Dear Valued Clients and Friends,
Several weeks ago we had the pleasure of listening to Dr. Richard Thaler, a Nobel Prize winning economics professor at the University of Chicago. Among several topics he discussed, there was one that resonated with us about how good football teams make good quarterbacks play at a higher level. That kind of synergy is what we experience with our Financial Concierge Services team. Collectively, our team helps us better quarterback the achievement of your financial goals. Our team of advisors and technicians include some of the brightest people across investments, estate planning, tax, real estate, retirement, risk management, business, law, and charitable giving. Each professional on our team is vetted for competence, character and value. Ultimately, it allows us to provide you and your family with a holistic and comprehensive client experience, more time to do what you are passionate about, and greater peace of mind. Furthermore, as legal fiduciaries, we are committed to doing what is in your best interest with complete transparency, no hidden fees and no conflicts of interest.
The Financierge is a monthly publication that complements our investment thought leadership (Dividend Cafe and Market Epicurean) and reflects the diversity of services we offer our clients. Collectively, our Financial Concierge Services team has a valuable amount of real estate experience across investments, tax, law, tenant representation, brokerage, insurance, lending, general contracting, performance reporting and property management. In this month’s issue we focus on several financial perspectives in real estate such as buying or leasing a home, mortgages and reverse mortgages, and moving residences to save money.
The Financierge – Issue #5
- Four Points to Ponder Before Buying or Leasing a Home
- Six Considerations About Mortgages, Refinancing and Taxes
- Five Elements of Reverse Mortgages
- Four Perspectives to Consider in Deciding to Move to a State with Lower Taxes
We are often asked by our clients to help them or their children evaluate whether they should buy or lease a home. In this article we will provide some of our perspectives to help navigate the decision process.
- Buying a Home – When you take a loan out to buy a home, you will normally have to pay a down payment and closing costs plus monthly mortgage principal and interest, taxes, insurance, utility expenses, and maintenance costs. Your tax advantages include an interest and property tax deduction (limited to $10,000 if you itemize), and when you sell the home there is a one-time exclusion of $250,000 per person. There are also selling costs like real estate agent commissions.
- Leasing a Home – When you lease a home, you pay a security deposit, fixed monthly lease payment, renter’s insurance premium, and some utility costs. There are no closing costs or home maintenance expenses. Ideally, you will have a lower home cost and be able to save more than when you buy a home.
- Factors that Favor Buying – Normally the higher your marginal tax bracket, the greater the advantage of owning a home. However, you should also consider the time frame. Shorter time periods favor renting while longer time periods favor buying. As an example, let’s look at the breakeven of renting a home for $6,600/month vs. buying a home for $1,225,000 with 20% down and a 4%, 30-year fixed mortgage. The breakeven is about 3 years – the time when buying became less expensive than renting. In the same scenario, if the rent was $5,600, the breakeven would be 4 years, and if the rent was $4,600 the breakeven would be 8 years. There are some good rent vs. buy calculators on the Internet or we can help you analyze your options. Other factors that favor buying include rising home prices, the ability to use the loan interest deduction, fixing up a distressed property, or the secure feeling of home ownership. Also, buyers sometimes get a better credit score based on their diversity of credit sources.
- Qualitative Considerations – When comparing costs, don’t forget to consider qualitative factors like peace of mind, stress, credit, and family or personal preferences. While buying a home may offer a certain sense of freedom and peace of mind, there is also the stress of home maintenance, buying, selling and worrying about home values. However, maybe there is less stress as a renter because you may have more discretionary money. Some people like the flexibility to move around and don’t need much space, while others want to plant roots and have a long-term home for their kids. Other areas of consideration include pure personal preference likes geography, demographics, job and income, transportation and lifestyle.
Whether you are getting a mortgage to buy a home or refinance a loan, here are six considerations about mortgages.
- Know Thyself – The very first place to start is to know how much you can afford by looking at your income, expenses, and down payment. Most lenders expect your mortgage payment (including property tax and homeowner’s insurance) to cost no more than 28 percent of your pre-tax income, with your total debt-to-income ratio to not exceed 36 percent. A high-income borrower might be able to have ratios closer to 40-50 percent. In addition, a good FICO credit score (acronym for Fair Isaac Corporation, the company that invented the model) is key to qualifying for a mortgage and a good interest rate. Scores range from 350-850 with 723 being median, and 680 being the minimum for getting the best interest rates. Generally, lenders look for a down payment of 5-20 percent of the home’s price and if under 20 percent, the lender will require private mortgage insurance (PMI) to protect themselves from losses. Lenders also look at the loan-to-value ratio when underwriting the loan. The higher your loan to the amount of your home’s appraised value, the less risk to the lender and the lower your interest rate. As a verification step, you might want to use an online pre-qualification calculator to see if you are likely to get a mortgage you want. You can also get pre-qualified with a lender, but the inquiry may affect your FICO score.
- Research Your Target Market – Once you know how much home you can afford, know your preferences and research the target market where you want to live. Do you want a home, condo, or townhouse? Location is most important but there are some other important considerations such as home price comparisons, schools, character of the neighborhood, safety, walk-ability, deferred maintenance, traffic, long-term value, taxes, home owner association dues and access to highways, work, shopping and hospitals.
- What is Your Mortgage Type? – Mortgages differ based on many factors and the kind of borrower you are. If you qualify as a first-time home buyer and have a low down payment and credit score, a Federal Housing Administration (FHA) loan might be best. If you are a veteran or serve in the military, the Department of Veterans Affairs (VA) has a less stringent mortgage program. If you live in a rural area, you may qualify for a U.S. Department of Agriculture (USDA) zero down mortgage.
- Perform Due Diligence – This is an area where our Financial Concierge Services professionals can help you shop the market across multiple lenders to help you get the best rates and terms. The difference in interest rates and terms can save you thousands of dollars over the life of a loan. We recommend getting at least three quotes and comparing the rates, terms and fees for points, underwriting, appraisal, title, and closing. When comparing rates, understand the difference between interest rates and annual percentage rates (APRs). APRs includes the interest rate plus points, broker fees, closing costs and other charges that can help understand the total cost of mortgage. And one last point, pick a lender who is trustworthy, competent, and fully discloses the advantages and disadvantages of various alternatives.
- Refinancing – Refinancing is similar to the costs of obtaining an original mortgage. When evaluating whether you should refinance a mortgage, there are three key areas to evaluate: length of time expected to stay in the home, cash flow capacity, and taxes. In general, reasons to refinance a mortgage include getting a lower interest rate, consolidating debt, shortening or lengthening the term of the loan, or getting cash out of the home.
- Consider Taxes – When considering a mortgage, refinancing, or even a home equity loan or line of credit, remember to consider taxes if you itemize. There is a limit to the amount of qualified residence interest that is deductible. For 2018-2025, the aggregate amount of acquisition debt (debt incurred to buy or improve a first of second residence) may not exceed $750,000 ($375,000 for married filing separately) and home equity loan interest is not deductible. Furthermore, deductions for state and local taxes are capped at $10,000 and include property, income or sales taxes. Keep in mind that under a grandfather rule, the new tax law does not affect home acquisition debt of up to $1 million before December 16, 2017 or under a binding contract before December 16, 2017 but closed before April 1, 2018. Also, grandfathered are refinanced loans closes before April 1, 2018. One key point to keep in mind is that the grandfathered rule applies to loans up to $1 million taken out before December 17, 2017 and refinanced – to the extent the initial principal balance of the new loan does not exceed the principal balance of the old loan.
Reverse mortgages can be an additional source of income in retirement to help cash flow, defer social security so benefits can increase, or reduce taxable distributions from retirement accounts. To see if this is the right strategy for you, here are five elements of reverse mortgages to help you understand some of the requirements, benefits and costs.
- What is a Reverse Mortgage? – A reverse mortgage lets you borrow against your home’s equity so you receive cash without selling your home. Cash can be received in the form of a lump sum, ongoing payments, or a line of credit. Repayment is triggered upon the death, the end of the loan term, or certain events such as a change in residence. It’s important to note that if you enter a nursing home, ownership of a home is not a barrier to Medicaid eligibility but there are state by state limits to the home’s value. If the home is sold to satisfy a reverse mortgage, the remaining cash proceeds are not protected and may cause the loss of Medicaid eligibility. If a reverse mortgage is distributed as an annuity, such distributions may be considered income in the context of Supplemental Security Income (SSI) and can cause the loss of such benefits. It is typically preferable to get distributions in the form of monthly requests from a line of credit. Also, Medicaid beneficiaries must name their state as a remainder beneficiary of their reverse mortgage annuity.
- Eligibility Requirements – A reverse mortgage is available to homeowners 62 years and older living in primary residence – condominiums, four-unit multifamily, or single-family home but not a vacation or second home. There are generally no income requirements but the lender will verify whether you can continue paying the housing costs including taxes, homeowner’s insurance and maintenance after you take out the reverse mortgage. The loan is based on age, appraised home value, current interest rates, and type of reverse mortgage. Generally, this is up to $679,650 for HECM (Home Equity Conversion Mortgage) reverse mortgages or more for proprietary reverse mortgages. Also, the home does not have to be owned free and clear to qualify for a reverse mortgage but your reverse mortgage must be enough to pay off your remaining home loan. Also, you can’t have any federal debts delinquencies like taxes or an FHA-insured mortgage. Finally, before applying for an HECM, you must meet with a counselor from an independent HUD-approved housing counseling agency. The counselor will review your financial situation, credit score, and verify you to help you decide whether a reverse mortgage is the right option. The counseling is required so that you understand reverse mortgage options, fees, total cost over time, and a comparisons of alternatives. You can visit HUD Exchange (https://www.hudexchange.info/programs/housing-counseling/) or call (800) 569–4287 for a list of counselors. The counseling cost is about $125 and can be paid from loan proceeds.
- Benefits – The main benefit of a reverse mortgage is access to cash tax-free without selling your home. There are no mortgage payments, you maintain ownership, and you can stay in your home as long as you want. Also, if properly structured, social security and Medicare are not affected. The reverse mortgage is a non-recourse loan, so the borrower or heirs will never owe more than the house is worth, even if that value is less than the loan balance. Also, once the loan is repaid, any remaining equity is distributed to the borrower or the borrower’s estate.
- Costs – The are many costs with a reverse mortgage. The first is the fee the lender charges to close the mortgage such as appraisals, credit reports, title search, escrow and loan settlement, document preparation, points, title insurance, and pest and environmental inspections. Costs to maintain the mortgage include interest, service and mortgage insurance fees. Most of these fees are paid when you leave your home but you might get less money than if you sold your home outright. Also, since a reverse mortgage is a loan, interest grows over time on your loan and this reduces the amount of money you or your heirs receive for selling your home. There is no annual tax deduction for interest until the reverse mortgage is paid off. Your loan must be repaid if you change residences either by not living in your home for more than six months in a year for non-medical reasons, or by not living in your home for twelve consecutive months for medical reasons. And finally, you still need to pay housing costs such as property taxes, maintenance and home association dues. If you fail to make these payments, the lender could foreclose on your home.
- What are the Different Types of Reverse Mortgages? – The first and most common type of reverse mortgage is a Home Equity Conversion Mortgages (HECM). HECMs offer federal backing, limits on certain fees, fixed and adjustable interest rates, and you can use the money any way you want. The loan is insured by the U.S. government through the Federal Housing Administration (FHA). If the amount you owe from the reverse mortgage grows to exceed the value of your home, the FHA will assume most or all of the loss. You will pay a mortgage insurance premium to cover the potential for this type of loss, but it can be financed into the cost of your loan. HECMs have restrictions on eligibility and borrowing. The maximum property value that a lender can use to determine how much to lend for an HECM reverse mortgage is the FHA maximum loan limit – $679,650 for 2018. The second type of reverse mortgage is a Proprietary Reverse Mortgage. Proprietary reverse mortgages are like HECMs, but do not offer a government guarantee. They have fewer restrictions and the lender could lower the eligibility requirements, but fees may be higher. A proprietary reverse mortgage can create loans secured by more than the $679,650 property value limit from HECMs, so they can be a good option if you have a high-value property. However, lender fees are not restricted to a specific amount, so fees may be higher. These loans are also harder to compare because they aren’t standardized. Finally, you can only receive a lump-sum payment from a proprietary reverse mortgage. Other payment options are not available. HECM reverse mortgages make sense for most properties valued at less than $1 million, whereas homes worth more than $1 million should review both options. The third type of reverse mortgage is a HECM for Purchase and can be used to buy a new home for your primary residence. You enter into a contract to buy your new home, pay a down payment and then finance the balance of the purchase with the reverse mortgage rather than paying cash or using a first-lien mortgage. The new home can’t be a vacation home or investment property. This strategy lets you complete everything in one transaction and you will not owe monthly mortgage payments for your new home. Many seniors use an HECM for purchase to downsize or move closer to family members. The fourth type of reverse mortgage is a the lender restricts how you can use the money perhaps like paying for home maintenance or property taxes. This kind of a reverse mortgage is called Single-Purchase where the lender restricts how you can use the money, like paying taxes or maintenance. This kind of reverse mortgage is generally the least expensive option but is limited in availability and for low- and moderate-income borrowers.
One question our clients ask about are the costs and benefits of moving to a state with lower taxes. While there is no one-size-fits-all answer, it is important to consider both qualitative and quantitative perspectives in deciding if moving to a new state to save money is a good idea.
1. Qualitative Perspective – While the quantitative costs of moving from state to state are important, many clients find that qualitative factors outweigh quantitative factors. Before deciding, some key areas to consider are family, friends, geography, population, ethnicity, income, jobs, housing, schools, hospitals, shopping centers, restaurants and transportation systems. There are some websites like moving.com that provide helpful information.
2. Quantitative Perspective – Quantitatively, it’s important to look at the cost of living, taxes and the cost to move. Cost of living items include housing, groceries, utilities, transportation and healthcare. According to Council for Community & Economic Research (C2ER) data, the following cost of living diagram shows the cost of living index for each state with the U.S. average cost of living index at 100. The five highest cost of living areas are Hawaii (186%), Washington D.C. (161%), California (141%), New York (133%), and Alaska, Maryland and Oregon (130%). One caution is that while state information may give you an overall perspective, it is important to make as exact a comparison as possible. For example, as a state, California is more expensive than New York, but according to Bankrate’s cost of living calculator, New York City is about 62% more expensive then Los Angeles. Another caution when doing your analysis is to remember the cost of living index does not address the quantity or quality of the goods or services. For example, you may have higher healthcare or childcare costs, or you may drive a vehicle that consumes more gas.
Another important area of consideration is state income tax. The diagram below shows the top marginal income tax rates for each state. The highest state income tax state are California (13.30%), Hawaii (11%), Oregon (9.9%), Minnesota (9.85%), Iowa (8.98%), New Jersey (8.97%), Washington D.C. (8.95%), and New York (8.82%). Alaska, Washington, Nevada, Wyoming, South Dakota, Texas and Florida have no state income tax.
In general, it is important to not only consider state income tax, but also state sales, property, local, estate and inheritance taxes. To further complicate your analysis, each state may handle income, deductions and credits differently. Also note that tax law can change. For example, in 2018 the Tax Cuts and Jobs Act limits federal income tax deductions for state and property taxes to $10,000 through the end of 2025.
Another tax consideration is state estate and inheritance tax. These are taxes in addition to the federal estate tax rate of 40%. The following diagram below shows which states have estate and inheritance taxes. While most states don’t have estate and inheritance tax, twelve states have estate taxes, five states have inheritance tax, and Maryland has both.
3. Cost to Move – While moving costs might be the least cost consideration in your analysis, it is the most time consuming. The American Moving & Storage association estimates the average cost to move is $4,000-$5,000 plus there is a consideration for your time to pack, change addresses and get a new driver’s license.
4. State Residency Perspective – Finally, it important to understand regulations for state residency whether you move or not. Most state residency regulations have purpose and time considerations. For example, if your purpose is to move to a state permanently, but travel out of the state the entire year, you may be considered a resident. Time also factors into state residency. Some states may consider you a resident if you are in the state 183 days or more (the so-called “six-months-and-a-day” presumption). There are also other residency tests that look at where your permanent residence is, where you are registered to vote, or where you have a driver’s license. If you don’t want to be considered a resident of a state, it may be helpful to keep a calendar and travel log backed up by credit card receipts. You need to be especially careful if you are a seasonal visitor to a high tax state. For example, some states tax residents based on their income no matter where the source, while some states tax non-residents on income from the state. Also, you may trigger a residency audit if a state finds significant taxable income along with you owning a vacation home, a business interest, have children in a local school, or have an extended visit (usually over 183 days) for retirement, employment or medical stay.
While everyone’s circumstances are different, our team of advisors can help gather both quantitative and qualitative information to analyze options and help you make a more confident and informed decision.
Thank you and we hope you enjoyed some of our perspectives on real estate. Please reach out with any questions or if there is anything we can do to serve you.
Don B. Saulic, CFP® CPA
Partner, Private Wealth Management
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Four Points to Ponder Before Buying or Leasing a Home (Jun 22, 2018)
Six Considerations About Mortgages, Refinancing and Taxes (Jun 22, 2018)
Five Elements of Reverse Mortgages (Jun 22, 2018)
Four Perspectives to Consider in Deciding to Move to a State with Lower Taxes (Jun 22, 2018)
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The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.
This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.
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