense to use the bulk of my cash to buy the property, and then get a mortgage on the remainder and use a home equity loan to pay for renovations. For that matter, could we mortgage one of our existing homes to help pay for the new property, thereby owning it free and clear, and then pay off the remainder of the mortgage when we sell that house? Do you have any general advice on what would make the most sense in terms of making the most of our resources? First Name: Bill, Barnstead, NH
Answer: First of all, before getting to your financial question, I want to highlight your idea of making improvements now that will make it easier to stay in your home as you and your woman friend age. It's something homeowners should take into consideration with remodeling projects.
For instance, if the home has more than one story, you might consider putting in a bedroom and full bath on the first floor in case the day comes when stairs are too difficult to climb. Bathrooms can be made safer with high-quality non-slip tile, and showers installed with no lip for easy wheelchair access. Kitchen counters can be designed at different heights to accommodate sitting as well as standing. For people in the 50s and 60s, if they're doing a major remodeling, it's the ideal time to make changes that will let them remain independent.
That said, let's look at the finances. You and your woman friend have solid finances. I would not put the new home on to your existing homes. Let's not put the value of those assets at risk.
It reads as if the remodeling, fixer-upper project will take a considerable period of time. If that's the case, your best bet will be a home equity line of credit. It's ideal for home improvements done over a period of time, a project here, a project there. A home equity loan is better when there is a major renovation to be done within a certain time frame.
So, a conservative plan would be to put more money down and take on a smaller mortgage. I would worry less about reserving the cash for home renovations. You can do some smaller, more sweat equity-type projects at first, get to know the place well, really figure out what you'd really like to do it, and then get more aggressive--and have more fun--once you've sold your places and moved into your new house up north.
It's clear that you two have carefully thought through this move. Still, I'd emphasize that you're investing in this property together. I would have a lawyer draw up a legal document that spells out and protects both you and your friends investment and lays out the financial responsibilities.
Faster mortgage paydown?
Question: Hi! We have a 30 year fixed mortgage at 5.625% interest rate. We have $342,300 left to pay on the loan and currently pay $2,776 per month. We received an offer from our large mortgage lender to join their "equity accelerator" program, essentially contributing one extra mortgage payment a year. I'm seeing it as a way to free up cash flow for our bill juggling every month, instead of one whole paycheck devoted solely to the mortgage, I can divide up expenditures a little so we aren't so strapped until the next pay date after paying the mortgage. The fee is $49/one time fee and $9/month. In addition, this will probably be our retirement home as it is lakeshore in a large metro area. We have been surviving on one income for nine years while my daughter was young and then diagnosed with leukemia and now that she is well, I'll return work next September. What do you think of these programs? Thanks so much. Stephanie, Mound, MN.
Answer: I'm happy to hear that your daughter is doing better.
Now, on to the finance question: I'm not a big fan of these kinds of programs as a general rule. One reason is that you can do it on your own without paying the upfront and monthly fee. Just send in an additional check on your own with a note that the exra payment is to go toward principal only. By the way, money will get tighter if you're sending more of your cash flow toward your mortgage.
However, a listener once pointed out that while I was right, she participated in one of these plans because she was a single Mom and her life was incredibly busy. Despite her best intentions she always forgot to send in the check. The automatic program worked for her.
On a more fundamental level, as I've noted many times before, I'm wary of people taking their discretionary money and sinking it into their home. I'd prefer the money go toward building up an emergency savings fund, as well as a well-diversified portfolio of stocks, bonds, international equities, Treasury Inflation Protected Securities (TIPS) and the like. Of course, accelerate your mortgage payments once your home is a smaller share of your overall portfolio.
09/16/08 by Chris FarrellRetirement savings and debt
Question: I have a SEP plan. I make quarterly contributions. I commit a % for the year. At the end of the year if I have extra I contribute more. My question is would I be better off putting the extra into paying off my car? Or just putting it in savings? I am sticking to my quarterly contributions but it is hard when by the next quarter it has "vanished". I am looking at retiring in 15 years. My spouse has a 401K, company pension and separate investments. Would it be better for him to not contribute at this time to the separate investments and work towards paying off the house? He is looking at retiring in about 11 years. Elizabeth, Indianapolis, IN
Answer: I'm glad that that you aren't just looking at your retirement portfolio. It's really easy to get caught up in the downward gyrations of the bear market in stocks and the abrupt shifts in market interest rates. (Imagine, the yield on the 3 month T-bill went briefly negative last wee. That's right, less than 0%.) It's good to keep funding it too.
When it comes to managing household finances, the main message of the past year has been get household finances in good shape by spending less and paying down debt. That's why I like your thought of taking that extra cash in this tumultuous environment and putting it toward eliminating the car loan.
However, I'd recommend that your spouse continue to save for retirement, too, as well as build up household savings rather than take dramatic steps to pay off the mortgage early.
Of course, in the heart of most (all?) homeowners burns an intense desire to say goodbye to the bank for the last time and own a home free and clear. There are advantages to accelerating mortgage payments. You can get a good return on your money, especially in this market. Let's say your mortgage rate is 6%. In that case, by paying down your mortgage early you'll earn the equivalent of a simple 6% rate of return on your money. If your rate is 5%, the return is 5%. (This simple example doesn't take into account taxes and other factors.) You'll save thousands and thousands of dollars in interest payments. And it's important for most people to be debt free when they enter their elder years--and that's what you want.
That said, here's why I'm cautious about getting too aggressive with mortgage payments. My basic problem is that most people end up putting too much of their financial eggs in one basket -- a home. That's another way of saying that your financial health is now increasingly dependent on how one asset performs and, as we are witnessing right now, home prices can go down as well as up. Diversification pays.
For me, the key is building up a well-diversified portfolio of cash, stocks, bonds, commercial real estate, commodities, and international equities--even in a market like this one. I especially like investing in Treasury Inflation Protected Securities (TIPS) and I-bonds. Both of these default-free securities sold by the federal government will protect you against the ravages of inflation. The value of your home shrinks as a percent of your net worth over time. Once you've built up a well diversified portfolio, then pay off the mortgage by all means.
A sensible way to shorten the life of your mortgage without taking drastic action is to make an extra monthly payment a year. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.
Refinance mortgage?
Question: Yes, I'm one of those people with a sub-prime mortgage. When I got divorced and took over my mortgage, money was tight, so I got a 5 year ARM at 4.625. The lower rate expires in April of next year, and goes to LIBOR plus my margin of 2.25. Right now, that would mean a rate of about 5.5%, which would mean my monthly payment would go up about $100.00, which I'm not crazy about, but I could manage. My mortgage is about 40% of my take-home pay. However, who knows what the LIBOR is going to do, and my rate continues to adjust each year on the anniversary. If I refinanced right now to a fixed rate, I think I could get something like 6.6%, which would raise my current payment about $175 dollars, plus I would have to start over at 30 years.
Here's the kicker: my mortgage is held by WASHINGTON MUTUAL! Am I exposing myself to anything dangerous by not going with a different lender? What should I do? When should I do it? I feel paralyzed with indecision. Victoria, Los Angeles, CA
Answer: Ouch! From the subprime to WaMu, the largest bank failure in U.S. history. You've had quite a window into the making of recent financial history. On a more serious note, you may feel paralyzed with indecision, but you've already started the process of calculating how much your monthly mortgage payments would go up if you kept your adjustable rate mortgage at current rates. You're right to be wary of what rates will be in the future. You've also figured out what a fixed rate will cost you. That's a good start. To jump to my bottom line, I would refinance at a fixed rate at the new WaMu/Chase--or another bank. But it won't easy.
Now, for some elaboration on why I say that. Regulators seized and sold most of WaMu to J.P. Morgan Chase & Co. The transaction went remarkably well. The mismanaged Seattle thrift was going under as depositors withdrew money at an accelerating pace. (As an aside, the one agency that has performed admirably throughout the financial crisis has been the FDIC. Indeed, if Washington had listened earlier to Sheila Blair, head of the FDIC, and her prescient persistent calls for a comprehensive mortgage solution we wouldn't be in the current financial catastrophe contemplating a $700 billion bailout. The FDIC is no FEMA and Blair of the FDIC is no Brown, the incompetent former head of FEMA during hurricane Katrina.) WaMu customers were getting money from ATMs this morning.
You're now a customer of the JP Morgan Chase, the largest bank in the U.S. measured by deposits. There's no rush to refinance right now, not with the bailout negotiations continuing in Washington D.C. But I would go to your branch and talk to a loan officer. I would have him or her look at your mortgage and see what options will be available to you and at what cost. You should also check out what competing institutions will offer you, since the takeover gives them an opportunity to nab some new customers that want to say goodbye to Wamu--even in its latest incarnation--for the last time. Hopefully, Chase will want to keep you as a customer (they did spend several billion buying WaMu's customers, after all). So see what kind of fixed rate refinancing mortgage is available to you after taking into account your credit score, the value of your home, and market conditions.
What's more, to break the paralysis I would play a financial version of Pascal's wager. Pascal is famous for saying, "Is there a God, or is there not a God?" Of course, there is no real answer to the question. But Pascal argued that we can rationally decide to act as if there is a God or act as if there isn't.
Peter Bernstein, the dean of finance economists, has long argued that people should think through a financial version of Pascal's wager. First, he says, we can't piece the investment fog of the future. There's no certainty--it's in the nature of the beast. Instead, he recommends focusing on how serious will be the financial consequences if it turns out that your wrong in your bet? If the bet goes wrong, how bad could it be and how much will it matter to your finances.
You could gamble that LIBOR will stay low. And if it does, you'll be just fine. But what if LIBOR soars, how much will it impact your finances? My own feeling is that with 40% of your income already going toward housing the downside risk is big. I would focus on getting into a fixed rate mortgage. And its fine if it is with your current lender.
Capital losses on home sale
Question: My wife and I were fortunate enough to sell our home in North Minneapolis last May, but we did end up bringing our checkbook to closing. We sold our house for a bit less than we owed. We were told at the time by a couple of professionals (a CPA and an investor) that we cannot write those losses off when we do our 2008 taxes. I was wondering if any of the bailout plan signed by congress and the president changed any of this to favor us, or if you see any chance that someday we could get a kick back for our loss? Thanks! Andy
Answer: The information you got from the CPA and an investor is right: Any loss from the sale of your main residence can't be deducted on your tax form come April 15.
Of course, tax cutting is high on the legislative agenda with a new President and a new Congress confronting a recession that's getting worse by the month. A hodgepodge of ideas is in circulation. The more popular proposals include suspending mandatory distributions from 401(k) plans and the like for those 70½ and older, allowing taxpayers to take out as much as $10,000 penalty- free from their retirement accounts (you'd still pay taxes on the withdrawal), getting rid of income taxes for seniors making less than $50,000 a year and allowing a 10% mortgage tax credit for any homeowner that doesn't itemize.
The notion of allowing homeowners to take into account capital losses on sales usually gets short shrift. It's a concept that gets a hearing every time there's a downturn in the residential real estate market. But homeownership is already such a tax favored investment that even the housing-and mortgage-friendly Congress has rejected this tax initiative in the past.
I can't handicap the odds, but the traditional avoidance of capital losses on home sales could weaken. For one thing, the idea of allowing homeowners to take capital losses has been making the rounds in the blogosphere. For another, there is a growing sense that the federal government needs to direct more aid to homeowners and less to financial institutions. For example, reading the Washington Post this morning I learned that Treasury Secretary Henry Paulson had--with little comment--changed the tax law to eliminate strict limits on the losses banks that take over other banks can deduct from their taxes later on. The restriction had been on the books for more than two decades. It was intended to put an end to an increasingly commonplace tax shelter abuse. Although not directly comparable, I can't help but think: If it's good enough for financial institutions why not for the homeowner?
However, in terms of personal financial planning, I wouldn't bank on the capital gains tax law changing when it comes to housing.
Co-sign a loan?
Question: My daughter and son-in-law have an empty "underwater" condo. We all shudder at the thought of renting it out! It's hurting them to be paying a mortgage and other expenses while not living there, so they hope to sell it in 2009. They will owe around $25,000 more at closing than they will receive. I am considering either loaning them the money at a rate about what I can earn on a CD or other savings, OR co-signing a loan from their bank or credit union. I trust them to make payments either way. What are the advantages and disadvantages of either of these plans - for them AND for me? Carol, St. Cloud, MN
Answer: I am not a fan of anyone co-signing a loan from a bank or credit union no matter how much you trust the person. You know them, and you know that they are trustworthy people. But sometimes even very good people can't pay a loan because of a lost job or big medical bills. And then you are on the hook to make the loan payments if you co-signed the loan.
I have been getting more questions lately about co-signing. It's a reflection of tough economic times. Although the circumstances are very different from yours, I want to highlight another email I recently received from a listener. It's from Gregory in Irvine, CA, and it offers a grim reminder of the risks of co-signing:
I co-signed a car loan for a friend and right now there is about 4,000 owed to it. This was a mistake that I regret a great deal because it turns out my friend is not responsible with money and I have just learned he lost his job a few weeks back. I no longer talk to this friend of mine and I do not want any communication. Last week Wachovia, the loaning business, called me and told me that this last months car payment is 15 days over due and they will report the late payment in another 15 days. Please help. I do not want to bail out my former friend for a car he never should have bought in the first place, yet I do not want my credit to be destroyed. Can I refinance the car in his name alone? If the car gets repossessed will it really upset my credit that much? What should I do? What would you do?
Greg is legally obliged to pay up. The only solution I can see is Greg needs to swallow his distaste and approach his former friend and see if they can negotiate some kind of solution.
Since family relations are strong in your case, and everyone wants to avoid the renting option, I would lend the money with an interest rate to your daughter and son-in-law. Then if they fall on hard times the three of you can renegotiate the loan without the involvement of credit reporting bureaus, credit scores, or an impersonal financial institution.
Buy a home?
Question: My fiancé and I are trying to decide whether or not it is a good time for us to buy a house. I am a PhD candidate earning a stipend and have savings for a down payment. He has a full time job as an analyst with a large aerospace manufacturer. We will definitely be in the Seattle area for another 2 years but aren't certain where we will go after that (once I graduate). We have heard mixed things about how long you have to live in an area for buying a house to be worth it and whether or not now is a good time to buy a house. Do you have any advice? Amanda, Seattle State: WA
Answer: Many people are wondering when it makes sense to get into the housing market again. After all, there have been double-digit price declines in most major markets. For instance, over the past year ending in August home prices are down 31% in Las Vegas and 27% in Los Angeles, according to figures compiled by the S&P/Case-Shiller Home Price Index. In comparison, Seattle has held up relatively well with a mere 8.8% decline over the same time period.
That said, I think there are more price declines to come. We're in a recession, and it took a turn for the worse in October. As far as I can see the economy in November is certainly no better than last month and probably worse. I can't imagine many people will extend their finances to buy homes until the scale and scope of the recession is clearer.
What's more, as a recent post on the Business Week Hot Property blog points out, by two common measures the housing market is still overvalued. Comparing the median cost of a new home to median income suggests that home prices nationwide could drop another 15% to 20%. The home prices to average rent ratio is predicting a 20% to 25% decline.
But here's the main reason I wouldn't buy a home right now: You say you might move out of town in two years. I wouldn't buy unless I knew I was going to live somewhere for at least 3 years and preferably 5 years. Even with prices down, a home is an expensive investment. The down payment will absorb savings. Then there are all the closing costs associated with taking out a mortgage. Closing costs can include points, taxes, appraisals, credit reports, title insurance, survey's underwriting fees, and document preparation. The price-tag for all this stuff can range somewhere between 3% and 6% of the mortgage amount. What's more, anyone who has bought a home could tell you that the money spigot doesn't end with ownership. I would save my money and wait to buy a home. That is, until you know where you'll be putting down roots.
Buy a home now?
Question: Is now a good time to purchase my first home in Santa Cruz, California? Buying in this area has never been an option until now. I have watched closely as house prices drop. Some properties, not particularly nice ones, have dropped to just about where my husband and I can afford to buy. My husband and I are worried that house prices in general will continue to fall, thus causing the fixer-upper we can buy now, which is already a financial stretch, to lose much of its value in the future. Lindsay, Santa Cruz, CA
Answer: More and more people are asking themselves: Is this the time to buy? Home prices are down sharply over the last two years, and mortgage rates have recently trended lower, too.
Take California. The Golden State's housing boom earlier in the decade was phenomenal, and the subsequent bust has been scary. Over the past year, according to the Shiller-Case index, prices in Los Angeles have dropped by 28% and in San Francisco by 30%. A recent article in the Santa Cruz Sentinel says the median home price in Santa Cruz County fell to $433,000 in November. That's down 41% from a year ago.
The price of a median home is still high, however. I don't know where the residential real estate market's bottom lies--let alone when the housing market will stabilize. My best guess--and it's a guess--is that there are additional price declines in our future.
A home is a good purchase for many people. The key is that your finances shouldn't be stretched. If that's the case, a home is a low return long-term investment with some tax benefits and, most importantly, a lifestyle--a neighborhood and a nesting place.
Price matters. What concerns me is that you'd have to make a "financial stretch" to buy a home. That's how people get into money trouble. I'm less concerned that prices might go lower than I am about what owning a home might do to your financial health.
It isn't just the cost of paying the mortgage principal and interest payments, real estate taxes, and homeowners insurance. A home is expensive to run. You may love tending to your garden and taking care of the lawn, fixing the roof and maintaining the garage, but that pleasure costs money. A good rule of thumb for the average homebuyer is that annual maintenance costs range from 1.5 to 4 percent of the home's original cost. It sounds as if you and your husband are handy since you're looking at fixer-uppers. Sweat equity is a good way to build value, but there is still a cost to repair and improvements.
It's no fun being house poor. That's why I lean on the conservative side when it comes to home ownership. Run the numbers carefully. Be comfortable with the fact that a home typically only pays off over the long haul. Make sure that owning doesn't prevent you from meeting other important financial goals, such as saving for retirement. If your okay by these measures, then buy by all means. If not, I'd be wary.
Refinance, or not?
Question: In 2006 we bought a house in a pretty strong real estate market with a 30 yr fixed rate that wasn't stellar, (6.75%). We have no problem making the payments and putting away ~10-11% into retirement funds. We have student loan debt (<30k, @2.45%) and are paying those down on a 10 yr plan with no problem as well. My question is with the recent fed rate cuts, and our mortgage being our biggest debt, shouldn't we consider refinancing, and should we be sinking more money into our retirement funds, or into the principal? I've been quoted 30yr rates as low as 4.75% for our situation with closing costs of ~$3.5k, so the savings on the interest rates seems substantial. If its relevant, we plan on keeping the house for at least 5 more years, no matter what, after that it is total unclear. Luke, Baltimore, MD.
Answer: The Federal Reserve Board made history this week by cutting its benchmark interest rate between 0% and 0.25%. Since Thanksgiving weekend the impact of the Fed's campaign has been noticeable with mortgage rates--and a pick up in mortgage refinancings. The gap has widened enough that for many homeowners it makes financial sense to refinance. However, the pool of qualified applicants is relatively small compared to previous refinancing booms because lenders are limiting their interest to those with a good credit score and equity in the home.
First of all, I would run some numbers. There are a number of good calculators. Check out the ones at www.dinkytown.net.
While there is nothing wrong with accelerating mortgage payments, here's why I am cautious about the strategy: You end up putting too much of your financial nest egg in one basket--a home. That's why I still prefer building up a well-diversified portfolio, even in a market like this one. I would still save for the long run in a diversified retirement savings plan.
For many people a reasonable way to shorten the life of the mortgage without cutting back on retirement savings is to make an extra monthly payment a year. I've recommended this before. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.
First time homebuyer
Question: What is your suggestion for finding up to date information on all I would need to know about mortgages for the first time buyer. I would assume that most books on the subject are now out of date with the current market. Paul, Valley Cottage, NY
Answer: One of the resources I like is www.hsh.com. It offers up to date information and thoughtful articles on the basics of buying a home, refinancing and the like. Another good source for information is www.bankrate.com.
Mortgage rates
Question: According to the Market Gauges in today's New York Times, the federal funds interest rate has dropped from 4.25% to 0.25% in the past year. Yet the rate charged homeowners for a 15 year fixed mortgage has dropped only from 5.33% to 5.05% in the same period of time. I wonder whether such discrepancies are historically typical, and what might be the typical time lapse before the mortgage rate drops proportionately to a reduction in the rate that banks charge each other to borrow money. Alternatively, does the discrepancy reflect the reluctance of banks to loan despite their receiving the TARP funds? This is of practical interest because I am contemplating refinancing my home mortgage and wonder how advisable it is to wait, assuming mortgage rates are likely to drop further as the effects of reduction in the prime rate will eventually trickle down to benefit consumers. Eric, Amherst, MA
Answer: If history is any guide, mortgage rates should drop farther, even though they are already at their lowest level since Freddie Mac started publishing the data back in the early 1970s. For instance, as I am writing this the yield difference between a 30-year fixed rate mortgage and the 10-year Treasury bond is 3.11 percentage points. (The 10 year Treasury bond is the benchmark interest rate for pricing mortgages.) The quick rule of thumb is that gap is normally about 1.5 percentage points, suggesting that the yield on the 30-year should be 3.61%. That's way below the current rate of 5.27% on the 30 year fixed rate. The interest rate on the 15 year mortgage would be even lower, closer to 3% instead of its current 4.83%. (Rates have come down slightly since you emailed your question which accounts for the different interest rate figures.)
History is one reason to suspect mortgage rates could go lower. Emerging signs of deflation or falling prices is another. And the government appears eager for mortgage rates to head lower. It's a good way to support the housing market since lower rates encourage refinancing and new home buying.
That said, we're living through a period where common rules of thumb are suspect. What's more, the government's ability to manipulate long-term bond yields is limited. Investor wariness about securitized mortgages is hampering the market's recovery. Lenders are wary of anyone with less than a stellar credit score. The housing market continues to deteriorate. All these factors are keeping mortgage rates historically high relative to Treasury yields. There's also the risk that at some point all the money the government is pumping into the system will ignite inflation fears.
What's the homeowner to do? Think through the downside. What if you wait for lower rates, and mortgage yields go up instead? How much of a difference will that make to your household finances? In other words, does it pay for you to bet on lower rates because it doesn't matter much to your overall finances if rates stay where they are or go higher and you can't refinance? Or is there a wide enough gap between your existing mortgage and current mortgage rates to make a refinancing financially sensible? if that's the case, why not refinance even if you do miss bottom? These are the kinds of questions and scenarios I would run through, always with an eye toward protecting yourself agaisnt the downside.
12/31/08 by Chris Farrell
When to pay off mortgage
Question: Given today's low returns on money market accounts and CDs, is now a good time to pay off one's mortgage? I am about 1/2 way through my 15-year, 4.875%, fixed-rate mortgage and plan to keep the house. The mortgage balance is $110,000. I have been "maxing out" my 401K for the last 18 years and am fortunate enough to work for a company that will provide a defined benefit pension. I have low expenses, no debt other than this mortgage and an income that allows me to save several thousand after-tax dollars each month. I have $250,000, after tax, in a money market account -- more than enough for emergencies.
I am thinking of using $110,000 of my after-tax cash to pay off my mortgage. Given the low returns on money market accounts and CDs, the argument for using extra cash to pay off debt, including mortgage debt, seems to warrant greater merit, right? Thank you very much, Carl (Currently working in Singapore), Alameda, CA
Answer: We've been getting a lot of questions about paying off the mortgage early and, while it isn't a financial mistake, I'm usually wary of the strategy. You'll see why in several previous postings. But I'm including your question as an example of when the strategy just might work.
You have a good-sized emergency fund, and after-tax savings. You're fully funding your retirement savings plan. You have a company pension to boot.You have no debt other than the mortgage. You are well-diversified with a great balance sheet. Wow.
I think there are only two issues to consider. First, are you going to stay in the home? Is this where you plan on living? It sounds like it, but if you were going to move shortly or desired a different house I'd probably just stick to the current mortgage payment schedule. Second, could you do better than 4.8% investing in the money in the market rather than paying off the mortgage? Of course, you don't know, but you might be able to. Still, in light of all the uncertainty in the economy and financial markets a 4.8% return on investment by getting rid of the mortgage and being debt-free seems really good to me.
Break the 401(k) piggy bank
Question: With the incredible deals in Michigan Real Estate and the loss that I've already taken in my 401K, what do you think about buying our dream home with the money left in our 401K? Patrick, Livonia, MI
Answer: Forecasting is a hazardous business. But for now it seems that the beleaguered Michigan economy will stay under downward economic pressure.
I think you're right that it's becoming increasingly affordable for many people to own their "dream home" with the sharp decline in home prices and the fall in mortgage interest rates. But I don't like the idea of raiding your 401(k) to buy that home.
You're far from alone with "paper losses" in your retirement savings account. Nevertheless, the money in this account is a pool of savings that will gain in value over the years. It's also a smart way to diversify savings outside the Michigan economy where you live and work. If you take the money out you will both lock in your losses and pay income taxes on the withdrawal and a 10% penalty. Taken altogether, it's a bad financial deal.
I want you to own your dream house. I don't see any reason to rush, however. The economy isn't going to turn around anytime soon, and even if you miss the bottom in home prices it's a good bet that prices will stay low for several years--at least. More important, one of the lessons of the past several years is to make sure you stay financially conservative when buying and owning a house. Another lesson is that a home is a long-term investment.
That's why I would start shopping for your dream house. Run the numbers, and figure out what you can afford while leaving the retirement savings plan alone (and continuing to save for retirement.). Add to and build up your savings so you can put down a good-sized down-payment. Make sure your credit score is high so you qualify for the best mortgage interest rate. You'll get that home, but with a healthier balance sheet than if you close out the 401(k). .
A home dilemma
Question: In 2005 my son-in-law bought a house in Florida for $220,000. He financed this purchase with a 15-year prime-rate mortgage, which he has been prepaying ever since. This house is his residence and he owns no other real estate.
In 2008 he married my daughter, who has been accepted to a medical school in another state. They will need to sell the house and move this summer. The problem is that they will need to get $160,000 for this house, which is now worth only $140,000. What options are available to people who are current or even ahead in their mortgage payments, but whose homes have lost value and they need to sell? My daughter and son-in-law do not want to walk away from this house or do anything that will jeopardize their credit rating. Susan, Bethesda, MD
Answer: This is a classic real estate problem exacerbated by the historic downturn in home prices. It's not unusual even during goods times for homeowners to face a loss when they want to move for a job (or in their case professional schooling) and they've only owned the place for a few years.
The classic answer is to rent it out. They'll earn rental income until the market rebounds. Then they can sell off the property. To be sure, there are difficulties to renting. They'll have to figure out if it's a viable solution for them. They'll want to find a good tenant. Since they'll be living out of state they'll need to contract with a professional property manager to oversee their home rental (which cuts into rental income). They should research the rental market in the area to see how much they can realistically charge. Still, renting is a classic way to buy time. For instance, when the New York City real estate market declined in the late 1980s and early 1990s a number of my friends rented out their condos and co-ops until they could unload them several years later.
Another time-honored solution is to dip into savings and make up the $20,000 shortfall to pay off the mortgage. In essence, it's the cost of doing business, part of their "investment" in her medical career. Yes, this option is financially painful, but it also stops their exposure to the housing market in Florida, keeps their credit record sterling, and allows them to start a new life and a new career in another state with a clean financial slate.
homebuyer tax credit
Question: My husband and I just bought our first home in South Minneapolis this past fall. Since then, I have heard a lot of talk about the IRS Federal Tax Rebate for first time home buyers that is being offered this year. I know that we qualify for the full amount of the rebate ($7500) but I am concerned about the provision to pay it all back in the remaining lump sum in the event we sell in the future. Is there a way to take less than the full amount or is this interest free government loan just too good not to pass up in its entirety? Christine, Minneapolis, MN
Answer: Thanks for the question. I hadn't looked very closely at the $7500 tax credit for first-time homebuyers. You've forced me to look at it more closely and, as far as I can see, it's a better deal than I thought.
Like all tax law today, there are quite a few wrinkles. (The IRS has a lot of good information here.) Here are the highlights:
*It's really an interest free 15-year loan. You claim the credit on your federal income tax form. The tax credit is equal to 10% of the qualified home purchase price, and tops out at $7500.
*You don't have to start repaying the loan for the first two years of homeownership. After that, you send the government $500 a year. If you sell the house before you have repaid the loan you pay it from the gains. No gain? The loan is forgiven.
*To qualify you have to buy on or after April 9, 2008 and before July 1, 2009. (Keep those dates in mind!). The purchase date is defined as the closing day. A first-time homebuyer is defined as someone who hasn't owned a home for 3 years preceding the closing.
*The income limits on adjusted gross income is $75,000 and less for single filers and $150,000 for married joint filers. For income above that a partial credit is available. Anyone with an adjusted gross income of more then $95,000 for single filers and $170,000 for married filers doesn't qualify.
The standard rule of taxes applies here: If taking the credit improves your finances then take advantage of Uncle Sam's offer. And for most people I think the credit will be a good deal.
Additional thoughts, anyone?
Here is an update. It's from a look at President Barack Obama's economic recovery plan as it was reported out of the House Ways and Means Committee. The analysis is by CCH, a Wolters Kluwer business.
New Rules for First-time Homebuyer Credit
The proposed legislation modifies the first-time homebuyer credit that was signed into law last year, removing a requirement that the $7,500 credit be repaid over 15 years, but the waiver applies only to houses purchased in 2009 and before the expiration of the credit on July 1. On the other hand, those who take the credit will have to repay the entire amount if they sell their homes within three years of purchase.
Under current law, those who purchased homes between April 9 and December 31, 2008, can claim the credit on their 2008 return, but must repay it over 15 years, beginning with their tax return two years after purchase. If they sell the home, they must repay the entire credit, but only up to the amount of their gain on the sale.
"Frankly, the distinction between 2008 and 2009 purchases is puzzling," Luscombe said. "It seems strange for the people who bought a home in December 2008 to be treated so differently from those who do so in January, 2009, so I wouldn't be surprised if somewhere along the line someone will take a second look at this."
Buy a home?
Question: With interest rates and real estate prices falling, I've begun looking around to buy a home. Some of my friends think this is a fine idea ("It's a buyer's market"); others think it's financially foolish ("Anything you buy now will lose value. It will be at least a year before the market bottoms out.") Where do you come down on this question? Lisa, Greenville, SC
Answer: I'm with you. It's a good time to look. But you have plenty of time. Of course, I have no idea how much lower home prices will go. In most parts of the country there's still downward momentum. I don't know how deep the recession will get and how high the unemployment rate will go. Still, the economic environment says there's no rush.
That said, why not start the process of figuring out the personal finances of homeownership for you? Run the numbers: Is it smarter for you to rent or own? Where is the breakeven point for homeownership? What's your credit score? Do you have 20% or more to put down? How long do you plan on staying in the home since the longer you live there the better the finances work out--and vice versa.
I'd also use this time to explore neighborhoods. What works bets for your lifestyle? A single family home? A condo? Townhouse? Research, plan, and then when the time is right act. It's a buyer's market.
Should we buy an apartment building
Question: My husband and I are ready to buy a home but given the uncertainty of these times and of even our seemingly secure jobs, we're thinking of buying a 2 or 3 family building, living in one of the units and using the rental income as a hedge against one of us losing our jobs one day. Or, if that doesn't happen, we would have the option of converting the building to a one-family home.
But my question is this--will banks take into account the value of the rental income when we are figuring out what we can afford and get a mortgage for? Is there any rule of thumb for that? Our income is about $250K and we would need to spend at least $1.1 million for a multi-family unit in our neighborhood in NYC. That's on the upper range of what most online calculators say we can afford, but with a rental income to help out, do you think we can do it? Any thoughts about whether this seems like a good idea? Erin, Brooklyn, NY
Answer: Buying an income producing property such as a duplex or fourplex is a classic way of lowering the cost of ownership. But the difference between being a homeowner and a landlord is comparable to the difference between driving a Volkswagen Beetle and a Mack Truck. Like a truck driver, when you're a landlord you're running a commercial business dependent on cash flow.
When we buy a home we hope to make money over time through forced savings (paying off the mortgage) and appreciation (a vague hope sometime in the future considering the state of housing). But a home is much more than an investment. It's a lifestyle, a neighborhood, a commute to work, school for the kids, and the like.
A rental property is a business. Like all small businesses, you'll get some tax advantages, such as depreciation (an offset to taxable income) and deductions tied to the repair and maintenance of the business. If the business does well and generates a good cash flow it will more than cover your mortgage and other expenses. It's a way to create wealth.
The size of the mortgage and the mortgage will be affected by a number of factors, such as the down payment, your income and debt ratio, and whether the apartments are empty or have tenants. The basic dynamic is the same as a home purchase: The larger the down payment the easier it is to get a loan and a decent rate. Mortgage loan limits are higher for a commercial mortgage, but so is the interest rate. The big issue for you--and the lender--is your ability to meet the monthly mortgage and other monthly financial payments even if rental units are empty. The banks will take the rental income into account, but at a discount because apartments can be empty.
In other words, like all small business there are genuine downside risks. For instance, you have to keep good books and your taxes will be more complicated. You'll need to work with a professional insurance agent to get the right kind of property and casualty coverage. Any landlord will tell you that the business is highly dependent on the quality of your tenants. It's a highly regulated business, especially in large metropolitan areas like Brooklyn or San Francisco, and landlords are sued more than any other group of business owners in the country. I would talk to landlords in your area about their experiences, go to some local landlord meetings, and tap into on the ground experience.
To be clear, owning rental property can be a great business. I just want to you to be sure this is the entrepreneurial venture for you.
Consolidate loans to mortgage
Question: Please help... Would it be a good or bad decision to put a non-consolidated Parent Plus Loan into a home refinance? The refinance rate is 4.5 and the student loan is 7.9 (!) I have two other consolidated loans at 3.25 and another at 5.875. I'm currently over the limit (2x) of interest I can deduct, so if included it, the interest it would be deductable, but does it make sense to increase my mortgage by so much (an additional 32K on a 156K mortgage? And I will have to pay an additional .25 point to do the cash out. Will the Plus Loan interest rate be reduced in July? Would it make sense to wait and consolidate? My refinance will settle before I know the next rate. Will the deductable student loan interest rate be raised? I have a line of credit rate currently at 2.5, but they will average 3 years interest to do a fixed loan, so that w on't help now. I would rather keep it separate, but am temped by the 4.5 rate. I want to make the best short and long term decision.... Thanks in advance for considering my question. Mary, Garrett Park, MD
Answer: I want to address the core of your question. I believe one reason why so many middle-income homeowners got into financial trouble in recent years is that they consolidated their debts into first and second mortgages. Yes, the interest payments are tax deductible. But I don't think the tax deduction is worth the extra risk.
For instance, it always upset me when financial advisors would recommend consolidating credit card debt into a mortgage. That's crazy. I feel the same way about student loans. There is financial flexibility with Parent Plus loans, such as a graduated payment plan, income sensitive payment plan, and an extended payment plan. (Of course, the price for taking advantage of these options is the overall cost of the loan goes up.) If you pay off the loan by rolling it into your mortgage you'll lose that flexibility, and increase the risk of losing your home if you have a job or income setback.
Refinance
Question: Today Friday the 13th, we signed refinancing papers for a 4.75% fixed 15-year mortgage. We had 6.0% 30-year fixed so this is a good deal for us. My first question. Will the "soon to be approved" stimulus packet have 4-4.5% refinancing available for those with good credit, as it was talked about last week? I have not heard anything this week about loan financing rates in the agreed upon plan.
If the lower refinancing rate will be available soon, it is worth it for us to decline the loan (within our 72 hours window) and take a chance on being able to get the lower rate loan in the near future. Or is the proverbial bird in the hand what we should hold on to at this point. Bryan, Ellicott City, MD
Answer: The fiscal stimulus package doesn't have anything to do with bringing down mortgage interest rates. The Treasury's proposed bank bail out plan does have the Federal Reserve buying securities in the market to bring down interest rates. (Don't worry; we're all confused about what is what these days)
No one really knows whether the Treasury and the Fed will succeed at lowering rates and, if so, by how much. So, the question is whether it's worth it to you to see if rates fall much farther and, if they don't, that it's a risk you're willing to take. My sense is that you got the mortgage and rate you want, and the cost/benefit trade-off for waiting isn't worth it.
Mortgage help?
Question: Hi Chris, I'm in more than a bit of a quandary...I purchased my home (townhouse) in 2005 and refinanced in 2006 (to get away from an frightful interest only mortgage to a traditional 30-yr fixed mortgage). While I live quite frugally, my mortgage is more than 60% of my income, and of course now my property value has tanked into what appears to be the abyss! I do also have a student loan that I'm paying off (great interest rate so I don't want to mess with that), so between all my mandatory payments, I feel I have absolutely no wiggle room at all, and do feel more than stressed. Will this new stimulus package be able to help someone like me, i.e., can I take advantage of this package to do some thing about my mortgage? Thanks so much. Mini, Herndon, VA.
Answer: I don't blame you for feeling stressed out. You're paying out way too much of your income for shelter. Let's hope the Administration's housing plan does buy you some relief. Now, it seems to me that the mortgage refinancing portion of the plan is designed for people like you. You're current on your payments. You have good credit, paying your bills on time. But you can't refinance into today's low rates because you don't have enough equity in your home after the steep decline in home prices. The new rules allow Fannie Mae and Freddie Mac to refinance mortgages where the value of it is between 80% and 105% of the value of the property. Many borrowers that are making their mortgage payments on time have seen their loan-to-value ratios climb into this range because of falling house prices. However, this program is for "conforming" mortgages, ones that fall within the $417,000 loan limit of Fannie Mae and Freddie Mac. (There are higher loan limits for 59 high-priced sections of the country.)
That's one avenue to pursue. There's another tactic to consider, or at least explore. The loan modification part of the package is aimed at borrowers in imminent risk of default. That's not you. But it has incentives for mortgage lenders and mortgage servicers to reduce monthly repayments to 31% of gross income--considerably less than you're paying right now. (And the new loan modification plan is supposed to stop the practice of lenders loading up mortgage modifications with fees, penalties and the like so that the new arrangement is actually more expensive than the previous one. How's that for disgusting?) I would at least try to see if you can get your loan modified. But if you do get an offer look carefully at the deal to make sure you come out ahead.
Hopefully, you will be able at least to refinance your mortgage at a lower rate.
Downsize?
Question: I'm 50 yrs old and have been thinking about downsizing and relocating for a few years now. I am self-employed and can take my work with me, so my income is not tied to a particular location.
My plan is to sell my current home, of which I own about 70%, and take that cash to buy a different house that would better suit my needs as I age, etc. Hopefully I could buy this house without a mortgage, though I would consider taking a small 10 yr mortgage if necessary.
I realize that it may be impossible to sell my house in the current market, but if I DID sell my house near the market rate, and put the money into another house in a similarly deflated market, would this be a foolish endeavor? Or is it ok since I'm just moving my equity from one house to another? Thanks. Anne, Olivebridge, NY
Answer: As Jane Austen wrote in Emma: "Ah! There is nothing like staying at home for real comfort." Problem is, many people's homes--their most valuable asset and the foundation of their retirement plans--provide scant comfort these days. At some point, of course, real estate prices will stabilize and economic growth will pick up again. The question, as always, is when--and by how much.
That said, I think your idea of downsizing and taking into consideration aging is spot on. For one thing, you'll have a nice equity cushion going into retirement, and one of the worst ideas coming out of the boom years was that it was okay for retirees to carry a hefty mortgage. That was bad advice in most cases.
Large homes cost a lot more to maintain and are subject to higher property taxes. The savings from lower energy costs and other expenses associated with running a smaller home compound over time. Plus, as we age, few of us want to perform maintenance. Smaller yards and single-level homes become more attractive, as do condominiums and townhomes with maintenance staffs.
So, no, I don't think what your contemplating is a foolish endeavor at all. I hope more people are building downsizing into their retirement savings plan.
Co-sign for brother
Question: I'm planning to cosign a home loan for my brother. What's the best way to insulate myself from unforeseen liabilities? Are there any pitfalls in joint ownership? I'm going to ask them to buy a life/disability insurance in my name. Though I'm not sure if the benefits of paying the insurance outweigh the cost of getting mortgage in their name. I'm cosigning to get them a better mortgage terms. He and his spouse earn a decent salary and want to buy a town house in LA suburb. They have recently moved to US, have less 15 month of credit history and 600+ score. House value: 350K. Income > 90K. Down payment - 10%. Naren, Boston, MA
Answer: Lenders love it when a loan is co-signed. It increases their security. More borrowers than ever are seeking better loan terms by turning to family members or close friends to co-sign loans. All I can tell you is that if your brother and sister-in-law can't meet the loan payments you are on the hook. There is no way out of it. There is no way to insulate yourself from that obligation. That's the risk you're taking.
It's wonderful that you want to help them out financially. The problem is we live at a time in our history when job security is vanishing, the depth and length of the recession is uncertain and the risk of unemployment unusually high.
I have two recommendations. The first is to question whether it makes more sense for them to continue renting for now, build up their credit and learn more about their new city. They have plenty of time. Home prices are not rising anytime soon. The other suggestion is not to co-sign but to help them out financially. For instance, you can gift to them up to $24,000 a year--$12,000 each--with no tax consequences. But you're not taking on the legal obligation of the loan.
A loss on selling home
Question: Hello, I sold my house last year and lost 30K. Can I claim any capital loss on my tax returns? Rozario, Nashua, NH
Answer: No, when you sell a home at a loss you can't turn to Uncle Sam to lesson the financial hit. A home enjoys enormous benefits when you have a profit at sale. A single filer gets to exclude $250,000 from capital gains tax and a joint filer a $500,000 gain. (There are some restrictions surrounding this capital gains exclusion.) But on the downside the loss is all yours.
Mortgage vs. savings
Question: Should I be making additional payments on my mortgage? We live in California and bought our home about 3 years ago, near the peak of the market. At the time, we put down 10% and took out an 80/10 30 yr fixed, and could well afford the house. We make pretty good money and normally paid extra on the loans. We finished paying off the 2nd late last year. In a normal environment, we would have moved our extra payments to the 1st mortgage, but given the current economy I have been hesitant to do so. The value of the house is down some 60%, so we are very underwater, and I feel like I'm throwing money down the tube if I make extra payments. My thought is to just ride out the market and put the extra money away in case some other opportunity or emergency arises. To further spook me, I was laid off in December, but thankfully managed to get another job in about a month. Otherwise, we are debt free, fully fund all of our 401k's, IRA, and have six months of emergency savings. Donny, Suisun City, CA
Answer: I like your thought: Stockpile the extra savings for now in a safe place, such as an FDIC insured savings account or certificate of deposit. You are in good financial shape overall. But it sure doesn't hurt to add to savings while the economy is in a tailspin. I imagine you still face some real job insecurity since you haven't been employed at your new place for very long, either.
Your job circumstances will improve and the economy will get better some time in the (hopefully very near) future. At some point, you'll figure out the best use of that savings. Don't let it burn a hole in your pocket. You've worked hard for it. The money could go toward accelerating mortgage payments, to pay for a career change, additional training and education or some other investment. What's important for now is that you're creating both a flush emergency savings account and a flush opportunity fund. They're really two sides of the same coin.
A home? a Master's? both?
Question: My son wants to buy a home and get his masters degree in the next five years. He is single and in his early 30s. He has excellent credit, very little debt, earns about $80K gross a year, and has cash for a 20% down payment. He has been with his current job for less than two years and is going to school part-time. If he gets laid off in this economy, he will have trouble paying his mortgage but it will put him back into school full-time and get him through his degree quicker. He is making a career change with the Master's degree program, which will take 2 years if full time and will leave him with $20K in student loans. When he graduates, he will have to look for a job in another field with a starting salary that is lower than his current job.
What suggestions do you have for him in terms of timing of his home purchase and education vis-Ã -vis the economy and his personal circumstances? I had suggested that he postpone his career change until the economy rebounds, but these days you can't convince kids to hold down unsatisfying jobs just for the sake of income and financial stability. Thank you. Ellie, Fitchburg, MA
Answer: Your son is making a big investment in his new career. He knows he'll probably graduate with student loans to repay, and he'll end up with a lower paying job once he has his Master's in hand. The return on investment comes from entry into a career he will enjoy and higher pay as he gains experience in his new field. He's making a big investment in his future.
I would advise against making an additional investment in a home. Sure, home prices look increasingly attractive. But he will be creating a high-risk personal balance sheet if he goes into debt to buy a home and takes on debt to get an advanced degree. He might come out okay if everything goes well. But the unexpected always happens--another bear market? a spike in interest rates?--sometimes on the upside and sometimes on the downside. He'll be at risk with all that debt if it's the latter.
He can always buy a home when he's embarked on his new career. Instead of using his savings for a 20% down payment, I'd use the money to reduce or even eliminate any student loans. He could also tap into that savings to help fund his career shift once he reenters the job market. I'd encourage him to invest in his career now, and buy a home later on.
04/08/09 by Chris FarrellGetting rid of escrow
Question: My mortgage (with GMAC) has an escrow element tied to it. Every year, the amount collected exceeds the amount needed for the tax payment, but when the annual Escrow Analysis statement comes in, the mortgage company declares there is a shortage, and the amount of my mortgage payment will go up whether I pay the shortage or not.
First of all, what is up with that? If I paid in more, how is there a shortage?
And secondly, can I remove the escrow from this mortgage without refinancing? I know I can easily save for this tax payment throughout the year, and collect interest for myself. Thanks very much. Diane, Milwaukee WI
Answer: I wish you luck. The money that goes into an escrow account is used to pay for expenses such as real estate taxes, property taxes, and homeowners insurance. Lenders require an escrow account if you put less than 20% down. That's a lot of people in the 2000s when a 20% down payment became the exception. The fluctuating payments could reflect a number of factors, ranging from higher bills to changes in the amount the lender requires as a cushion. Whatever the reason, some homeowners love escrow for its convenience and others can't stand it.
Here's the thing: If you have 20% or more equity in your home you can approach your lender. They may waive it for a fee. But lenders like escrow accounts so they aren't eager to make the change. That's why many homeowners with 20% or more in equity in their house end up refinancing to eliminate escrow (or perhaps more accurately, getting rid of escrow is an additional benefit to refinancing).
Home equity and credit cards
Question: I have a $16,000.00 credit card balance with Chase at 3.99 % until balance is paid off. I also have a home equity credit line that would support paying this balance off. The home equity interest rate is currently at 4.12%.
My question is would I be better off paying off my credit card and putting it into my home equity line of credit where I could deduct the interest on my taxes even though the interest is slightly higher or stay the course and continue to make monthly payments on my credit card. Some one told me it is not a good idea to put your credit card balance against your mortgage. What do you think? Roger, Minneapolis, MN
Answer: I am against using home equity to pay down credit card debt. Yes, you get to deduct the interest. But you're hardly paying much of an interest rate anyway.
Far more important, once all your debt is home-based you risk losing the house if you suffer a setback. If you look at the credit problems of recent years a common mistake was homeowners tapping into their home equity to consolidate debts for the tax break. Then they got into financial trouble--lost their job, suffered a major medical illness, got divorced--and suddenly they couldn't make their mortgage and home equity payments. Results: Foreclosure, a short sale or extreme stress holding on to the property.
Yet there are a number of ways to get financial relief on auto loans, credit cards and similar consumer debts. For instance, you can make minimum payments for a while, go into debt counseling, and even declare bankruptcy. And you get to keep the home. The bottom line: I don't like the risk-to-reward ratio.
I would just focus on paying off the credit card and leave your home equity al
The Administration's home refinance program
Question: WE OWE 3 mortgages at 5.3755% 6.25% 6.98% for three different homes. Would we be qualified to refi under the HOME AFFORDABLE REFINANCE program with the current rate under 5%? Thank you so much. Mai, Los Angeles, CA
Answer: It's always worth a phone call to try and negotiate a deal, but I doubt that you'll qualify under the Administration's program. The reason is the way the Administration's homeowner rescue plan is designed, it explicitly won't help out anyone with homes purchased as an investment. The home must be owner-occupied. The federal government says it doesn't want to be bailing out speculators (unless they call Wall Street home and gambled with billions of dollars).
The Administration's home rescue plan is complicated with a number of twists and turns. For instance, the federal government isn't reaching out to borrowers who misrepresented their income on no-doc loans. The plan loosened the rules so that homeowners current on their mortgage can refinance even if their mortgage represents as much as 105% of their home's current value. But the sharp decline in prices in many parts of the country means many troubled homeowners still don't qualify for relief.
I would call your lender and see if you qualify for a refinancing under their normal guidelines.
Mortgage vs. CDs
Question: We have several CD's that are coming due. Interest rates are so low we are wondering if we should pay off our 6.875% home loan with the CD's and then pay our house payment to ourselves to resave. We only owe about $72K. The CD's are for our retirement; we are self employed. Gail, Arlington, WA
Answer: First of all, I don't see how you can go wrong by paying off the mortgage or reinvesting the money into CDs.
On the one hand, the advantage of eliminating your mortgage is that you'll earn a 6.875% return on investment--not bad in this market. I also believe that most homeowners should enter their retirement years without a mortgage.
On the other hand, if you keep the money in savings you have a personal financial safety net in case business slows down for one or both of you during the economic downturn. I also believe it's smart to own a well-diversified portfolio and not put too much of your savings into a single asset like a home.
So, my answer really comes down to evaluating how much risk you face. The more secure your income and the better diversified your overall household portfolio the more I would lean toward getting rid of the mortgage, and vice versa.
Buy a home soon?
Question: My girlfriend and I want to buy a house soon. My credit is great, I have no debts, but I have been unemployed living on my savings since 2006, continuing my good credit history with the use of a credit card. Together, we have about $20,000 in savings and $7,000 in a Roth IRA. She also has great credit that she built with Macy's and personal loans. She has secured full time employment in the LA County, making about $37000 a year. She just earned her MPH with potential for a better position that pays $52800 a year. She has $13,000 in student loans. Should she pay her loans off before we apply for a home loan? Should she get a credit card to continue her good credit history? Should we wait for her to get a higher position? Gerardo, Los Angeles, CA
Answer: A house is expensive to buy and to own. My concern is that your finances are too fragile for homeownership, and you'll end up buying financial trouble. The lesson of the recent real estate boom and bust is that stretching to own is truly risky.
Now, it's wonderful that your partner has landed a good job with the prospect of a promotion. I would wait until the promotion came through. I wouldn't buy anticipating that she'll get the higher paying job, especially with all the state and local government financial problems in California. She doesn't need a credit card, either.
Instead, I'd focus on paying off loans and building up savings. I'd let your partner get established in her job and, hopefully, you'll find one soon. This will put you in a much stronger financial situation whether you end up buying or not.
To be sure, you might miss being able to take advantage of this year's first-time homebuyer tax credit of $8,000. That's a lot of money. But I don't believe home prices will skyrocket anytime soon, either. The latest figures show home prices continuing to decline both nationally and in Los Angeles. And I don't want to see your finances stretched too far.
Buying a home
Question: My wife and I are considering buying a house but don't really know where to begin. We've spent the past few years rebuilding our credit after having both filed bankruptcy. We have a good income to debt ratio. We will be first time home buyers.
Can you recommend some resources that will help us get started? There is so much information out there, we are willing to pay someone to help sort through it all. We know we should get prequalified for a loan, but don't know the best resource for that. How do we determine what we can really afford (accounting for property taxes, HOA dues, etc.)? Thanks, Paul, Aliso Viejo, CA
Answer: A good starting point is Home Buying for Dummies. It's by Eric Tyson and Ray Brown. I've interviewed Eric over the years and he's always thoughtful. He's out to help you, not line the pocket of real estate agents or mortgage brokers. It's a bit dated since it was published in 2006, but the basic informaiton is solid. Another useful book is Elizabeth Razzi's The Fearless Home Buyer: Razzi's Rules for Staying in Control of the Deal.
There are a number of home affordability calculators on the web, such as Dinkytown.net and hsh.com. A home is the biggest financial purchase most of us ever make, so be sure it's a wiser course for you financially than continuing to rent.
If you do decide to buy keep the finances conservative. The experience of the past couple of years tells all of us the risks of stretching our finances to own. It's not just the mortgage, taxes and insurance costs that matter. A home is expensive to run and maintain. When you move in, you'll see that the furniture you've accumulated over the years looks wrong. You'll probably need more furniture if you're moving from an apartment into a house. You may love tending to your garden, but that pleasure will costs money. Financial conservatism means leaving behind the notion of buying as much house as you can afford.
Once you've gone through some basic books you can start talking to professionals, such as a banker. Take your time. There is no rush.
Good luck.
The $8,000 home buying credit
Question: My husband and I are looking to buy our first home. Since our annual income is around $34,000, we tend to get all of our tax money back at the end of the year (at least until I'm out of college). Is the tax credit a wash for us? Thank you for your help, Leslie, Lemon Grove, CA
Answer: No, it should be a real financial help for you. The tax credit is for qualified first-time home buyers that purchase a primary residence between January 1, 2009 and before December 1, 2009. The tax credit is equal to 10% of the home's purchase price up to a maximum of $8,000. You should qualify for the credit since you're a first time homebuyer and you come in under the income limits. (For instance, the income limit for married taxpayers is $150,000, and it phases out at modified adjusted gross income of $170,000.)
Like most tax law changes, the $8,000 homebuyer credit has created a lot of confusion. The National Association of Home Builders offers up detailed information on the tax credit here. I've also answered a number of other question on the credit on the Getting Personal blog.
Your question is about the tax implications. You have a choice when it comes to filing for the credit. You can amend your 2008 tax return to get the money quicker or you can elect to file for the credit on your 2009 return. However, you must have purchased the home before filling for the credit.
There is additional news this week on the $8,000 tax credit front: The Federal Housing Administration (FHA) has come up with new rules that allow new home buyers using an FHA-insured mortgage to tap the credit to pay for closing costs and the down payment. The lender must be FHA approved. You can find a list of qualified FHA lenders by tapping into this database. New home buyers still need to come up with an initial 3.5% down payment before taking advantage of the credit money.
You can read the official FHA statement on the program here.
06/02/09 by Chris FarrellBorrow to buy land?
Question: My husband is the primary income, and I work 12 to 15 hours per week from home while I take care of the kids. We have a 5 month emergency fund, and he is saving 10% from his pay for retirement. Our only debt is the mortgage. We would love to build a house one day. The question is ... should we take money from our emergency fund to buy the land? We are nervous about doing this. We also hate to add another debt payment. Additionally, we are not investing other than in his 401k fund. Should we do anything differently? It is very hard because the emergency fund was a long hard process to build. Litsa, Charlotte, NC
Answer: When I read your question my first thought was that you've already answered the question. You don't think now is a good time for you and your family to drain your savings and take on debt to buy land. I would agree. Even though the economic news is less bad these days the economy remains weak with the unemployment rate at 9.4% and home prices still trending lower.
That said, it's terrific that you've managed to set aside a 5-month emergency savings account. That isn't easy to do. I would focus on continuing to add to that savings. It's a strong financial foundation for your household.
You should also have your own retirement savings plan. A SEP-IRA is an easy retirement savings plan to set up for the self-employed. You could also open up a traditional IRA (funded with pretax dollars) or a Roth-IRA (the contributions are with after-tax dollars.) You can learn more about these retirement savings IRA options on the Getting Personal site.
Mortgage tax deduction
Question: hey guys. someone had written in with a question recently, asking Chris if they should pay cash up front for a Townhouse, or take out a mortgage.
Chris responded that it was a good idea to start with a mortgage, which could be paid off a couple years down the road if the situation was right, giving the buyer some leeway with their finances. however, what he didn't address, and what I was expecting to hear, was a comment about the tax implications of having mortgage (aka, being able to deduct interest payments), versus paying cash upfront. so my question is: is it at all worth it to take out a mortgage in this case for the sole reason of being able to deduct the interest payments? thanks. Thomas, San Mateo, CA
Answer: No, I don't think it makes sense to take out a mortgage because of the interest deduction. What's more, the advantages of the mortgage interest deduction are exaggerated. It's a nice benefit for anyone with a mortgage but it's far from a financial windfall.
For one thing, most couples living outside the most expensive metropolitan areas or the more exclusive neighborhoods around the country can do almost as well taking advantage of the standard deduction. Put somewhat differently, the mortgage interest deduction becomes valuable the higher your income and the more expensive your home. But for most people it isn't that big a deal. For another, the mortgage interest deduction seems to encourage people to buy a bigger home than they need, and I think that's a mistake. Most importantly, the debt needs to be repaid and the interest payments add up over time.
So, the real question doesn't involve the tax deduction. The cash vs. mortgage issue is all about investment opportunity. Does taking out a mortgage let you put the cash into investments that potentially offer a higher rate of return? Is that what you want to do or would you prefer the security of ownership?
My bottom line: Don't let taxes determine your borrowing and investment strategy. It's the underlying economics of your household finances that matter. Only then take taxes into consideration.
06/11/09 by Chris FarrellAssume a mortgage
Question: I own a house in Tennessee. An investor offered to buy the house by keeping my mortgage in place in order to save him the cost of getting a new mortgage and to save me the loss of selling short. He said he would buy the house as is and would assume ownership of the house as well as responsibility for paying the mortgage that I already have. As I have never heard of this before, I want to know if this is a good opportunity for me to finally get rid of my house without loosing money or could this be a trap? Nick, Sterling, VA
Answer: I would be very wary. The investor described the idea right: Assuming your mortgage means the buyer takes over the existing payments instead of getting a new mortgage. But most lenders no longer allow for their mortgages to be assumed. It's prohibited in the mortgage documents. So, I would look at your mortgage papers first to see if it's possible. If it is an assumable mortgage, the lender will still insist (rightly) on running a credit check on the buyer.
Finally, what concerns me is that I don't really understand the advantage to the buyer who will assume the mortgage. There are two real benefits to assuming a mortgage, a lower interest rate and cheaper closing costs. In your case the closing costs would be less. But the mortgage rate? Even though interest rates have crept up recently they remain remarkably low and, if you have good credit, there is plenty of mortgage money available from lenders.
The bottom line: Check this deal out very carefully, starting with your lender. It may not even be possible depending on your mortgage contract.
The mortgage lock-in
Question: I am a first time homeowner ready to go ahead with the purchase except for the dreaded "lock" of the interest rate. My closing is set for August 10 so I am still at the 60 day lock rate which today at 4 pm is 5.375%. (Of course, if I was closer to my closing AND I had watched the rates after Obama's speech this morning, I could have locked in at 5 and 1/8!!) Am I the only one who is not only confused but resentful at just how much of a crap shoot this is? Who has the time or moxy to watch rates minute by minute? All I know is that for me the difference between 5 and 5 375% is $13,000. A lot of money in my book. Will rates come down before my closing? Is there any truth to the rumor that if unemployment rates are up at the end of the month, rates will be lower? Are there indicators that you can watch for? Or should I just resort to an Ouija board or the Psychic Hot Line? HELP! I am an avid listener and look to you for sage advice! Carol, Jordan, MN
Answer: No one knows where interest rates will be come August 10. You can consult an Ouija board, tea leaves, entrails, a psychic hotline, an economist or Wall Street money maven and the value of their prediction will be pretty much the same--not much. The unemployment rate could be higher at the beginning of next month and interest rates could be lower; then again, rates could be higher; and so on. As the movie mogul Samuel Goldwyn once remarked, "Predictions are very difficult to make--especially about the future."
Here's the thing: The advantages and disadvantages of a mortgage rate lock-in has nothing to do with forecasting interest rates. It's a risk management tool. If you lock in current mortgage rates you eliminate the risk that rates will be higher in the beginning of August. The price you pay for that security or promise is this: If rates go down you don't enjoy the lower rate.
You can't get rid of the uncertainty about interest rates. What you can do is manage the risk. The question for you then becomes which gamble makes the most financial sense. For most of us, it pays to get rid of the financial danger of rising rates before the closing date. That's what I would do. But some people are flush enough and have sufficient financial resources that it's a reasonable not to take the lock-in and bet that rates will be lower in the intervening weeks.
You can learn much more about the costs and benefits of the lock-in at this consumer guide published by HSH here.
Stick with adjustable rate mortgage?
Question: My wife and I have an Adjustable Rate Mortgage on our home with a current interest rate of 6.125%. We recently received two letters from the lender presenting us with two options. The first is to accept an interest rate adjustment which would decrease the rate to 4.125% and lower our mortgage payment by about $300 / month. The second option is to convert the loan over to a fixed rate mortgage with an interest rate of 5.00% for a one time fee of $250. This would decrease our current loan payment by $175.00 / month.
We will also have the option to convert the mortgage next year. My question is should we wait on converting the loan to a fixed rate and take advantage of the 4.125% interest rate for the next 12 months, and convert next year and hope to get a decent fixed interest rate. I know we are taking a gamble on the interest rates a year from now, but having an extra $300 / month for the next to put toward our savings would be pretty nice. Paul, Olive Branch, MS
Answer: Boy, the trade-off between risk and reward would push me to grab a fixed rate mortgage at 5%. That's an attractive rate. The $250 conversion fee is minimal. Once you have locked in the fixed rate it doesn't matter how high rates go in coming years. You're protected. If rates trend lower, you can always refinance. I wouldn't minimize the risk of higher interest rates when it comes time to reset the rate next year.
The savings aren't great with the ARM anyway. If you stick with the ARM you'll have an extra $3,600 for the year. That's a nice piece of change. But if you convert to the fixed rate mortgage you'll still have improved your yearly cash flow by $1,850 ($175 a month in savings minus the $250 fee). And you will have locked in that extra monthly cash cushion. So, for an extra $1,750 (he difference between your savings with the ARM and the fixed rate) you're accepting the risk of a higher rest rate a year from now. There's no guarantee the lender will offer the same deal, either. It doesn't seem worth it to me to stick with the ARM.
Why gamble? Our money lives are difficult enough these days. There is a lot to be said for grabbing for some financial certainty.
by Chris FarrellBorrow to invest?
Question: My husband and I are both 50+, with two children of college age. Our house is paid off and we are without debt. He wants to take out a mortgage for 1/2 of the appraised value of our home, betting that inflation is inevitable and invest it in higher interest CDs.
Safe bet or stupid investment? Thanks Mary, Towson, MD
Answer: I get variations of this question all the time and my answer is always the same: I don't like it. I wouldn't do it. It's an extremely risky investment strategy. I don't even consider it an investment. It's a speculative bet.
Right now, millions and millions of Americans are envious of your financial situation. You have no debt. You own your house free and clear. You have a great deal of financial security. Why gamble away your security?
If you borrow half the value of your home to invest in CDs you'll have to make those interest and principal payments no matter what. The interest payments on the debt will be higher than what you can earn on a short-term CD at the moment. You'll pay a steep "fee" while you wait to profit from your strategy.
Of course, there is a school of Wall Street thought that believes high and rising inflation lies in our future. A number of economists worry we could suffer through a reprise of the 1970s inflation rates following the extraordinary actions the Federal Reserve has taken to bail out the banking system and avoid a depression. It could happen. It's a real risk. Thing is, it might not happen. Inflation could stay tame.
Instead of borrowing I would buy shelter from the potential inflation storm by investing in safe, high-quality securities that offer a hedge against inflation. Treasury bills, for example, hold their value even during inflationary times because you can reinvest the money at higher interest rates if inflation does stir. The same holds for a mix of savings accounts, short-term CDs, I-bonds and Treasury Inflation Protected Securities.
Best of all, you'll still be debt free and own your home.
Buy or rent
Question: My husband and I can't decide whether or not to buy our first house. We will likely be in any house we buy for at least five years -- there is some possibility we would move after that. We have $50,000 available for down payment, but we also have a 13-year-old and a 10-year-old and are worried about college. We only want to buy a house if it is beneficial to us financially in the long run -- otherwise, we are happy renting. And we hate to say goodbye to that pot of cash that could buy our boys more choices for college (though we also worry about inflation destroying it, and losing this opportunity to buy in a neighborhood we like but usually can't afford to buy in). Should we become homeowners, or not? Laura, Milwaukee, WI
Answer: I really like the way you're asking the question. The answer comes from understanding the trade-offs you'll make to own, and whether it makes sense for you. Owning can make sense. Prices are attractive. The $8,000 first-time homebuyer tax credit is an added incentive if you quality. A home is a lifestyle, too. It's a place where you live with all the benefits that come decorating and landscaping it the way you want.
That said, you want to ignore the two biggest lies in the real estate business. The first is to "buy as much home as you can." It's a recipe for financial trouble. The second is renting is "throwing your money away." That's wrong.
Here are my principle guidelines to weighing the costs and benefits of homeownership:
*Compare the cost of owning vs. renting.
*Buy only if the deal is financially conservative
*Keep the mortgage and financing simple--no piggy-backs, 80/20s, and the like
*Smaller is both smart and socially sustainable
Number crunching will help keep emotions in check. Let's say you calculate that the monthly cost of ownership, taking tax benefits into consideration, is higher than the monthly price of renting for a comparable property. If you buy a home, you're making a big bet that home prices will rise to justify the purchase. But you have a financial cushion if the cost of ownership is less than renting. There are a number of good online calculators, but I tend to gravitate toward the websites www.dinkytown.net and www.hsh.com. Time is critical. Ownership doesn't make sense unless you're confident that your time horizon is at least 5 years. You're in the ballpark from a time perspective.
After you've gone through all this, I would then decide whether ownership is sensible for you. There's nothing wrong about deciding to rent and save.
Own home free and clear
Question: I still owe about $36,000 on a 5 1/2% mortgage on a co-op. I'm wondering if I should take my savings & pay if off since my money market & CDs are only paying a bit more than 1%. (!!!) But, I get a tax deduction on the interest paid on the mortgage, although soon the $400+ monthly payment will probably soon go mostly for principal, & then there won't be a tax deduction--right? Natalee, Scarborough, NY
Answer: Assuming 1) you like the co-op and 2) you will still have savings to tap in an emergency, it can make financial sense to pay off the mortgage. That's a 5.5% return on investment which, as you say, is a lot better than 1% or so. What's more, my guess is that the value of the mortgage interest deduction is not only minimal, but it is far below what you can get by simply taking the standard deduction. Own your home free and clear.
07/13/09 by Chris FarrellFirst home
Question: I am considering buying my first home at age 52. What would you consider as the best strategy for scoping out a wise real estate investment at this rather late date, as opposed to channeling my savings to other types of investment? Katie, Arlington, VA
Answer: You'll need to address all the classic home buying issues about affordability. You'll also need to figure out how ownership fits in with your overall savings when you enter into your retirement years.
Here are some guidelines to thinking through homeownership:
*Compare the cost of owning vs. renting.
*Buying make more sense the longer you will live there.This may be more of a consideration at your age. But you should plan on being there at least 5 years.
*Buy only if the deal is financially conservative. In other words, put down a hefty down payment, hopefully the traditional 20%. You don't want to end up stretched financially or house poor.
*Keep the mortgage and financing simple.
* Small is beautiful. It's both financially practical and environmentally friendly to own a smaller home. It's cheaper to own and to run.
Now, you're still young and retirement is far off. But when I can I like to add a twist, something else for you to think about. So, let me add an assumption: If you buy, chances are you'll live in the home for many years. If that's the case, what I'm about to add to the basic first-time home buyer questions may seem strange, but it's financially savvy over the long haul: Ask yourself, is this the kind of place I can see my self comfortably living two to three decades from now?
This suggestion builds on a conversation I had a year or two ago with Jon Pynoos. He's head of Gerontology policy, planning, and development at the University of Southern California. He recommends that homeowners in their 50s that are considering remodeling projects take advantage of the construction to add in design changes that make it easier to age comfortably over time. "People in their 50s often upgrade their homes and spend the most money in the kitchen and bathroom," say Puynoos. "If you're doing a major remodeling, it's the ideal time to make changes that will let you remain independent."
His comments made a lot of sense to me. Now, you aren't facing a remodeling project. You're buying a home. But I think for most buyers in their 50s--assuming it's a long term purchase--this is something to add to the list of things to take into consideration. As Jane Austen wrote in Emma: "Ah! There is nothing like staying at home for real comfort."
07/21/09 by Chris Farrell
Safe savings
Question: I am a newly divorced mom who has just sold her home as part of a divorce settlement--at a big loss. I have 60K as my share. I was unable to negotiate a mortgage because I have not worked full time since my special needs child (now teen) was born. I am seeking full time work (bank says they need 12 months work history) and have rented a small house for 1 year. (My rent will be more than my mortgage would have been if I had been able to buy the house I just sold.) Where should I put my 60K until I can purchase a home? Preferably somewhere where I earn a return, without risking the principal. Would your answer be different if I decide not to buy a home for 2 or more years? Karin, Scarborough, ME
Answer: You right to want to park the money in a safe place. I would put the money into a FDIC insured bank or a federally insured credit union. You could put some of the money into a savings account and some into short-term CDs. The other alternative is to buy short-term Treasury bills from the U.S. government at www.treasurydirect.gov. In all these examples the money will be there when you need it.
My answer would be the same whether you buy a home in two years or not. Here's why: You're going through a lot of tumultuous changes. You've gotten divorced. You're looking for full-time work. And you're raising child with special needs. So, I would avoid making any dramatic investments--and that includes a home--until you have a better sense of your new work and home life. You'll figure it out, but it takes time. Meanwhile, keep your savings safe.
07/28/09 by Chris Farrell
Home equity line of credit
Question: I have a $50,000 mortgage on my condo and was just approved for a $150,000 equity line of credit (no processing fees). I have no emergency funds and was planning to use the LOC to pay for major dental work (not cosmetic) I have been told I need - cost approx $10,000. I am financially very conservative and very uncomfortable with the idea of a second mortgage on my home - would I be better off canceling the equity LOC (I have 3 days) and charging the dental costs on a credit card? I have an excellent FICO score and don't want to do anything to jeopardize that rating. Thank you! Annel, Norwood, MA
Answer: My strong bias is against borrowing against your home to pay for dental work. It isn't just dental work. My general rule of thumb is that any money borrowed against the equity in a home should go toward improving the value of the place and your enjoyment from living there. I think your financially conservative instincts are spot on.
Here's my overall perspective. It was commonplace during the great real estate bubble for homeowners to take out second mortgages to consolidate their debts, pay for vacations and meet tuition bills. It's cheap money, right? The interest rate on a home equity line of credit is lower than the rate on credit cards. You also get to deduct the interest on your taxes. But treating a home like an ATM backfired when the boom went bust. Fact is, too many people needlessly put their homes at risk. For instance, credit card companies can't go after your home if you miss credit card payments. But a lender can start proceedings on the home if you start skipping equity credit line payments.
Now, to be realistic you're far from needing to worry about financial trouble. After all, the lender is willing to set up a very large line of credit with you so I know that you have a lot of equity wealth. The dental payment is comparatively small. You could handle it easily.
Still, I'd prefer that you pay for it on a credit card and then focus on eliminating that debt as quickly as possible. To me, it's a better strategy and money habit. By the way, no matter what you decide to do your FICO score is fine.
30 or 15 year mortgage?
Question: Hi, I am a 34-year-old single woman with no debt, a comfortable, stable salary, and a high saving rate. I am planning to buy a home for the first time and need to get a mortgage. I can put 20% down for the down payment but the question is, what length of mortgage should I sign up for? My bank is advising me to get a 30-year mortgage (about 35% of my income) but my parents are pushing for a shorter-term mortgage (20 or even 15-year) with the argument that I would build equity in the home much faster. In their opinion, the total interest you pay over the course of the loan only benefits the bank -- not the owner. What is your opinion on this? Laura, Hanover, NH
Answer: Your parents are right. The 15-year fixed-rate mortgage does save you a lot in interest payments. For example, a $100,000 mortgage at 6.25% for 30 years will cost you $121,900 in interest if your marginal tax rate is 25%. The interest charge on a 15-year mortgage at 6% is $51,900. (The rate on a 15-year mortgage is lower than the 30-year rate.) So, it's a good move if you have the cash flow to absorb the higher monthly mortgage tab. The main advantage to you of the 30-year mortgage is that your monthly outlay is significantly less.
However, there is another option: The 13th monthly payment. Many people like locking in the lower monthly payment of the 30-year fixed-rate mortgage, but they don't want to pay the bank all that interest. They make an extra monthly payment during the year. You just tell the lender to apply the 13th payment to paying down principal. You cut your interest payments significantly this way. For instance, by making one more monthly payment on a 30 year fixed rate mortgage at 6.25% you'll shorten the life of the loan by 5 years 4 months, saving $27, 263 in interest.
The advantage of this approach is flexibility. Let's say your financial circumstances change--you lose your job, you need a new car, your children need extra tutoring--you can always go back to the 30-year payment schedule with no penalty. Just make sure there is no prepayment penalty with the mortgage if you go this route.
First time home buyer
Question: I am considering buying a house (for the first time) - the government incentives to do this are a big factor in this decision- However, I am in my 50's - Is it a good idea to buy a house, or should I continue to rent ? I would be buying it with a friend, so we would be sharing the mortgage payments-( I don't know whether that would factor into your answer)--What are your views on buying houses at a later point in your life? Thanks for any input! Rachel, Athens, GA
Answer: I don't see any reason why you shouldn't be a first time homeowner in your 50s. All the normal economic caveats about owning versus renting apply to you, of course. The $8,000 credit is really a drop in the bucket when it comes to the overall cost of owning. So, make sure that the motivation and numbers work first--the $8,000 is a bonus.
A couple of other points. I believe that it's generally a good idea to be debt free in retirement. So, in your financial planning with your friend I would discuss the practicality of being aggressive with paying down the mortgage. Since you will be buying with a friend both of you should make sure that you're legally protected.
I posted some more details about home ownership versus renting in your 50s responding to a similar question on 7/21/09. Check it out.
08/19/09 by Chris FarrellCheck out landlord
Question: The rental market in Miami has gotten very soft, and I can get a much better apartment for the same money that I'm paying now. Virtually all the rentals in Miami are condos. There are almost no purpose-built apartment buildings. So, while I'd like to move into a nicer rented condo, I don't want to get myself into a situation where I have to move out in 6 months because the owner is in foreclosure. If I asked to see the owner's credit report I would just get laughed at, so how can I research the status of a condo and/or its owner? Thanks for your help. Jenna, Miami Beach, FL
Answer: It's a good question. There are a couple of steps you can take, but none of them is foolproof. Yet just as it's a buyer's market for homes, it's a renter's market for renters. You can't ask your potential landlord for her social security number and latest credit report, but you can do some due diligence on the person and property before signing on the dotted line.
It's surprising how much research you can do on the web. For instance, websites like www.rentalforeclosure.com let you see if your potential landlord is in foreclosure. Of course, as we all know the foreclosure data isn't always complete. That's why it pays to go to the county tax collector's website. The property is registered here and you'll want to see is if there are any back taxes owed. That's a classic sign of financial trouble. Depending on how diligent you want to be there are a couple of other steps you can take. For instance, head over online to the county's Clerk of Deeds or Recorder's office. You can learn whether the landlord may be losing the property. You can research at the General District Court for any civil, criminal or other legal cases against the landlord.
I'd also look at the property carefully. Is it well maintained? If it's a larger building is the lobby busy? Buttonhole a couple of tenants and ask them how the condo is doing. People love to gossip and share insights about where they live--especially if there are signs of trouble. I'd also ask your potential landlord for a look at the condominium association's latest budget.
08/21/09 by Chris FarrellRent my home
Question: I'm a freelance writer, currently making a reasonably comfortable income. I have no student loan or credit card debit, and a Traditional IRA (max contribution every tax year). Part of the reason I can survive as a freelance writer is that I have no mortgage--I inherited my house from my mother (who inherited it from my grandmother).
However, I have been considering leaving the area to go to graduate school--this means I would have to rent the house. The prospect makes me very leery, given how much money I've sacrificed to rehabilitate my old home. I'm all too aware what tenants could do to destroy its value, while I was away, and I'm also nervous about keeping an eye on rent collection/utilities payment from a distance.
My questions: I would need to rent the house to pay for my rent in another area while at grad school. Should I consider this option of renting my house if I am not accepted to any grad schools in my immediate area? And, finally, is getting a PhD in English literature a truly terrible idea, as opposed to continuing 'as I am'? Mary, West Long Branch, NJ
Answer: I'm never going to tell anyone that pursuing a dream is a terrible idea. I just think you should be practical and clear-eyed about the trade-offs. Why do you want to get a PhD in this area? If it's to get a job, then you already know that the academic job market is tough, especially for scholars in subjects such as English, anthropology, and sociology. What kind of jobs might be available to you after spending several years living as a student? What sort of income will you earn once you've gotten your PhD? How do those prospects compare to what you're doing now? Of course, these questions are irrelevant if this is the pursuit of a dream and you have the savings to go for it without worrying about employment at the end of the process.
I would revisit the rental question once you have figured out the work-and-dream equation. I take seriously your apprehension about becoming a landlord, especially if you move far away. Still, there are ways to minimize your concerns about renting. You would need to hire a management rental company to handle routine maintenance and rent collection for you if you move far away. That contract will reduce how much you'll earn off your rental income, but it will also relieve you of some stress. You could rent to a friend or someone you've known for a long-time. I would also get a copy of Nolo's Every Landlord's Legal Guide. Nolo.com is a terrific resource.
I know I'm raising more questions to think about than answers, but what about selling the home to fund the next chapter in your life, assuming you decide on pursuing a PhD? It's probably best to continue owning your debt-free home. But it's another option to consider. You would have a nice financial cushion to buffer the years of transition. You wouldn't have to be a landlord, either. Of course, the price of this approach is letting go of a beautiful home with plenty of memories and no debt. You might also have to wait awhile to go this route since the housing market is still tough.
09/01/09 by Chris FarrellEstate planning and same-sex couples
Question: Hi Chris - my partner and I are starting to accumulate assets together - equity in a jointly owned house, beneficiaries on each other's life insurance, etc. Although we are legally married in Canada, as a same-sex couple and US citizens our marriage is not recognized by the federal government nor the state of North Dakota. Should we spend the money to set up a trust in order to try to avoid the debilitating taxes that the other would incur should one of us pass away? Is there a better way to try to protect each other? Thanks! David, Fargo, ND
Answer: You have a lot of work to do to financially protect yourself and your partner. I wish I could say it was otherwise, but it isn't in the current environment. To be sure, the law is in flux in a number of states with same-sex marriage, civil unions, and domestic partnerships. But for now the burden is on same-sex couples to protect each other through a combination of a will, a living trust, power-of-attorney, and other legal documents. By the way, a trust won't save your partner or you from a tax hit at death. The real value of a trust is that it makes it more likely that your estate planning intentions are followed by the courts.
My favorite resource for understanding and dealing with the financial issues faced by same-sex couples is The Legal Guide for Lesbian & Gay Couples by Denis Clifford, Frederick Hertz, and Emily Doskow. It's a self-help legal guide published by Nolo.com. You can see it here. I would then work with an attorney to set up your finances in a way that protects both of you.
Mortgage and taxes
Question: I always enjoy listening to your comments and hope that you have a moment to settle a discussion a friend and I are having. Is the "benefit" of the itemized tax deduction on one's income tax worth retaining a mortgage if one is able to satisfy that debt? In this case, we are discussion someone who has about fifty thousand dollars on the mortgage and is of retirement age, no children and few other itemized deductions. There is no other debt. Thank you for your thoughts on this matter. Judith, Reading, OH
Answer: Sure, I'd love to weigh in on your discussion. The short answer is that any financial benefit you get from the mortgage deduction is swamped by the cost of paying interest on the loan. My guess is that the value of your mortgage interest deduction is not only minimal, but it's below what you can get by simply taking the standard deduction. (It's worth finding out.)
The main reason not to pay off the mortgage has to do with your personal financial safety net. You don't want to put all your savings into one asset, like a home. But if you have a well-diversified portfolio and adequate savings why not get rid of the mortgage. And that sounds like you or your friend.
How much of a down payment?
Question: I am buying my first home. I've been a diligent saver, and have enough for 20% of the down payment. I wonder what the drawback is to putting down more than the required 20%. I can put down between 30 and 40% of the purchase price, without interfering with my 1.5 year living expenses safety fund or my retirement accounts. I have no debt. I'm attracted to having lower payments and paying less interest in the long term, and plan to be in the house for more than 10 years. What are the drawbacks to putting down a larger amount for a house, if you already have a safety fund, no debt, and a retirement account? Andrea, Durham, NC
Answer: You sure are a diligent saver. It's really nice to take a question from someone in such terrific financial circumstances. Since you're a first time homebuyer remember to take advantage of the $8,000 tax credit (assuming you qualify). Also, you want to make sure that there is no prepayment penalty with the mortgage loan. In other words, you don't want to pay a fee to the bank if you end up paying off the mortgage early. I have a feeling that's what you'll do, too. My bottom line: You can't go wrong if you put 20% down or 40%. There isn't any real drawback to the larger down payment.
That said, there are two traditional trade-offs for you to consider: In return for a smaller mortgage and less interest payments you could give up 1) some financial flexibility and 2) some potential diversification. (A lot of people will say you're also reducing tax benefits from the mortgage interest deduction. But I think the cost of interest payments and the extra financial security swamps the tax gain.)
Here's what I mean: When you make a 20% to 25% (instead of 30% to 40%) you have more savings readily available to you to fund an investment opportunity, to pay for a career shift, to embark on an adventure or to withstand a severe setback. What's more, the cost of owning, furnishing, and maintaining a home is often more than renters anticipate. So the 20% down payment leaves you a larger cushion while you adapt to homeownership. Of course, you can always borrow the money from your home equity. But why take on debt when you can tap savings? You can always accelerate your mortgage payments and pay off the mortgage early.
Second, with a bigger down payment you tie more of your savings to the performance of one asset--a home.
You'll play with the numbers, but I wonder if this might be a good financial compromise for you? What if you put 30% down instead of 40%? You get benefits of a larger than normal down payment, but you also keep your savings flush while you learn the ins-and-outs of homeownership. And then if you still are flush, I'd pay off the mortgage on an accelerated schedule and save yourself thousands and thousands of dollars in interest payments.
A stock market winner
Question: My wife and I are in our mid 30s and we decided to take a gamble back in Jan 09 when everyone said the world was coming to an end. We took $20,000 out of our savings and plunged it into an established travel company we used to work for that was trading below its all time low (lower than after 9-11). Well the world did not end, and 9 months later we're sitting on a handsome sum of money thanks to a 4x growth in stock price. My question is what should we do with the money? Popular ideas are to slowly work the money into a Roth IRA or other investments, or to pay off our $120,000 7.2% 30 year mortgage (25 years remaining), which would free up $1200 in expense monthly.
I appreciate your help and love the program. Jonathan, Miami, FL
Answer: I love your story. We all know that being a contrarian investor is smart, but it isn't easy. As John Maynard Keynes famously wrote eight decades ago, "Worldly wisdom teaches it is better for reputation to fail conventionally than to succeed unconventionally."
What would I suggest doing with the money? You could always refinance your 7.2% mortgage with fixed rates to 5% these days. And then you could use the money to build up a broadly diversified portfolio. But, assuming you like your home and neighborhood, I'd lean toward taking advantage of your windfall to live debt free. Imagine, you're both in your mid-30s and from here on out you could live well off your income from work, add to your savings, and avoid borrowing. Being debt free at your age will give you a lot of financial flexibility and personal freedom down the road.
09/24/09 by Chris FarrellGet rid of escrow
Question: My husband and I refinanced last year and since then our mortgage has been sold twice. We have always paid in a timely manner and we have never missed a payment. The previous banks collected escrow for the exact annual amount of our taxes and insurance. This new bank just sent me notification that they have the legal right to collect more so that the escrow balance doesn't go below zero immediately after they pay the taxes. The amount that the account went below was by $3000 but it was all recovered by the end of the year. The bank wants a cushion of $4500 which is even more than the negative balance. I asked to pay eliminate the escrow so that my husband and I can pay the taxes ourselves and not give them all that extra money and we were told that we could make this request but that they were not required to allow us to do so. Is this true? If so, why do the responsible people always get slammed? Any thoughts? Rachel, Cumberland, RI
Answer: Many people don't like escrow accounts. But it's really hard to get a bank to drop an escrow account once it's in place. It's to their benefit and lenders have little incentive to waive it. You should make the request anyway. Sometimes the lender will agree to drop escrow in return for a fee, especially if a good chunk of the mortgage has been paid off. The bank is right: They can require a savings buffer in the account. However, a partial mitigation is that Rhode Island is at least one of only 14 states that insist the lender to pay interest on the escrow funds.
Taylor Bean and Whitaker
Question: My mortgage is through Taylor Bean and Whitaker which has just been implicated in a fraud scandal, (which made headlines in August.) When no payment was deducted from my husband's bank account in September, we made a call to TBN and were told that the company has ceased to operate, but that we should send a check to the Ocala, FL address. I'm afraid to send my mortgage company now knowing that it has "Ceased to operate," but am equally afraid of missing a mortgage payment. How should we proceed? Jessica, East Waterboro, ME
Answer: You're instincts are right. Before you do anything you need to see who is now responsible for servicing the mortgage. There has been a great deal of confusion since Taylor Bean went under, but it looks like government agencies have straightened it out.
The FDIC and Federal Reserve each offer Taylor Bean and Whitaker customers a hotline to call for more information. The FDIC number is 1-877-275-3342. The Federal Reserve's hotline is 1-888-851-1920.
Basically, if the loan was insured by the Federal Housing Administration, Veterans Administration or USDA's Rural Development, it was probably securitized (turned into a product that can be sold like a bond) by Ginnie Mae. Bank of America has taken over the servicing of government-insured or guaranteed mortgages securitized by Ginnie Mae. The Ginnie Mae website offers more information, and you can get the BofA address. Other TBW loans were securitized by Freddie Mac. It has arranged for Cenlar FSB, Saxon Mortgage Services, and Ocwen Loan Servicing to assume responsibility for the loans. It's website is freddiemac.com.
So, check out where the payment should go first, and then write the check..
$7,500 homebuyer credit
Question: I bought a house in 2008 and received the $7500 first-time home buyer credit (the first one not the $8000 giveaway). I lost my job and sold my house at a lost in spring of 2009. Do I still have to payback that $7500 credit? If so how soon? If I kept my house I would have to repay it over a 15 year period. Sean, Camden, AR
Answer: The $7,500 homebuyer "credit" was truly misnamed. It wasn't a credit. It was a 15-year interest-free loan from the government for first-time homebuyers. You got the "credit" upfront and then you paid it back in equal installments over 15 years. (The $8,000 first-time homebuyer for 2009 that expires on November 30 is a pure tax credit. You simply pocket the money. You don't owe anything so long as the home is your principal residence for at least 36 months after purchasing it.)
The balance of the $7,500 loan is paid off in full if you sell your home at a profit before the 15 year term is up. The amount paid back to the government, however, can't exceed the amount of the gain. When a home is sold at a loss--as in your case--the balance of the loan is forgiven.
By the way, I find it intriguing that even the IRS on its website suggests checking with a tax professional if you sell a home bought with the $7,500 "credit/loan" with no gain or a loss. The agency knows it's a confusing piece of legislation. So, who am I to argue with the IRS? Check with a tax pro first.
Buy a home
Question: My wife and I are considering buying a home in San Francisco, but also know that we will be moving to LA sometime in the 3+ years. Homes in SF are extremely expensive, and we would be able to put down a 15%~20% down payment, but I don't want to lose this money if the market gets worse. We are both currently employed luckily and are expecting which is what is prompting this decision. What tools are out there to help us make a smart decision on whether this is a financially smart idea? Also if we do buy a home, when we move what are the consequences of renting out the home?
Thanks in advance and love the show. David, San Francisco, CA
Answer: I would be very wary of buying with your time frame of 3-plus years. Whenever I run the numbers it's clear the longer you intend to stay in a home the better the financial advantages of ownership. It's safe to say that if you plan on staying in a place for three years or less renting is always preferable. I don't think ownership makes sense unless you're confident that your time horizon is at least 5 years, and preferably longer.
It does appear that the housing market is stabilizing. That doesn't mean it won't stagnate for a long period of time in many markets. It's what I expect. In coming years, the ebb and flow of home values will largely be dependent on local job and income growth. In the words of a Business Week story on the housing market, it will be "back to blissful boredom." It will be a welcome respite.
Still, it's always a good idea to run the numbers. Online calculators will do the math for you. There are a number of good ones, but I tend to gravitate toward the websites dinkytown.net and hsh.com. By playing with different assumptions these calculators will help you figure how long it might take before you break even on the investment or, to put it somewhat differently, how much risk you're taking with the down payment money.
When you rent out a home you are no longer a homeowner but a small business person. It's a business. Nolo.com is a good source on what it takes to be a landlord.
Refinance, or not
Question: I own a home which I'm in the process of refinancing under the Keeping Homes Affordable program. As part of the refinancing, the mortgage lender wants to subordinate my home equity line of credit (which is through a different lender - my bank) to the mortgage. In order to do this, my bank wants to lower my line of credit from $28,000 to $10,000 and they want to freeze it for the time being.
I'm very uncomfortable with this as it has been serving as my "safety net" to pay for unexpected expenses in the past year, which I know isn't ideal, but things have been challenging economically because I've had to take a 20% pay cut at my job for the past 9 months. In the long run, refinancing will save me thousands of dollars, but it will also extend my mortgage 5 years and could put me in a difficult situation if anything happens in the short term. What should I do? Laura, Minneapolis, MN
Answer: I understand your trepidation. Pay cuts are tough to absorb, especially when it's unclear when you'll get back to par. My bet is that it won't happen anytime soon. Companies are in no hurry to act with an unemployment rate of 10.2% and the broadest measure of underemployment at a record 17.5%.
That said, from what you've told us the refinancing is putting you on the path toward a stronger financial position. I would take the lower line of credit limit. I would focus on reducing your spending--yes, budget--to shore up your savings instead. Of course, it's always easy for me or anyone else to say "budget." It's always hard to make cuts in spending. Nevertheless, It will pay off for you to go over your spending carefully, see where you can nip and tuck, and add to your savings. The sums may not seem like much at first. But save a bit here and a bit there and all of a sudden your talking real money.
By the way, there should be no prepayment penalty with your mortgage. So, when your income and finances take a turn for the better you can always start paying off your mortgage more aggressively.
What do other members of the Getting Personal community think? Send Laura your thoughts and suggestions.
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Chris Farrell Marketplace Money personal finance guru
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Latest Comments
- Taylor Bean and Whitaker (13)
- Lori Bodamer wrote: what about our escrow checks? lots of people- including me- were issued escrow refunds from our ove... [read]
- Patricia Marcus wrote: I spoke with someone at Taylor Bean and Whitaker she advised me all loans will be transfered that th... [read]
- How much of a down payment? (2)
- jj wrote: I think you're trade-offs are pretty much spot-on. When we went to buy our house, we had a very sim... [read]
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