Before you pay cash for a home

Before you pay cash for a home, ask yourself if there is a possibility, at some point in the future, you might put a mortgage on the home and would want to deduct the mortgage interest on your federal tax return.

Current federal tax law allows homeowners to deduct the interest on up to $750,000 in acquisition debt used to buy, build or improve a property.  When a person pays cash for a home, the acquisition debt is zero.  The only way to increase the acquisition debt is to make and finance the improvements to the home.

As with many IRS regulations, there are exceptions to this rule.  If a mortgage is secured on the first or second home within 90 days of the purchase closing, the debt is considered acquisition debt.  The interest on the funds used to purchase the home can be deducted on up to $750,000 of the mortgage balance.

Assuming a borrower has good credit, the ability to repay the loan and the home justifies the loan, lenders are willing to make mortgages for homeowners.  It does not mean that the interest on the mortgage will be deductible.

Additional information can be found in Publication 936, Home Mortgage Interest Deduction, of the Internal Revenue Service at IRS.gov.

To deduct home mortgage interest, you must file Form 1040 or 1040-SR and itemize deductions on Schedule A.  The mortgage must be secured debt on a qualified home in which you have an ownership interest.  Interest on home equity loans is only deductible if the borrowed funds are used to buy, build or substantially improve the taxpayer's home that secures the loan.

If you answered yes or even maybe to the question first posed in this article, contact your tax professional to determine the best way to approach your individual situation.  For more information, download the Homeowners Tax Guide.

Optimize Your Sales Price

Doing a lot of work to a car before you trade or sell it to a dealer is not generally a good idea.  In most cases, you won't recapture the cost of the repairs.  They can do the repairs for a less than you can.  Not to mention, you are selling to a wholesaler who needs to sell it again to the end user and still make a profit.

A home sale is totally different.  The owner is selling the home to an end user.  Since the buyer, in many cases, is using their available funds for the down payment and purchase costs, they don't have money to spend on repairs or decorating the home.  They would need to live in it "as is" for a while which may not be as appealing as finding a home that is refurbished, up-to-date, and ready to move into.

Even if the buyer would be willing to get a home improvement loan after the sale, it would be a separate loan at a higher interest rate making their payment higher than financing it all in one mortgage at the lower first mortgage rates.

The seller may experience some inconvenience going through the remodeling process, but it will, most likely, result in a higher sales price in less time.  Occasionally, sellers say they'll let the buyer choose their own colors but not all people have the imagination to know what something will look like after it is finished.  It is better to go ahead and get the work done before putting it on the market.

The bathrooms and kitchen are the most important rooms to update.  If the finish on the cabinets is bad, have them painted.  New countertops and appliances can make a world of difference.  Paint, countertops, and fixtures in the bath give the home a great feel.

In addition to the repairs, a major cleaning and decluttering can make a home look and feel better than the competition.

The first step is to go through the home and pack up or get rid of things you don't need or things that detract from the home like excess furniture, exercise equipment, personal artwork, etc.  Now, do the same with the closets and cabinets.  By getting rid of things, there will be more room and they'll look larger.

Next, walk across the street from your house and give it a critical look.  How is the drive-up appeal?  Would you want to go inside to see the rest if you were a buyer?  Are the trees and shrubs trimmed?  Yard cleaned up?  Do you have blooming flowers in the beds?  Does the front door and mailbox need a new coat of paint?  Do you need to power wash the outside of the home and the sidewalks and driveway? Do the windows need washing?

Buyers are visual people and beauty is always rewarded.  Restaurants know that people eat with their eyes first and they go to a lot of effort to plate the food so it is visually appealing.  The same approach works for selling a home.  Ask your agent if they have ever taken a buyer to a home that refused to go inside because they didn't like the looks from the street.

Your real estate professional can make specific recommendations and assist you in finding someone to do the work.  This is what they do.  TRUST THEM!

Say "NO" to FSBO

To understand the reasoning behind why a homeowner should not sell their home by themselves, we need to identify the motivation.  Probably, more times than not, the homeowner wants to "save" the cost of the commission.  It certainly represents a significant amount of money.

In 1981, homes sold For Sale by Owner represented 15% of the homes closed while 85% were agent-assisted.  The percentage of sellers handling their own homes alone has declined over the decades to only 8% of homes sales in 2020.  Interestingly, half of the sellers knew the buyers and the other half did not.

The FSBO sellers who knew the buyers, who were predominantly a friend, relative or neighbor, had a market time of less than a week and received 100% of the asking price, less expenses of course.

According to the NAR 2020 Profile of Home Buyers and Sellers, 50% of FSBO sellers determined the asking price of their home by recent home sales in the area while slightly more than 1/3 used an appraisal. 41% of sellers stated they did not want to pay a fee or commission as the reason they sold it FSBO.  Another 30% did so because they had a relative, friend or neighbor who wanted to buy their home.

A significant problem encountered by For Sale by Owners was exposing their home to the marketplace.  They run the risk of selling the home for a lower price because it is not marketed to the highest pool of available buyers.

Negotiating on their own behalf is another concern many for sale by owners share.  There are so many different things as well as people with whom to negotiate.  For instance, besides the sales price in the contracts, other negotiable terms include financing concessions, closing and possession dates, inspections and earnest money.  However, the negotiations could continue well up to the moment of closing with repairs, appraisals and other unforeseen things.

While the seller might feel uncomfortable negotiating directly with a buyer, there could also be negotiations with the appraiser, inspectors, mortgage company or escrow company.  The layer of separation that exists between the seller and other parties is the real estate professional.  They are trained to de-escalate sensitive areas so that feelings are not hurt as well as acting as a go between so the way something is said can be minimized.

Difficulties experienced by FSBOs include negotiations with the buyer, not familiar with the process and standards that are involved in the 92% of the transactions that are agent assisted. 89% of Sellers say they were satisfied with the service their agents gave and would use them again and recommend them to others. 

A seller should realize the motivation of a buyer wanting to deal directly with a seller without an agent.  They are trying to save the commission but both buyer and seller cannot save the commission.  The more knowledgeable and possibly, the better negotiator will usually benefit the most.

13% of the sellers were contacted directly by the buyer.  It is conceivable that these buyers may have been trying to take advantage of an unknowledgeable seller to eliminate competition and purchase a home at a lower than market value.

In a seller's market, a FSBO can sell their home.  The question will be whether they received the highest price with the best terms and the fewest problems.  Protecting a large financial asset is important and sellers deserve the peace of mind that a real estate professional provides along with the fiduciary duties that accompany them.

The median price achieved by For Sale by Owners is considerably less than the median price sold by agents.  While there may be other factors involved, it certainly introduces the question "is the FSBO is selling below fair market value?"

Before embarking on the sale of your home by yourself, talk to a real estate professional or possibly two, to get as much information as possible to make an informed decision.  Your objective should be to maximize the proceeds from the sale.  For more information, download the Sellers Guide.

Homeowner Equity and Wealth Accumulation

National homeowner equity grew in the fourth quarter of 2020 by $1.5 Trillion or 16.2% year-over-year based on a CoreLogic analysis.  The study was done on the six out of ten homeowners who have mortgages on their home.

The fourth quarter of 2020 also saw the number of mortgaged residential homes with negative equity decrease by 8% from the third quarter.  Compared to the same quarter in 2019, negative equity decreased by 21%.

Equity is defined as the value of the home less the mortgage owed.  Negative equity means that the homeowner's debt is more than the value of the home.  Appreciation is the dynamic that is moving homeowner's equity to the positive position.

On a national basis, according to National Association of REALTORS®, annual price growth for the last ten years has been 6.4%.  In the last five years, it has grown at 7.3% annually.  According to the CoreLogic Home Price Index, home prices in December 2020 were up 9.2% from the year before.

Frank Nothaft, Chief Economist for CoreLogic, is quoted as saying "the amount of home equity for the average homeowner with a mortgage is more than $200,000."

Equity in a home is a significant component of net worth.  The latest Survey of Consumer Finances reports the median homeowner has 40 times the household wealth of a renter: $254,000 compared to $6,270.  According to the 2019 Survey of Consumer Finances by First American, housing wealth was the single biggest contributor to the increase in net worth across all income groups.

The study also concluded that housing wealth represented nearly 75% of total assets of the lowest income households.  For homeowners in the mid-range of income, it represented 50-65% of total assets and 34% of total assets for the highest income households.

Renters do not benefit from the appreciation of housing or the amortization of the mortgage which are significant contributors to home equity that results in net worth.  Examine what a down payment can grow to in seven years with a Rent vs. Own.

It Costs Less to Own

The rent to income ratio is the monthly affordable rent as a percentage of monthly income.  Ideally, tenants should keep it within 30% of monthly gross income.  In some markets, in may not be possible because the shortage of available rental units.  In these situations, tenants are required to spend more than 30%.

Let's assume that a person/couple makes $100,000 a year which would be $8,333 per month.  Thirty percent of their monthly gross income would be $2,500 which would be at the top of the ratio for their rent.

If they were to buy a $300,000 home on an FHA loan at 3.00% for 30 years, the total payment, principal, interest, taxes, insurance and mortgage insurance premium would be around $2,034 or almost $450 less per month than their rent.

If you factor in the monthly principal reduction and the monthly appreciation, assuming 3% annually, the net cost of owning the home would be under $1,000 a month.  The people would be paying about $1,500 more per month to rent than to own.  In a year's time, it would amount to over $18,000 lost by renting which is more that the $10,500 down payment for an FHA loan and the closing costs.

 

Rent vs Own Example
Purchase Price	$300,000
Mortgage at 3.00% for 30 years	$294,566
Monthly Payment ... principal & interest	$1,241.90
Monthly Tax & Insurance escrow (estimated 2.25%)	$562.50
Total Payment (PITI + MIP)	$2,033.89
Less Monthly Principal Reduction	$512.50
Less Monthly Appreciation	$750.00
Plus Estimated Monthly Maintenance	$150,00
Plus HOA fee	$20.83
Net Cost of Housing	$942.22
Monthly Rent for Comparison	$2,500
Monthly Cost of Renting vs. Owning	$1,557.78
Annual cost of Renting vs. Owning	$18,693.30
Down Payment	$10,500
Estimated Equity after 7 years at 3% Appreciation	$121,579

One of the benefits of renting for tenants is that they are not responsible for the maintenance and repairs.  At the end of the lease, they are able to move without having to dispose of a home.  However, they also do not benefit from the increase in value due to appreciation nor do they benefit from the equity buildup due to amortization of the mortgage.

Disregarding the monthly net cost of housing in the example above since it considers both appreciation and amortization, the payment alone is over $450 less than the rent in this example.  If you look at the cumulative results, the down payment, or initial investment, of $10,500 grows to $121,579 in equity in seven years.  The owner of the home, in accepting additional risk, reaps the rewards of the equity as well as the lower cost of housing.

In the case of a tenant, their landlord will receive the benefits of the appreciation and the equity buildup.  Whether you rent or buy, you pay for the house you occupy...either for yourself or your landlord.

To plug in your own numbers, go to the Rent vs. Own.  If you have questions with the calculator or would like to visit about anything, give me a call (616) 402-3535.

Skip the Starter Home

For generations, people have begun their homeowner experience with a "starter" home.  Part of the logic may be that by beginning with a smaller home, they can learn what it takes to run the home and discover some of the unexpected costs that come along with it.  A slightly longer view into the future could suggest a different strategy.

As of March 4, 2021, the average 30-year mortgage rate according to Freddie Mac was 3.02%; up .37% from the week of January 7th this year.  At the same time, in 2020, the rate was 3.29% and in 2019, it was 4.41%.  That is a difference of 28 and 139 basis points.

The principal and interest payment on a $300,000 mortgage would have been $236 higher two-years ago and $44 more one-year ago.  Today's low mortgage rates are saving buyers lots of interest especially when you factor in the median tenure for sellers is approximately ten years.  Even though prices have increased over the last two years, some people may be able to afford more now with the lower rates.

Anticipating the future wants and needs now may present some opportunities for preparing for the inevitable.  By purchasing a larger home today, a buyer can lock in today's low rates and prices to allow themselves room to grow without the expenses of moving.

Each time you sell and purchase a home, there are expenses associated with each side of the transaction.  Purchase costs could be 1.5 to 3% while sales expenses could easily be 2.5 times that much.  These expenses lower the value of your equity. 

Instead of looking at the low mortgage rates as generating a savings from the payment you might normally have to make, consider it an opportunity to purchase more home that will possibly meet your needs for a longer time while eliminating the cost of selling and purchasing in the transition.

Your Refund Could Open the Door

One of the silver linings to filing your income tax return is finding out that you are going to receive a refund that could literally open the door to owning a home.  If you happen to be one of these fortunate taxpayers, your next decision is what to do with it. 

With the average tax refund near $3,000, it could be the ticket to buying a home sooner rather than later.  Regardless of the size of your refund, it can be used toward the down payment or closing costs of the home.

Most people think it takes 10% or more down payment to purchase a home, but actually, it is much less because of several low down payment mortgages .  There are VA and USDA mortgages that allow for no down payment for qualified buyers.  FHA has a 3.5% down payment program and FNMA and Freddie Mac have 3% down payment mortgages for qualified creditors as well as 5% down programs.

Closing costs for originating new mortgages can easily range from two to three percent of the purchase price but most lenders will allow the seller to pay part or all of them based on the agreement in the sales contract.  If you are using a VA or USDA loan, your refund could go toward paying the closing costs.

On a practical matter, if you are due a refund, have it deposited directly into your account.  It is necessary to trace the source of the funds.  Cashing a refund check and depositing the cash adds an unnecessary aging requirement.

Maybe you have the money saved for your down payment and closing costs but you have other debt that is keeping you from qualifying for a mortgage.  The IRS refund could be used to pay down that debt.  However, you need solid advice from a trusted mortgage professional before you do that.

While the average tax refund might not cover the down payment on the median price home, it certainly helps.  Your refund could make it a simple as 1-2-3 to get into a home.

1. Get the hard, cold facts for the homes and mortgages in your area and price range.
2. Get pre-approved with a trusted mortgage professional.
3. Start looking at homes.

Download the Buyers Guide and contact me at (616) 402-3535 or Linda@BuyTheLakeshore.com to get started.