11-7-18 Should I refinance and payoff my HELOC?

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Question of the week:  Should I refinance and payoff my HELOC?

 

 Answer:  My most frequent response to questions of the week definitely applies to this question: It depends.

 

There are several factors to consider when deciding if now is the time for you to refinance and fix the rate on you Home Equity Line of Credit (HELOC).

 

Before we get into various factors to discuss, let’s take a quick look at why the question is being asked. Your HELOC has three components that determine your current payment, the balance, the prime rate and the amount added to the prime rate (called the margin) that results in the rate you are being charged.

 

Of the three factors the only one you somewhat control is the balance; you can impact your payment by paying down the balance on the HELOC. Obviously, the more you pay towards the balance the lower your payment will be on a monthly basis. Most HELOCs have two periods of repayment. The initial payment period usually has a minimum payment requirement that is the interest accrued on the loan since the last payment. The next stage of payments is usually a fully amortized period for the remaining life of the loan; if you may have a HELOC that is a twenty year loan, in this case typically the first ten years of the loan have an interest only payment, at the start of the eleventh year the loan will be fully amortized based on the remain ten years of the loan.

 

Example: You have a $150,000 balance on your HELOC that you obtained in December 2008 and the current rate is the prime rate, currently 5.25% plus one-half of one percent (0.500%) for a payment rate of 5.75%. Your minimum payment for November is the interest on the balance, $718.75 (balance times rate divided by twelve months). Next month you begin your eleventh year and the loan payment is now fully amortized using the rate that month plus the remaining term of 120 months. The rate for the December payment is the same as November, since the prime rate has not moved, at 5.75%, since you paid the interest only payment in November balance is still $150,000 but now instead of interest only the payment is amortized to include principal reduction and the payment will be $1646.54. Since the Federal Reserve is expected to increase its funds rate by 0.25% in December that means the prime rate will increase by 0.25% as well so the January payment will be calculated at 6.00%** and your payment will be $1655.00 for the month.  **Since the Fed will increase rates into the month the rate will only be for part of the month with the earlier part of the month being calculated at the 5.75% rate, but for demonstration purposes easier to show as one complete month.

 

The lower your balance when you enter the fully amortized payment portion of the repayment of your HELOC the lower your required payment will be.

 

If you have a HELOC for three years or more you have seen your rate increase by two percent since 2015 and one percent since last November. The chances are you will see at least another one percent increase in the next year, with a 0.25% in December when the Fed is expected to increase rates again.  (To see why the Fed increasing rates impacts your HELOC rate here is link to WR&MU from a few weeks ago addressing the issue.)

 

With rates having climbed one percent or more in the past twelve months the decision to refinance is a lot harder than it was one year ago, or even two to three months ago and moving forward the decision might not get easier.

 

The first consideration is if you are risk averse or not. The risk averse individual would be more inclined to want to refinance to avoid future increases in rates on their HELOC as well as for long term fixed rate mortgages that would be used to refinance. The person more comfortable with risk might be less inclined to refinance. Why?

 

The person who is willing to accept more risk may take the stance that their underlying primary mortgage has an interest rate that is lower than the rate available to refinance their primary loan plus their HELOC and will accept the higher rates on their HELOC in the future and if need be make interest only payments with the hope that rates decline in the future so refinancing makes more sense, or to enable easier paying down of the mortgage.

 

The risk averse person does not want the uncertainty of not knowing how high their rate and payment will go on their HELOC and is more willing to trade off what would probably be a higher payment in the short term for what may be a lower payment in the long run. The risk averse person knows if rates do drop in the future they can likely refinance and lower their payment.

 

What are the factors in terms of payment that need to be considered? First and foremost is the payment differential between doing nothing and refinancing. There are four primary factors that will determine the payment at which the interest rate for your refinance will be calculated: balances, credit score, loan-to-value and whether the transaction would be considered cashout or not.

 

The first three factors are pretty elementary; the combined balances of your existing primary mortgage and your HELOC will determine the refinance loan amount, your credit score is determined when we pull a credit report, the loan-to-value is determined by the estimated value of your home and the refinance loan balance.

 

The fourth factor, whether the refinance transaction is considered a cashout transaction or a rate and term transaction. For conventional mortgages unless the HELOC can be proven to be part of the purchase price of the property the transaction is considered to be a cashout transaction, if your HELOC was used to purchase your property the transaction is considered to be a rate and term refinance, and will have lower costs than the cashout. If the loan is a jumbo loan we have several programs that will consider the refinance a rate and term transaction is you can prove you have not accessed any funds from the HELOC in the past twelve months.

 

Once we know the four factors we go to our rate sheets and determine the rate, and also your what your new payment would be after refinancing. With this information you can determine if you want to refinance and payoff your HELOC into a fixed rate mortgage, or continue as you are with your current primary mortgage and HELOC.

 

Since the minimum payment for most HELOCs is interest only even if you were able to refinance near what your current mortgage rate is the chances are you will see some increase in total payment as you move from interest only to paying down principal on your HELOC. With rates higher and most homeowners with rates closer to 4.00% than today’s rates the chances are that your payment will likely increase a few hundred dollars per month, or more, when refinancing to pay off your HELOC. And this is the basis for the hard decision, is the extra monthly payment worth it to remove future risk based on rising interest rates, or is the cost too much for you to want to remove the risk?

 

This is a question I am very willing to help you answer by running the numbers and options for you and your particular situation. For several years we have been encouraging homeowners with HELOCs to refinance to fix their rate and payment on their mortgage debt, while I still feel it is a good idea for most homeowners, it may not be your choice, however I encourage you to run the numbers and know the options. If your HELOC is converting from an interest only payment to fully amortized in the next few years you may want to give refinancing even more consideration due to the sharp increase in your monthly payment when that occurs.

 

If you, or someone you know, has a Home Equity Line of Credit please contact me to go through your information so you have the information needed for making a decision on whether to refinance.

 

Have a question? Ask me!

 

Better economy, higher rates. That correlation is something long time readers of the WR&MU have learned over the years. This week we have positive economic news released every day, some data a lot more positive than others. Here are the data releases that have the greatest impact on rates.

 

Households made more and spent more in September. Income growth for the month was slower than August but still positive at 0.2% matching the core inflation rate for the month. Holding back income growth was a slow down for self-employed businesses. Savings rates dropped as consumer spending increased in September by 0.4%, the seventh month in a row with spending increasing by 0.4% or more. The disparity in spending and income growth may have been impacted by Hurricane Florence. The very good news for the economy inside the data is that there was a sharp increase in the purchase of new cars and recreational goods—the sort of spending that occurs when the economy is strong and consumers are optimistic. The news is not good for interest rates, though tempered a bit as the year over year inflation index of 2.0% is in line with the Federal Reserve’s target.

 

My oldest was one the last time the American consumer was has confident as s/he was in September, as the consumer confidence rose to its highest level since 2000. The cutoff date for the survey was mid-October, before the stock market slump so the expectation is that the index will drop in November. This news also puts upward pressure on interest rates.

 

Continuing the short term historic gains was the Employment Cost Index which showed wage gains in the private sector reached their highest level in ten years in the third quarter, with wages, salaries and benefits increasing 0.8% for the period. The gains reflect the lowest unemployment rate since 1969. A very big concern for economists is wage inflation, higher prices driven not by demand but by the cost of production of goods and services being driven higher by employment costs. The ECI report puts that concern very much in the center of the inflation and rate conversation. While this news is good for workers it is bad for those wanting lower interest rates.

 

Today’s data just piles on. The jobs report was released by the Labor Department today showing the labor situation in September. The news shows a very strong labor market, stronger than expected. Nonfarm payrolls increased by 250,000 in September, well above the forecast of 208,000 jobs. Included in the report was year over year growth in wages of 3.1%, the highest gain in one year since 2009 when the recession ended, the average hourly pay is now $27.30. This report fully supports future rate hikes from the Federal Reserve and continued upward pressure on mortgage and other long term rates.

 

Rates for Friday November 2, 2018: Despite the quantity and quality of positive economic news conforming rates hold on from last Friday, high-balance loans ($453,101 to $679,650) increased from last week back to seven year high first reached in early October. The only reason I can see for rates to undergo a migration down would be a catastrophic event causing investors to flee to the safety of long term fixed rate returns available in U.S. Treasury bonds and mortgages.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                                4.75%       Flat

30 year high-balance conforming                       5.125%     Up 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

 

As many of you know I love baseball. During the season most afternoons I have the Phillies radio broadcast, or some other game back east playing on my computer and on weekends I listen to games from Philly or around the country while driving around or doing chores. Last Friday night’s game between the Dodgers and Red Sox that went 18 innings was pure heaven for me and I was thrilled the way it ended, not necessarily because the Dodgers won but that it was won on a great home run and not an error. Every inning was thrilling and had fans on the edge of their seats. While mildly upset the Red Sox won another championship and the Dodgers drought is now thirty seasons, I admire the Sox for the way they played this season and through the playoffs; the best team hoisted the trophy to end the season.

 

Now we wait until the end of February when Spring Training starts!

 

Have a great week,

Dennis

 

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com

10-26-18 Why can’t you use my bonus income to qualify me for my new home?

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Question of the week:  Why can’t you use my bonus income to qualify me for my new home?

 

 Answer:  Income must be of a constant and continuing nature.

 

What constitutes “constant and continuing?” Generally, at least a two year history of receiving the income fulfills the requirement. There are some exceptions which I will cover below, but the question of the week specifically addresses bonus income, and much of this will apply to overtime and commission income as well.

 

Bonus income typically fluctuates from year to year depending on the matrix upon which the bonus is based. Because of the fluctuation there must be a guideline for the lender to consider the income for qualification purposes for your mortgage application. The industry standard is that if you have received a certain type of income for two years are more then we have reached the threshold of constancy. To reach the continuing nature policy we generally need a statement from your employer that the bonus will in all probability continue; this guideline is usually met with a letter from the employer or with a Verification of Employment (VOE) that we send your employer to complete. The VOE has sections for your employer to complete stating the length of employment, income for each of the past two years plus year to date broken down into base, bonus, overtime and commission. As well there is a place to indicate whether the continued payment of bonus, overtime and commission is likely to continue in the future.

 

Whether your bonus is paid annually, quarterly, monthly or per pay period does not matter for qualifying, we will convert the amount received into a monthly amount based on the amount received for the past two years, and if applicable year to date. The rule of thumb for bonus income, as well as overtime and commissions, is to use at least a two year average, unless the most recent year is lower than the prior year in which case the lower amount is taken.

 

Example: You have been with your company for five years and have received bonuses every quarter for the past three years and the bonus is paid on the first paycheck after the end of the quarter. In 2016 your bonuses totaled $12,000, in 2017 $12,600 and on your October 15th pay period your total bonuses year to date including September totaled $9700. The total amount received in bonuses is $34,300 over the past 33 months (two full years plus nine months in 2018), so we divide the total amount received by the time period over which it was received and get $1039.39, this is the amount of bonus income we will use for your qualifying for your mortgage—provided your employer verifies that you are likely to continue to receive bonuses in the future.

 

Example 2: Same employment scenario as above, however in 2016 you received $12,000 bonus, in 2017 you received $10,000 bonus and through September you have received $9000 in bonus income as reflected on your recent paycheck. It is evident you received $1000 per month in 2016 and so far in 2018. However, in 2017 your bonus was $833.33 per month—this is the bonus income that most lenders will use for income qualifying as it follows the standard guidelines from Fannie Mae and Freddie Mac. Even with a letter from your employer regarding 4th quarter bonus the lender will take the worst case scenario when calculating income.

 

All this covers how we do calculate and count your bonus income, back to our question, why is your bonus income not allowed? Reading through the above it is likely because of any or all of the following:

 

  • You have not received your bonus for at least two years
  • Your bonus has been inconsistent, i.e. you received bonus income in 2016 but not 2017
  • Your employer will acknowledge that your bonus is likely to continue, which we saw not infrequently during the recession with employers very hesitant to put in writing bonuses are guaranteed or likely to continue creating a legal document an employee may use against the employer should bonuses be canceled.

 

Any non-wage employment income is generally treated in a similar manner, most prevalent being overtime, commission and self-employment income.

 

As mentioned above there are some exceptions to the two year income rule:

 

New job—If you are starting a new job, depending on the circumstances, we can generally count your income with a short, or perhaps no, history of employment at the new job. Typically, showing at least thirty days of income is needed. If you are transferring from working for Dennis Sprockets to Smith Widgets and in somewhat the same type of work, we can use your new income—but not overtime or bonus unless expressly addressed and quantified in an employment contract and if you received similar amounts in your prior job. New professionals can also have “young” income used for qualifying with proof of education in the field and an employment contract. If transferring geographically and a new job with a new company we can usually use your new employment income before you start on your job with an employment contract and separate letter from a senior executive at the company.

 

Spousal support—If you have a divorce decree or separation agreement that is recorded that includes your receiving alimony or child support we can use that income once you can prove you have received six monthly payments in a timely fashion. Note the income must be received as one payment every six months and not six months’ worth of payments upfront. As well the agreement must indicate the income will be received for at least three years after the date of your mortgage application; for instance, if you are receiving $800 per month for each of your two children until they are 18 and your son is 16 then we will only accept $800 for qualifying for your youngest child.

 

Retirement income—If you receive a pension or social security income you do not need to show a two-year history. Provide your award letter stating the amount of income you are to receive and we will use the current income for social security; for a pension, we must show that the pension income will continue for at least three years.

 

Asset accounts—Most individuals and couples have their financial assets in a retirement account and/or taxable investment and bank accounts. Depending on several factors these accounts could be used for qualifying income. Retirement accounts can be used for income if you are taking regular withdrawals from the account. Depending on your age and the type of retirement account you may be having to take mandatory distributions on an annual basis, this can be used for income. Or if you are taking regular distributions we can use those amounts as income as well. If you have funds in non-retirement accounts there are some cases where we can perform a calculation called “asset depletion” so we can achieve qualifying income.

 

Rent—If you are purchasing a new home and renting out your existing home there are guidelines we can follow to use the rental income from your current residence as qualifying income to offset the mortgage, tax and insurance payments.

 

Bonuses, commissions, retirement, wages, there are many different sources of income; whether yours is eligible for use as qualifying income can depend on different factors. If you, or someone you know, if looking to purchase or refinance property please contact me to ensure you are fully qualified for the transaction you want to make.

 

 

Have a question? Ask me!

 

Don’t bury the lead. A couple of big pieces of economic news, since weekly update is primarily about mortgages and real estate we will start with the major news on home sales. This week the California Association of Realtors released its housing report for September. Based on the data I am of the opinion the real estate markets have become a buyer’s market. Los Angeles County saw the median home price increase 4.5% from August and 4.7% from 2017 to a value of $634,680. While the median price increased there was a dramatic drop in total sales. Sales volume for the month was down 18.3% from the prior month and 22% from last year. Neighboring Orange County saw both the median price and total sales volume drop in September. The county median price of $825,000 was down 1.6% for the month and 3.3% for the year, total volume was down 20.3% from August and 21.8% from September 2017. The data that supports my contention of our regional market being a buyer’s market is the increase in the number of active listings on the market and the time a home is on the market before it is sold and enters escrow. Basic premise, more supply leads to lower prices. Supply is growing and demand is not due to several factors, primarily higher interest rates.

 

Impacts sales and refinances. The softening market not only impacts sellers as they see values slowly erode, but also can have an impact on homeowners looking to refinance to lower payments, consolidate equity lines or obtain equity for various reasons. How? With a softer market there is more downward pressure on appraisals and therefore values needed for refinancing, or the rate and cost of the refinance due to potentially higher loan to value based on potentially lower appraised values.

 

The national economy is not following housing. This morning the initial estimate for the Gross Domestic Product was released and it showed growth in the quarter of 3.5%, slower than the 4.2% GDP growth in the second quarter. The expectation is that 2018 will end with total economic growth of 3% or greater, the first year with such growth since 2005. The report was, as you can expect, sprinkled with good news most notably the decline in inflation from 2% in the second quarter to 1.6% in the third quarter. That is good for consumers, but is it good for the economy? With some weakness in business spending and investment, slowing inflation and the equity markets dropping in recent weeks the signals are there for economic growth slowing, or reversing in 2019. It is quite possible, probable?, that a mild recession will begin in the third or fourth quarter of 2019. Overall the GDP news was market neutral as the growth figures met expectations.

 

Rates for Friday October 26, 2018: With stocks falling this week investors have been moving their funds to bonds and mortgages resulting in rates falling from last Friday. We remain in a volatile market and caution is strongly advised when thinking about floating your rate.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.75%     Down 0.125%

30 year high-balance conforming                       5.00%     Down 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

 

 

Few things are better than a short trip that feels like a very long trip. That was the experience Leslie, our daughter and I had last week when we flew out to Boston to see our college freshman. Leslie and I walked about 13 miles on Saturday, mostly up the Charles River while the internationally famous Head of the Charles rowing regatta was going on, watched a performance by the marching band, where ironically our daughter is the tallest in the flute section as she was in high school, then we all enjoyed a fantastic and leisurely lunch/dinner at an Italian restaurant, topped off with the ubiquitous visit to Mike’s for some pastries. Another long walk to LL Bean to get our girl squared away with duck boots for the coming winter and it was back to our hotel for a few hours of catching up and just being together. A packed day, with plenty of needed hugs, mostly for me, and just seeing how happy she is with her friends, college and new city and mom and dad have come home at ease.

 

Now we are looking forward to our next time seeing her when she is home for four weeks at Christmas!

 

Have a Happy Halloween and don’t get too spooked by the gremlins and goblins showing up on your doorstep…I’ve noticed they leave you alone if you bribe them with some sugary treats!

 

Have a great week,

 

Dennis

 

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com

10-12-18: We just received our property tax bill…

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Question of the week:  We just received our property tax bill…

 

 Answer:  Okay, okay this is not a question; it is the start of a question. There are several phrases to make it a question I will quickly go through this week:

 

…why is it lower than you estimated when we purchased our home earlier this year?

 

…why is it higher than last year since we are under Proposition 13?

 

…how much should we pay?

 

 

…why is it lower than you estimated when we purchased our home earlier this year?

 

If your property tax bill is significantly less than my estimates when we funded the loan to purchase your home then you will very likely receive a supplemental tax bill, if you have not received one already and the two bills added together, the tax bill you have just received from the County where your property is located and the supplemental tax bill, should be close to the estimate we used when you purchased your home.

 

In California the fiscal year is from July 1st to June 30th. The tax bill property owners have received in the past week from their County Assessor has an option of paying half the bill by December 10th covering first half taxes from July 1st to December 31st and the other half by April 10th covering the second half taxes from January 1st to June 30th. The tax bill mailed in September or October is based on the prior tax bill as adjusted for Prop 13, or if there was a transfer the value on January 1st.

 

When you purchase a property the tax base for the property is adjusted based on your purchase price. Depending on when you purchased the property the new value may not be adjusted by the County Assessor before the tax rolls are set for the coming fiscal year. If this is the case the tax bill you have received reflects the prior assessed value plus and adjustments for Prop 13 (see below) or additional payments for taxes or bonds put in place by voters or local government. This is the primary reason your tax bill is probably lower than you anticipated, and why you will receive, or have received, a supplemental tax bill.

 

The supplemental tax bill covers the difference between the taxes on the tax bill and the taxes you should be paying from the date of the close of escrow on  your property purchase to the end of the fiscal year, June 30th. Depending on the seller’s assessed value and your purchase price the supplemental bill can be very large, very small, or even “negative,” in which case you will receive a refund from the County.

 

Supplemental tax bills are only mailed a few times a year, so it may be some time after you closed your purchase before you receive your supplemental bill. Please note, if you have an impound account and your lender is collecting and paying your property taxes that your supplemental bill is not sent the supplemental tax bill, the payment is entirely your responsibility.

 

Confused? Let’s say you purchased a home for $650,000 and closed escrow on February 7th. Using our rule of thumb of your property taxes being 1.25% of the purchase price your annual taxes the first year of ownership should be $8,125 per year ($4062.50 for the first and second half tax bills). Your seller purchased the property in 2000 for $375,000 and their assessed value has risen through the years and their tax bill the year they sold the property was $5500. You just received your first property tax bill from your County Assessor and it shows you owe $5610 conveniently payable in two payments of $2805 each.

 

There is a difference in annual taxes between what you should be paying and what you are being billed of $2625. However this will not be the amount of your supplemental tax bill as that is the annual property tax differential and you only owned the property since February 7th, not July 1st of the prior year. There are 143 days between February 7th and June 30th, and that is the period which the higher assessed value should be applied for property taxes. Therefore your supplemental tax bill will be the annual property tax differential divided by 360 days multiplied by the number of days you owned the property between the sale date and end of the tax year:

 

$2625/360 = $7.29 per day x 143 days = $1042.71 as your supplemental bill.

 

Note that depending on your closing date you may receive more than one supplemental bill.

 

It can get pretty confusing, however most County Assessor websites have links where you can input your address, sales price and closing date and it will calculate your estimated supplemental tax bill.

 

…why is it higher than last year since we are under Proposition 13? Prop 13 was passed at the ballot box by California voters on June 6, 1978. There were three major items in the measure that immediately impacted property owners in 1978. First, it decreased assessed values by having all properties in California re-assessed to their assessed values in 1976. Second, it capped the assessed value of real property taxes by to the state at 1% of the ad valorem value of the property, i.e. the transaction value. Third, it limited increases to assessed values to an inflation index but not to exceed two percent (2.00%) per year.

 

It is the third factor that confuses many new or experienced property owners when they receive their property tax bill that the total is higher than what they paid the year before. Since property values are increasing your assessed value is increasing as well, but not more than two percent above the assessed value from the prior year.

 

Also surprised are those property owners who do not follow the news or politics. Their surprises come in the form of special assessments put on tax bills by either voters or elected officials in the form of bonds or taxes. For instance for our home in Long Beach we have nine such assessments that add 29% to our base tax rate of one-percent. Three of the assessments are local bonds for the Metro Water District, Long Beach Community College District and the Long Beach Unified School District; the other six are county measures and bonds for parks, flood control, sanitation, etcetera. Every city and county has different special assessments on their property tax bills that are added to the one-percent maximum taxable assessment from the state.

 

…how much should we pay?  The first question, “how much should we pay?” is a follow up to my Weekly Rate & Market Update from December 22, 2017 after the new tax law was passed that limited SALT (State And Local Tax) deductions to $10,000 per year. In the WR&MU the question was given the reduction in ability to deduct California state income tax and property taxes to a cap of $10,000, did it make sense for California property owners to pay both the first (due by December 10th) and second (due by April 10th) half taxes in 2017, which would result in most property owners who did this paying three half year tax year bills in 2017 (2nd half of 2016-17 in April 2017, 1st half of 2017-18 in December 2017 and 2nd half of 2017-18 in December 2017) thereby maximizing their property tax deductions. The advice from my CPA tax preparer friends Lew Finkelstein and Paul Scholz was, “depends” as some clients would not benefit from the additional half-year of taxes deduction if they were under the Alternative Minimum Tax (AMT) zone for 2017. For most people however it did make sense to pre-pay the April 10th payment and get the deduction.

 

What about this year? Before I answer here is the disclaimer: I am not a tax professional or accountant, before you make any decision as to how much you should pay in property taxes this year consult your tax preparer.

 

If you did pay the second half of your property taxes in 2017 instead of in April of this year, your property tax payment due by December 10th will be your first property tax payment of the year. Should you also pay the second half bill due by April 10, 2019? Again, it depends. If you pay just the first half payment, will your total of property taxes paid plus state income taxes be less than or more than $10,000? If your total is less than $10,000 you may want to go ahead and pay both first and second half property taxes in December to maximize your deduction; if your total is more than $10,000 you may want to pay the second half taxes next year in April when due—which means in 2019 you will again be over the $10,000 limit but at least you will not have a double tax payment in December when you may need the extra cash for the holidays.

 

Confused? Let’s say your annual tax bill is $6,000, you owe $3000 by December 10th and another $3000 by April 10th. You paid the full property tax bill in December of last year, so this year you have paid no property taxes. As a household your state income taxes for 2018 are approximately $8000 for the year. You have to pay your first half tax bill of $3000, so you will have paid a total of $11,000 in SALT (State And Local Taxes, i.e. income and property taxes) and can only deduct $10,000 on your federal taxes, so you have lost $1000 in deductions you used to get. If you pay the full $6000 then you will pay a total of $14,000 in SALT, can only deduct $10,000 so lose $4000 in deductions you used to get.

 

If you just pay the first half, in April you will have to pay $3000 for the second half taxes, in December you will have to pay the first half taxes for 2019-20, assuming it increases the maximum amount (2%, see above) that payment will be $3060 for a total of $6060 paid in property taxes in 2019. If your state income tax bill is the same, $8000, then you will have paid $14,060 in SALT and be able to deduct only $10,000 so you have $4060 you miss in deductions.  Provided there are no changes to the tax bill that increases SALT deductions.

 

The question you want to answer is do you want to have deductions left on the table this year or next year if the laws do not change? Personally, I will only pay the first half taxes this year and see if there is some political deal to revise the SALT deductions for 2019—I doubt there will be but we never know since there will be a new Congress starting in January.

 

Repeating my disclosure: I am not a tax professional. Before making any decisions regarding our taxes please consult with your tax preparer.

 

If you own property I strongly recommend you have two professionals assist you: a family law attorney to help you establish an estate plan with a trust and a professional tax preparer to ensure you are maximizing your tax opportunities as well as able to provide advice when needed.

 

If you have any questions on property taxes please do not hesitate to contact me and I will assist you the best I can.

 

If you, or someone you know, do not currently pay property taxes I am very willing and able to speak with you about how you can purchase property and become a homeowner!

 

 

Have a question? Ask me!

 

Prices are still under control. Strong increases in prices are still anticipated by many economists and analysts, as they have been for the bulk of the year, but have yet to manifest in the market place as inflation still remains under 3%. After dropping 0.1% in August, the Producer Price Index rose 0.2% in September and year over year wholesale prices are up 2.6%, the increase was in goods and services as food and gasoline prices both dropped nationally in September. On the consumer side the Consumer Price Index increased 0.1% in September, less than anticipated and slower than August’s increase of 0.2%. Year over year consumer prices are up 2.3%, a drop from August’s 2.7% annualized increase in prices. The most significant push on higher prices in September were higher costs for renters and home owners. Good news in the report was the after inflation wages for workers rose 0.3% in September and year over year are up 0.5%. The report is the basis for 2019 CPI adjustments for the government and it has been reported that social security benefits will increase 2.8% next year. Over all the price news is neutral for mortgage rates.

 

Rates for Friday October 12, 2018: A see-saw week for mortgage rates this week as investors ran to and fro with their money reacting to Fed-speak and speculation the Fed will increase rate by one-half of one percent (0.5%) in December instead of the anticipated one-quarter of one percent (0.25%) and have four rate increases next year instead of three. As well the drop in stock prices this week caused many investors to put some of their proceeds from selling their equity holdings into bonds—though it appears most of the money went into cash. We have a volatile rate environment, now is not the time to float your rate or try to time a dip, lock your rate when you can. All that said, rates are down slightly after last week’s spike late in the week.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.75%    Down 0.125%

30 year high-balance conforming                    5.00%     Down 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

Is it me or does it seem like Hurricane Michael had little of the pre- and post-landfall coverage that Florence received last month? Michael was the strongest hurricane to hit the United States mainland in over fifty years and the power of the storm is very evident in the pictures we are now seeing. Whole groves of trees snapped in half, houses not only flattened but blown completely away. The devastation looks more like a tornado than a hurricane, but with a significantly larger impact area. Several times a year it seems I post this link in the WR&MU, here it is again, if you are able please make a donation of any size to the American Red Cross who does incredible work assisting those impacted by disasters.

 

Have a great week,

 

Dennis

10-5-18: How does the Federal Reserve impact mortgage rates?

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Question of the week:  How does the Federal Reserve impact mortgage rates?

 

 Answer:  Indirectly.

 

Long time readers of the WR&MU know I mention the Federal Reserve, aka the Fed, a lot in updates, usually in the section covering news of the week that impacts mortgage rates. Whenever the Fed changes rates I usually get inquiries from different sectors of my life as to what it means for mortgage rates. This week the Fed raised its Federal Funds Rate by 0.25% and at two different meetings subsequent to the rate increase I had conversations regarding what it means for mortgages.

 

Before we cover the impact that the Fed has on mortgage rates let’s cover what rates the Fed does impact directly. There are two interest rates that are directly associated with the Federal Reserve and the Fed does not directly control either. The Federal Funds Rate is the rate at which member banks charge each other for over-night loans so they can cover their required minimum reserves, the Federal Discount Rate is the rate at which the Fed loans money over-night to member banks so they can cover their reserves.

What reserves? Depending on its size a bank in the United States must retain either 10% of their total deposits (banks with more than $122.3 million in deposits) or 3% of their deposits (banks with $16 to $122.3 million in deposits) in their banks. If a bank slips below this requirement due to making loans that total more than the either 90% or 97% that can be out in loans, the bank must borrow money to add to its reserves to meet the requirement. The bank can either go to the Fed’s discount window and borrow the needed funds, or it can borrow the funds from another bank that has reserves above the reserve requirement. Depending on whether it goes to the discount window or another bank will be determined by the rate each is charging.

 

How are those rates set? The Federal Reserve sets the rate it charges at the discount window, and this changes daily based on the market, demand and objectives of the Fed as to what it wants to do with its assets—loan them out to member banks or retain them for its own reserves. The rate that gets all the publicity is the Fed funds rate, the rate banks charge each other to lend money over-night.

 

This week the Fed was in the news and it was reported that the Open Market Committee of the Federal Reserve (aka the FOMC) raised the Fed funds rate by 0.25% (one-quarter of one percent). So to the casual observer with some knowledge of the Fed the presumption is that the Fed is telling its members that it must increase the rate it charges other banks to borrow money over-night by 0.25%. Somewhat accurate, but not entirely. What the FOMC announces when it “increases” rates is the target rate it would like to see banks charging each other, but the actual rate is determined by supply and demand each night and what lending banks are willing to charge and what member banks are willing to pay.

 

Confused? Example: Fred’s Bank at the close of the day has $150 million in deposits, but only $15 million in reserves on hand, it is short $1 million to meet the reserve requirement. Fred’s Bank’s reserve requirement manager goes on-line and sees the Fed is willing to lend the million dollars over-night at a rate of 2.25% (the Fed discount rate), the manager then checks the member bank website and sees that Jane’s Bank, which also has $150 million in deposits but $19 million in reserves, or $4 million above the requirement, is willing to lend one million dollars over-night for 2.23% under the Federal Funds agreement between member banks. The manager at Fred’s Bank can save 0.02% borrowing from Jane’s bank and initiates the transaction. In reality the amount borrowed over-night is in the billions, tens of billions so the savings for small differences such as 0.02% become pretty big.

 

The only rate set by the Fed is the discount rate it charges for over-night loans, but it influences the funds rate by making a strong suggestion to member banks as to what rate it would like see them use for making over-night loans. The two are usually very close, but again determined by the market.

 

Back to our question, how does the Fed impact mortgage rates?

 

As you can see there is no consumer rate that the Fed manages or dictates. However, but by impacting the rate at which banks can borrow money it is also impacting the rate at which banks will loan money to consumers. If a bank can make enough loans so that it is constantly below the reserve requirement, borrow money from the Fed at 2.25% to cover the required reserves and then lend the money it is borrowing at 2.25% to clients at say 5.25% it is making 3% on the money it is borrowing.

 

The 5.25% in my example is what the current prime rate is after the Fed rate increase last week. This impacts homeowners with Home Equity Lines of Credit directly, and the increase in the prime rate was a direct result of the action by the Fed’s Open Market Committee to raise its target for the funds rate.

 

However, long term mortgage rates, the 30-year fixed rate the majority of borrowers obtain, is not impacted by the FOMC decision. Directly.

 

Indirectly, the Fed’s move impacted mortgage rates months ago. And the current actions, and statements, by the Fed are impacting future mortgage rates. How?

 

Mortgage rates are determined by the open market. Investors, and think hundreds of billions of dollars daily, have many choices to make that balance their desire for high returns for their funds and minimizing risk that those funds will decline in value due to the wrong investment decision. Investors are also gamblers. They are constantly research the economy, markets, industries and hundreds of other factors with the sole objective of trying to predict what will happen tomorrow, next week, next month and next year. Based on their information they make the decision to invest in equities, aka stocks, which means you own part of a company; or fixed rate assets that pay a specified rate of return for a specified period like bonds, or mortgages.

 

The most basic piece of information to determine whether to invest in equities or bonds is information that shows how the general economy is doing. If the economy is doing really well, or looks like it will be doing really well, money will go into stocks, causing stock prices to increase, and money will go out of bonds and rates will go up. Why? If the economy is doing well companies will earn more money and therefore be worth more in the future, investors are buying today, low, and looking to sell in the future, high. They leave fixed rate assets like bonds because as the economy improves rates will increase so the rates they are fixing today by buying a bond will be worth less money in the future after rates increase. Conversely, if it appears the economy is slowing down, or contracting, investors will sell equities as companies will be earning less or be losing money in the future, and buy fixed rate invests instead locking in higher rates today with the presumption rates will decline as the economy declines; the higher rates they lock into today will be worth more money in the future when rates are lower.

 

Example: Investor reads the economic tea leaves and sees a growing economy. The option is to purchase a fixed rate investment paying guaranteed 4% for the next five years, or purchase a shares in a mutual fund that focusses on growth. Based on the economy growing, rates will increase so in one or two years the same fixed rate investment may be 5% or higher, or 25% more than the current return, but the money would be locked in at 4%, missing out on the opportunity for the higher rate of return. The mutual fund with companies that experience growth in strong economies is expected to return 6-7% over the next one or two years. If the investor is correct the money will be invested in the mutual fund, and then in a year or two the decision will be made with that money to either sell the mutual fund and re-invest in fixed assets now paying over 5% or leave the money in the fund. Because the 4% fixed rate is not enough to attract investors to invest the rate will increase until investors are attracted.

 

Move ahead two years and the economic growth is losing, or has lost, steam. Rates have gone up to encourage investors, which has also been a factor in slowing economic growth. The investor has made an average of 6.5% by investing in the growth fund but sees the economy has slowed. Looking at the markets there is a fixed rate bond that is guaranteed to pay 6.25% for the next five years. Knowing a bad market will cause rates to decline, and also slow the growth of companies, the investor sells the growth fund holdings and purchases the fixed rate bond. As the economy does slow down the investor is collecting a higher rate of return on the fixed asset than newer bonds coming to market are paying, as well as a lot more than the growth fund that is now losing value.

 

The Fed indirectly impacts mortgage rates as it provides a look into the future for investors as to which way interest rates are headed, often by broadcasting in advance its future intentions with rates. The rate increase last week had no impact on mortgage rates because the Fed told the world in 2017 its intention to increase rates through 2018, how often and by how much. We know that the Fed will increase its target for the funds rate by December 31st by another 0.25%, if it does then there will be no impact on mortgage rates as investors have already priced this increase into bonds and mortgages. If however, the target is increased by 0.50% instead of 0.25% mortgage rates will jump as the rate increase was higher than expected and investors will have been caught off-guard and will sell off holdings they purchased anticipating only a 0.25% increase.

 

What impacts mortgage rates is the expectation for what rates will be in the future. What rates will be in the future is determined by economic activity. This is why I include a brief economic report every week in the WR&MU, so readers can get an idea of the strength, or weakness, of the economy and from that get a good idea if rates will be going up, going down, or holding steady.

 

Even with economic activity it is still somewhat of a guessing game as at any time rates can bounce up or fall down based on national or international events. The rule of thumb for mortgage rates is bad news means low rates and good news means high rates.

 

I hope this was not too much deep in the weeds in describing the Fed’s impact on your mortgage rate, but it is hard to make a simple explanation on a somewhat complex issue.

 

Have a question? Ask me!

 

 

First Friday means jobs. On the First Friday of every month the Labor Department releases the labor statistics for the prior month. Today’s release contained a huge headline number that will cause a stir and details that need further examination. The important data is that non-farm payrolls increased by 134,000 for the month, well below the expectations of 168,000 and below the average of over 200,000 new jobs for month for the first nine months of the year. It is unknown if the lower than expected number of new hires was impacted by Hurricane Florence, or if it is signifying a slow-down in hiring that will continue. Employers are having a hard time finding workers, as indicated by the headline unemployment rate dropping 0.2% from August to 3.7%, the lowest unemployment rate since December 1969. Wages grew 0.3% for the month and are up 2.8% from last August. The news is not positive for rates. With unemployment dropping employers will need to continue to increase wages to fill vacancies, which will in turn require prices to increase to cover the higher labor costs. This can start a wage and price inflation spiral that can be difficult to control. This leads to expectations for higher rates, which puts very strong upward pressure on interest rates.

 

Rates for Friday October 5, 2018: Several months ago, I wrote about the Fed selling off its accumulation of mortgages and U.S. Treasury bonds it purchased over the years following the recession. At the same time these assets are hitting the market the U.S. Treasury is also selling short and long term debt to finance the operations of the government. With increased supply on the market, which drives down prices and rates up, plus economic data indicating there is a strong possibility of higher inflation, and therefore higher rates, it is not surprise that the U.S. Treasury 10 year bond yield is at its highest since July 2011 and that 30-year fixed mortgage rates today hit their highest levels since April 2011. There is some over-reaction from investors this week to the employment data, however when they make adjustments to their behavior, any decrease in rates will be much more modest than the increase we have seen since the end of August. Now is the time to lock in your mortgage rates.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.875%    Up 0.25%

30 year high-balance conforming                    5.125%    Up 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

 

Thanks to my wonderful wife Leslie, PR consultant extraordinaire, and her terrific team, my website is fully functional and includes past Weekly Rate & Market Updates through 2016. The posts from 2016 and 2017 will see some changes, hopefully over the weekend, as I tighten up the titles. The posts from this year are listed by date and also show the Question of the Week to help visitors find topics they are interested in learning more about. There is still some cleaning up and beautifying to go but I am excited that archives of past updates are now available.

 

To visit the website, go to www.DennisCSmith.com or directly to the page with the WR&MU history go to www.DennisCSmith.com/MyBlog .

 

Thank you to everyone who got back to me on last week’s topic regarding the Propositions on the California ballot in November, it was the most feedback I have had on a Question of the Week in some time. If you missed it click here.

 

Have a great week,

 

Dennis

9-28-18: Are there any Propositions on the November ballot that are real estate related?

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Question of the week:  Are there any Propositions on the November ballot that are real estate related?

 

 Answer:  With the election just over month away, and your absentee ballot available in ten days, and the onslaught of television ads just starting, now is a good time to review some of the propositions on your ballot.

 

A brief bio break before I get into the ballot measures. I have a Bachelor of Arts in Economics and Political Studies from Pitzer College (1984) and have continued to be a student of both disciplines. My philosophy is that economics is the foundation of most personal, organizational and political decisions—if you cannot afford it you cannot do it, and if  you do the long-term consequences will generally not be positive. With that out of the way let’s look at the real estate related propositions on your November ballot.

 

There are four ballot measures that in some way involve real estate in California, Props 1, 2, 5 and 10. Here is a brief description of each and my position (if you are so inclined to care).

 

Proposition 1: Affordable Housing Bond If passed this measure authorizes the state to borrow $4 billion in bonds for affordable housing. The funds would be broken into different areas of expenditure with the largest amount being for the building and renovating of rental units. Other funds would be used to provide home loan assistance to Veterans, housing construction in densely populated areas, down payment assistance programs for low and moderate income potential homebuyers and housing development for agricultural workers.

 

Understanding that more affordable housing is needed in the state I do not feel adding $4 billion in bond payments to our budget and cycling the money through state and local bureaucracies is the way to provide more affordable housing. Supply and demand create prices, some of these funds are targeted in a manner to increase demand, which increases prices, and other funds are targeted to rather ambiguous objectives that appear to expand the power of the government in the market place. I feel that local ordinances and applying tax benefits to developers and property owners would be a more efficient way to create more affordable housing. Dumping government funds into a market has never been shown as a way to lower market prices. I will be voting No on Prop 1. I expect this measure to pass given the lack of a unified opposition and the funds coming into the “Yes” side of the ballot.

 

Proposition 2: Mental Health Housing If passed this measure authorizes the state to re-allocate funds currently directed to county mental health services across the state to fund supportive housing for those suffering mental illness. With a directive and the funding the state can make strides in providing long-term solutions to mental illness sufferers and provide blueprint for counties to help with their homeless problems. Across levels of government funds have been allocated for the homeless with no impact on the problem—it seems to be getting worse. By creating housing for the mentally ill that includes on site social services and medical services this proposition is the best solution I have seen proposed so far at any level to start to make a dent in the issue. I will be voting Yes on Prop 2. I expect this measure to pass given its purpose and how much the issue has been one of top concern to most of the state’s residents.

 

Proposition 5: Residential Property Tax Portability If passed this measure would expand the current property tax transfer rules of Props 60 and 90. Under current rules if homeowner over 55 sells their current residence and purchases a new residence of lower value the homeowner can transfer their current tax base to their new home. The portability of the current tax base is limited as only a few counties in the state allow those otherwise eligible to transfer their current tax base into their county (i.e. homeowner selling Orange County could not transfer tax to new home in Shasta County). As well the current laws allow only a one-time transfer.

 

If Prop 5 is passed the one-time transfer limit is eliminated and the purchase price of your new home does not eliminate your ability to transfer your tax base to lower your taxes if your new home costs more than the home you sold—your tax base will go up but not to market value. As well if you purchase a home for lower value than the home you sold your tax base will be lower than your current tax base. Here are two examples to hopefully clarify how the measure will work if passed.

 

Buying more expensive home:  A couple that qualifies for the property tax transfer owns a home in Los Angeles County they purchased many years ago for $110,000. Today the taxable value is $200,000 and their base tax is $2200 per year ($200,000 x 1.1% state property tax rate). They sell their home for $600,000 and purchase a new home in San Luis Obispo County for $700,000. Their new property tax base is calculated by subtracting the sales price from their prior home from the sales price of the new home and adding the result to the tax base from their prior home:

 

New home price minus prior home sales price: $700,000 – $600,000 = $100,000

Price differential plus prior home tax base: $100,000 + $200,000 = $300,000

 

The new tax base is $300,000, for annual property tax base of $3300 ($300,000 x 1.1%). Without Prop 5 the tax base would be $7700 per year (market value $700,000 x 1.1%), the homeowners are saving $4400 per year.

 

Buying less expensive home: This gets a little more complicated as the new tax base is reduced by a percentage based on the difference between the old property value and the new property value. Same couple sells same home for $600,000 with $200,000 tax base. They purchase a new home in San Luis Obispo County for $450,000.

 

New home price divided by prior home sales price: $450,000 ÷ $600,000 = 75%

Old tax base times price differential percentage: $200,000 x 75% = $150,000

 

The new tax base is $150,000 for annual taxes of $1650 per year, a savings of $550 per year over what they are currently paying.

 

I think the best tax law in America is California’s Prop 13. We pay some of the highest income and sales taxes in the country, but homeowners have the best property tax protection from the state of any state in the country. Prop 5 makes the Prop 13 even more generous to homeowners over the age of 55. Because of the over-generosity of Prop 5 I will vote No. If Prop 5 were to mirror Prop 60 and only eliminate the inability to transfer tax bases over any county lines in the state and enable more than one transfer, particularly in cases of divorce or spouse who have passed away, I would vote for Prop 5. As it is written with homeowners purchasing a new home and being able to lower their tax base to me is not equitable to the counties, state or other tax payers and is not needed. And most importantly, if Prop 5 does pass I see it as a strong rallying issue for those who want to eliminate Prop 13 or severely alter it so that higher property taxes result in the future. I expect this measure to fail.

 

Word has it that the California Association of Realtors is already working on a revision to Prop 5 for the 2020 ballot should the measure fail this year. I hope they do as I would like to see the current Prop 60 benefits available to be transferred across county lines. Were I to be asked to craft a revised proposition I would make the changes I suggest changing the calculation on purchase a new home for a higher price to increase the tax base from formula in Prop 5, eliminate ability to lower tax base by purchasing a new lower priced home, eliminated unlimited ability to transfer the tax base but enable additional transfers due to divorce and/or spousal death, and finally I would raise the age of eligibility to 60 from 55.

 

 

Proposition 10: Local Rent Control Initiative If passed this measure will roll back a 1995 law that limited the use of rent control in California (Costa-Hawkins) and enable greater ability for local government to pass, and/or expand, rent control in their jurisdictions. Costa-Hawkins disallowed cities from enacting rent control on properties first occupied in 1995 and single family dwellings (including condos and townhomes). If passed Prop 10 would enable rent control on all rental units, including single family dwellings—and room rentals inside a single family dwelling.

 

Any rent control imposed by government on landlords benefits a very narrow group of residents: those already renting. Wherever rent control has been enacted rental prices are higher than similar geographically nearby markets. Rental units are scarce in rent control communities as tenants do not move to preserve their low housing cost. Because of the scarcity of available units with a rent control unit does come on the market the landlord is able to get premium rent for the unit since there is little competition. Over time as each generation of rent controlled tenants vacate units the rents in the market climb disproportionate to the surrounding markets.

 

According to a spokesman from the California Business Roundtable there are currently 12,000 rental units across the state approved for construction. Every project is on hold until after the November election. Should Prop 10 pass the projects will not start building as the investors/builders do not want their investments to be restricted from market returns by local governments enacting rent control. I will vote No on Prop 10. I expect this measure to fail.

 

There have been many great benefits to Californians as a result of the ballot initiative process, ad many great detriments as well. It is our duty to study the issues, and candidates, presented and understand both sides before casting our ballots. I hope the above comments on the propositions involving real estate provide you with a decent perspective and spur you on to study these and the other propositions more thoroughly.

 

 

Have a question? Ask me!

 

A busy week for mortgage rate impacting news. First, and most expected, the Fed increased it Fed Funds Rate by 0.25%, as expected. The immediate result was the prime rate, and therefore rates on Home Equity Lines of Credit, also increase 0.25%. Prime rate is now at 5.25%, up one percent from one year ago. The Fed announcement also indicated it is sticking to schedule of one more increase in rates this year and three next year. The news is mortgage rate neutral since the rate increase was expected and the Fed did not announce they anticipate more increases than previously announced.

 

Second quarter Gross Domestic Product went through its third and final evaluation and there was no revision made to the prior revision putting the growth for the quarter at 4.2% annualized. With no change to the growth number there was no impact on mortgages.

 

Last Friday of the month gives us important data on consumers as personal income, consumer consumption and inflation data are released. Good news on all fronts for mortgage rates as personal income matched last month’s increase of 0.3% and the core inflation rate dropped from 0.4% in August to flat this month—meaning those higher wages will go further. Consumer increased spending by 0.3%, lower growth than previous months but still the sixth month in a row of positive spending growth and the eleventh of the past twelve months and 3.8% overall gain in spending from last year. Overall the news should be somewhat negative for rates as it shows economic strength is continuing and should continue through the third and fourth quarters absent some catastrophic event.

 

 

Rates for Friday September 28, 2018: Intra-week rates had a bounce up and then down and the result is the conforming rate is flat from last Friday and the high-balance rate is down slightly for the week. Many analysists are hinting at a possible decline, very small decline, in rates in the next week or so; however, this analysist is not convinced of the underlying factors that would make a such a prediction a strong one.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.625%    Flat

30 year high-balance conforming                      4.75%     Down 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

I have a pretty strong background in politics and economics, which perhaps comes through in my WR&MU. My mom grew up in a very politically connected household in Sacramento. Her father was an attorney and lobbyist and her mother was socially active in political circles. My mother continued the family behavior. When my sister, brother and I were growing up we did so with campaign pins and bumper stickers, meet-and-greets with candidates and seeing our mom very briefly on the television from the 1968 Republican National Convention in Miami.

 

Growing up my goal was to become and attorney like my grandfather and both uncles and I majored in economics and political studies in college. My study habits my last few semesters were not great so I put law school on hold to get some discipline. I started earning money, found the mortgage industry and law school was permanently in the rearview mirror. However, my interest in the two disciplines that comprised my major has never left me and I continue to study and read history, economics and political books, articles and journals. For those wondering, the basis of my personal philosophy is that economics is the overwhelming factor that influences politics and therefore history, be it within a family (microeconomics) or nation (macroeconomics). As I often say, take care of the economics and most other issues sort themselves out.

 

Whatever your interest I hope you are able to spend personal time daily, weekly, monthly to indulge in your interest and continue to expand your scope of knowledge and understanding.

 

Have a great week,

 

Dennis

9-21-18: Should we refinance and use proceeds to payoff debt?

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Question of the week:  Should we refinance and use proceeds to payoff debt?

 

 Answer:  Not if you can payoff your debt without tapping into your equity.

 

With rates still low many families are looking at their accumulated consumer debt and wondering if they should refinance, or get a home equity loan, to payoff their debt and lower their monthly credit payments. Being able to get a rate for a cash-out refinance possibly somewhere around 5% for a 30 year fixed rate mortgage seems better than paying high, possibly as high as 20%, on credit cards. But is it a good idea?

 

On paper, the math seems really good, but a deeper look shows it probably is not for most families.

 

Take a scenario where you have a home worth $550,000 and you have a balance of $365,000 on your current mortgage with a rate of 3.75% and your payment is $1850 with about 25 years left on the loan. You do not intend to move anytime in the future as your kids are in, or just about in, middle school.

 

For various reasons, some emergency, some just consumer spending, you have accumulated about $35,000 in revolving debt (credit cards) with minimum payments totaling about $700 per month, have a few collections from past medical expenses for another $2000, a car payment of $560 with a balance of $20,000 and you need to replace your roof which will cost about $20,000. You have about $10,000 in savings and are making maximum contributions to your retirement accounts. You have been trying to pay down your credit cards but have not seem to be able to make a dent in the total balances and are at the stage where you make minimum payments and pay off most of what you charge each month.

 

Recapping, you have about $57,000 in debt costing you $1260 per month in minimum payments, this includes collection accounts with no payments being made, and you need about $20,000 for a roof. Should you either refinance and add $77,000 to your mortgage or get a home equity line for close to that amount, to payoff all your debt, fix the roof and start over with only a mortgage payment? To do so would require about $442,000 for a mortgage balance, or your current mortgage with a home equity line.

 

We would want to keep your new loan amount at or below 80% loan to value, which would be a new mortgage for $440,000, a bit short of what you require but you would be able to pay that off quickly with your new financial obligation shift.

 

Taking a look at a new mortgage of $440,000 for a cash-out refinance at 80% loan to value you would be looking at a rate of about 5% depending on credit score and other factors. This would make your new mortgage payment about $2350 per month, or $500 more per month than what you are spending now on your credit obligations plus replacing your roof. With the new loan and $500 per month higher payment you are getting rid of $1260 in monthly payments for a net savings of $760 per month.

 

Sounds pretty good, payoff debt, get a new roof and save $1260 per month. But is this something you should do?

 

Scenarios I run by clients before initiating the application for such a debt-relief refinance are as follows:

 

Reconsider including your vehicle loan in any debt consolidation scenario. Auto loans are generally lower rates than credit cards, and in the past several years with decent credit rates below mortgage rates. They are also fully amortized, meaning with every payment you are paying down the loan balance until it reaches zero. In the above scenario, you have about three years left on the loan and you are paid off. If you include it in a mortgage refinance you will be paying for the car as part of a thirty year mortgage. Taking the loan out the new mortgage balance would be $420,000, your payment on the mortgage would drop to about $2245. You would now have a mortgage payment that is just over $400 per month higher than your current mortgage, you are paying off debt with payments of about $700 month for net savings of $200 plus have funds to replace your roof.

 

Consider a home equity line of credit (HELOC) instead of refinancing your mortgage. The rate will be higher, and adjustable with it going up the next few years, however you will have the opportunity to save on monthly payments, or not depending on how you handle the repayment of the HELOC. If you go this route, you obtain a HELOC for $50,000 (following advice above and leaving vehicle loan out of the consolidation plan) at a rate of Prime plus one-half of one percent. Prime is at 5.00% today giving you a rate of 5.5% on the HELOC. The minimum payment for most equity lines is interest only, in this case that would be about $230 per month which looks like a big savings over what you are paying now—and that is the debt trap. If you pay interest only you are in worse position than you are now. Yes, your monthly cash flow is better but you are making no reduction in the balance. If you get a HELOC my very strong recommendation is you continue making the same total of payments you were making before, except instead of paying minimum payments on credit cards you are paying down your HELOC balance. Currently you are paying $700 on the cards, so pay $700 on the HELOC, this will decrease the balance $470 per month at the current rate. If the rate never changes and you make $700 per month payments you will have the HELOC paid off in about seven years. However, the rate will very likely be going up at least one percent in the next year, and perhaps more in the future. When calculating long term HELOC rates I usually use an average Prime rate of about 8% to be safe, at this average rate and a payment of $700 per month your time frame to payoff the loan for your credit card debt and roof repair is about eight years.

 

Equity lines often have balloons. One factor to consider with the equity line is the repayment terms. Many are “open” for ten years, meaning you can reuse them as the balance is paid down/off, and during this period they require only interest only. After ten years HELOCs are either fully amortized for the remaining term, or are due with a balloon payment. Because of the change in terms later in the loan it is important to have a payoff plan on the HELOC when you obtain it so you are not in a position in the future where you need to potentially refinance again in the future.

 

Create a realistic plan to payoff you consumer debt yourself and just borrow to pay for the new roof. Make a very realistic budget of your net income and expenses, including debt payments. See what adjustments you can make to your lifestyle and how much those adjustments will save you per month. Take the savings and dedicate them to paying off your credit cards. Many years ago, before Dave Ramsey became a multi-millionaire by counseling families on paying off debt I would help clients with debt payoff plans that pretty much matches Ramsey’s plan. I called my plan Stop, Drop and Roll. Stop using credit. Drop your credit card balances one at a time, starting with the lowest balance. Roll the payments into the next lowest card when one is paid off. It takes commitment to the payments and whatever austerity measures you put in place but if followed will enable you to payoff your consumer debt without refinancing your mortgage and adding tens of thousands of dollars and years to your existing mortgage.

I am in the debt business, a mortgage after all is a debt—the largest debt for almost every homeowner. If you are feeling overwhelmed with your debt please contact me and I can help you, at no obligation or cost, work through options for paying down/off your credit obligations.

 

 

Have a question? Ask me!

 

August home sales are a bit of a mixed bag. While the total number of sales are down in the state from last year prices continue to rise and days on the market are stretching out in most areas as inventory on the market has grown for the past five months. Looking at the data it looks like the market is trending towards equilibrium between buyers and sellers after we have experienced several years of a sellers’ market. Statewide total sales in August were down 1.8% from July and off 6.6% from August 2018. The statewide median price, $596,410, is up 0.8% for the month and 5.5% from last year. Sales and prices locally are in line with the statewide direction on prices and units sold. In LA County, the median price in August was $607,490, up 1.7% from July and 6.4% from last August, the total number of sales were up 5.5% for the month but down 8.9% from last year. Orange County’s median price in August of $838,500 was 1.1% jump from July and 6.3% increase from 2018 with total sales showing 2.9% drop month to month from July and a 9.7% fall from 2018.

 

 

 

Rates for Friday September 21, 2018: Rates are up from last Friday as investors put money into the equity markets (i.e. stocks) and hedge against next week’s Federal Reserve Open Market Committee meeting—these are the folks that set the Fed rates that impact consumer rates, such as the prime rate that determines equity line rates. The Fed will bump their funds rate by 0.25%, that is expected and priced into the markets. Hedging is occurring because of what the FOMC members say about the future of short term rates, how many future increases, how soon, how high? While they will not directly answer these questions those who can read the Fed tea leaves will discern much from the minutes of their meeting. The consensus appears to be that the Fed will raise rates faster and higher than previously thought. Lock your rate when you can!

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.625%    Up 0.125%

30 year high-balance conforming                      4.875%     Up 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

Long time readers of the WR&MU know I can be a bit of a data geek…well more than a bit. So I found it interesting that the link to the Waffle House index last week had one of the highest click rates I can recall from readers. For those in Southern California the nearest Waffle House is in Goodyear, Arizona, 337 miles away from the Smith abode in Long Beach. There have been plenty of trips home in the family van from Scottsdale that have begun with breakfast at Waffle House, but have not been to the one in Goodyear as I recall. I do love me some waffles!

 

Looks like a perfect fall weekend, which commences tomorrow (fall and the weekend) in Southern California with great weather, playoff implication baseball plus college and pros going at it on the gridirons. Enjoy your weekend and the first days of fall!

 

Have a great week,

 

Dennis

9-14-18: Can we afford this payment?

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Question of the week:  Can we afford this payment?

 

 Answer:  Statistically, yes you can.

 

Statistics dictate the underwriting guidelines when determining how much of a mortgage and housing payment a family can afford to get loan approval to purchase a new home, or refinance an existing home. The key number is the debt-to-income (DTI) ratio which is your new housing payment (mortgage, property taxes, insurance and homeowners association dues if applicable, collectively referred to as PITI) divided by your adjusted gross income (income before taxes). Depending on the loan program this percentage of your total income for your total new debt obligations inclusive of housing payment cannot exceed between 43 and 50% of your gross income. (Note, VA mortgages do not adhere strictly to DTI guidelines for qualifying.)

 

For instance, if you are purchasing a new home and the total housing payment is $3,000 and you have car payment, student loan payment and credit cards with monthly payments reported on your credit report totaling $1275 per month, your total obligations are $4275 per month. If your gross monthly income is $10,000 per month you have a DTI of 42.75%, generally good enough to qualify for most programs.

 

Statistically. The debt-to-income guidelines were created based upon data from millions of property owner’s history of making payments in a timely fashion, and more important those that have not. Mortgage data is analyzed to see the percentage of defaults for debt-to-income ratios and there is a breaking point at which the percentage of defaults become untenable risk for lenders and that is where the DTI guidelines are set. It is important to note that the default data is also analyzed for occupancy, type of property and credit scores among other criteria and this is how rates are priced (sounds like a good question for next week).

 

Back to if you can afford the payment that we have given you which would be approved by underwriting.

 

I tell almost all clients purchasing a new home when we are going through the qualification process, “there are three things that are very true regarding your new home purchase. One, I will not use my savings to purchase the home. Two, I will use my income to help you make the monthly payment. Three, I will not spend any time sleeping or living in your home.” This is to say, while I may feel comfortable with the payment I am giving you for your potential new mortgage, property taxes and insurance, I am not making the payment so it is important that you are comfortable with what you feel you can afford.

 

That said it is also important to stretch a little of your comfort if your comfort level is well below your income ability, unless there are some exceptions. One gauge many first-time buyers, and some move up buyers, use for their new housing payment is what they are currently paying in rent. If you make $10,000 per month and are paying $2200 per month, using the $2200 per month to be what you would like your new housing payment to be you will be looking at homes that are significantly below your ability to qualify, and from my experience frustrated in the homes you will be looking to purchase as few, if any, will feel “right” for you and your family.

 

If the payment I am quoting feels too high for a client I ask that they take a look at where they spend their money, and is this likely to continue once they become homeowners. Purchasing a home is not just purchasing a place to live, it is also entering a new lifestyle, that of homeowner. For most first-time buyers, purchasing a home occurs before they start a family, or with younger children. This changes your lifestyle dramatically and the stability of owning a home and fixing your housing payment pairs perfectly with a growing family. Most meals will be made at home, changing your budget if you eat out a lot. Weekends will likely be spent with the family at different events, games and activities involving the children, which means fewer weekends travelling to the wine country or Vegas.

 

Essentially, is your expectation that your lifestyle and spending habits that make your potential new housing payment seem uncomfortable to remain the same? Chances are very, very high that it will not. When considering your new home and the cost also consider the changes you will be making in your lifestyle, and therefore expenses.

 

Finally, why are you buying a home? Is it to change your life in a positive manner? If so what other changes are you willing to make so you can experience the value of homeownership?

 

Pretty much everything decision in life has trade-offs and consequences, even not making a decision. One area at which I will immodestly say I do very well is explaining to my clients the positives and negatives of the options available to them when purchasing a home. If you think owning a home is not in your budget please contact me so we can discuss your financial situation and options.

 

Have a question? Ask me!

 

August economic data was interesting. The Producer Price Index dropped 0.1% in August, the first month over month decline in 18 months and read by many as a sign that inflation may be easing. Supporting the read was the Consumer Price Index for August that showed prices rose 0.2% for the month, however up only 0.1% for the “core” rate (minus fuel and food). The monthly increase was the fifth straight increase, however the size of the CPI increase lowered the year over year inflation for the core index to 2.2% from 2.4%. Gas and rent were the primary factors putting upward pressure on the index, many other consumer sectors fell, primarily clothing which saw prices drop for the third month in a row—good news if you have growing children. The news is mostly positive for interest rates as any easing of inflation releases pressure for rates to go higher.

 

Retail sales also grew at a slower pace in August from the prior month, however the slow down was not unexpected given the surge in sales in July. Supporting future increases in sales was the Michigan Consumer Sentiment Index which continues to rise, reaching it second  highest level since 2004, and highest since March of this year. Positive consumer sentiment leads to consumer spending, which drives the economy and can lead to higher rates.

 

Rates for Friday September 14, 2018: A large drop in Mortgage Backed Security (MBS) prices in the middle of the week put strong upward pressure on rates. Some easing later in the week saw us with rates this Friday flat from last Friday. I have been asked a lot lately what I thought rates will do, my standard response is that I feel they should be higher than they are currently given the economic data.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.50%             Flat

30 year high-balance conforming                      4.75%      Flat

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

Thankfully Hurricane Florence started losing power earlier in the week and when it made landfall this morning in North Carolina had lost enough power to be designated a tropical storm instead of a hurricane. Even with the winds at less power the amount of water that will be dropped in the southeast will be significant, especially if the storm remains in place. As always when nature becomes fierce the Red Cross is there to help residents through the event and after. We are truly fortunate to have such a wonderful organization looking after people negatively impacted around the globe by human and natural acts that displace and harm people.

 

Many communities are also grateful they have a Waffle House or two in their communities. The butt of many jokes, mostly from those not in the Waffle House regions, the company does great work when disasters are about to hit. So great in fact that FEMA follows the company’s “Waffle House Index” to help determine the severity of a storm. Waffle Houses rarely close, they want to stay open as long as possible as the company knows in many communities it may be the only place for residents and emergency personnel to get a meal. The company also assists with employees from other stores in nearby, less effected, regions to go into disaster zones and fill the jobs at Waffle Houses so those employees can take care of their families and situations as a result of the hurricane, tornado or other event.

 

Here is a good article on the Waffle House Index. Just so you know, Stage Yellow probably means no bacon—you can get sausage because it takes up less grill space and takes less time to cook so the restaurant can serve more people faster by taking bacon of the restricted menu.

 

Have a great week,

 

Dennis

9-7-18: Should we pay extra on our mortgage?

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Question of the week:  Should we pay extra on our mortgage?

 

 Answer:  This is a question we answer every few years and it has come up a few times over the past few weeks with different clients as they consider paying extra on their mortgage every month or year to pay it off faster. It is natural to want to pay off debt, get rid of the monthly payment and quit paying a lender interest are the main two reasons.

 

But is paying off your mortgage early the best financial move for you? Here are several items to consider before you commit to paying off your mortgage ahead of schedule.

 

Are you maxing out your contributions to your retirement account? Most Americans are underfunded for their retirement, many of whom own homes. Instead of paying additional principal down on your mortgage I suggest putting it into your retirement account instead for several reasons. First, the money you put into retirement is usually deducted from your taxes (an exception can be if you contribute to a Roth IRA account), whereas the money you pay down on your mortgage is not. Most homeowners in California will have combined state and federal tax rates around 33% of adjusted gross income. If you contribute the $18,500 maximum to a 401(k) ($24,500 if over 50) that is a tax savings of about $6000, pay the same amount down on your mortgage and there is zero tax savings—in fact you will have negative tax savings because…

 

The government pays for part of your mortgage due to the mortgage deduction allowed on state and federal income taxes. You can deduct the amount you pay on your mortgage interest directly from your income for both federal and California state income taxes (there are limits, for married couple $1 million if mortgage used to purchase home was put in place prior to 12/16/17 or you were in contract to purchase home prior to that day; if your current mortgage was a refinance or put in place after 12/16/17 the new limit is interest up to a $850,000 balance). So if you have a $500,000 mortgage with an interest rate of 4% you can deduct $20,000 from your income, saving approximately $6500 in taxes. If you pay down $18,500 on your mortgage you lose approximately $250 in tax savings since your interest payments are lower. Paying down $18,500 on your mortgage instead of putting it into your 401(k) can cost you over $6000 in tax savings.

 

If you are maxing out your retirement contributions, how are you on saving for your children’s college education? As the parent of college freshman and a future college freshman, and someone who has looked at thousands of clients financial statements, I can attest that college expenses have far outpaced most families abilities to save for those expenses. Having gone on several college tours the last few years one common theme from the financial aid offices was that the general threshold for receiving direct aid (i.e. tuition reduction in form of grant from school) is income around $70-80,000, which is great if you live in some parts of the country but not too far above the median income in most parts of California. So unless your children have exceptional talents in some endeavor plan on needing quite a bit of money if you wish to contribute to your children’s college finances. Putting additional money into a 529 College Savings account or other savings instead of paying down your mortgage might be a better allocation of funds. By doing this you are essentially “borrowing” at whatever your mortgage rate is today for use in the future instead of potentially borrowing in the future at what may/probably will be a higher rate.

 

Speaking of your mortgage’s interest rate, is it lower than other debt you have? Credit card debt, auto loans, your own student loans? If you are maxing out your retirement contributions, you do not have to worry about future college expenses but have consumer debt it makes more sense to pay off that higher interest, non-tax deductible debt before paying off your mortgage. It not only makes more sense but it is very good math.

 

Are you planning on selling your home in the future, before the current term of your mortgage is completed and before your over-payment plan would pay off the mortgage? If so you should consider putting the additional funds into savings, investments, even cash. Your home is not worth more, or less, depending on your mortgage balance. Your home’s value is determined by location, size, condition, etc, not by the amount of debt secured by the home. Paying $40,000 down on your mortgage over say five years and then selling it with a $400,000 mortgage balance was a loss of opportunity for those funds to work for you with compound interest and/or dividend reinvestment. There is no compound equity or equity reinvestment in your personal residence, it will be worth what the market dictates when it comes time to sell. Yes, your net proceeds from the sale will be $40,000 more than if you have not paid down the mortgage. At a 4% return on the extra $666 per month you pay on the mortgage over five years would result in over $44,000, 10% more than your net proceeds gain from paying that money into the mortgage.

 

One final consideration, it costs money to get money back out of your home. If you have $100,000 equity and want to access some of it you will either need to refinance, obtain 2nd loan or HELOC, or sell the property, each of which has costs. What if you pay down your mortgage and need money in the future for home improvements, medical emergency or other unexpected life event?

 

All these are factors, and there are more, that you should consider before paying extra down on your mortgage. There are some factors that more strongly support paying off your mortgage early than other, primarily looking at your current income, your projected retirement date and your projected income during retirement. Or you have a property that is a rental with a low enough balance that you can use rental income to accelerate the payoff of the mortgage, again looking at some of the factors above, to have a free and clear investment that gives you more options in the future, such as selling and carrying a large mortgage to defer capital gains and continue to receive income.

 

As with most/all of our questions of the week, before we can answer the question we need answers to more questions—and this particularly the case this week. If you are considering accelerating the principal reduction on your mortgage, please do not hesitate to contact me to discuss your options.

 

Have a question? Ask me!

 

With the center of the news universe seemingly being in the Senate Judiciary Committee hearing room this week, you may need to look a few pages into your daily paper tomorrow to find the employment data released today, or any other news for that matter. The Labor Department announced today that 201,000 jobs were created in August, 204,000 in the private sector. The front-line unemployment rate remained at 3.9%. These pieces of data are positive, but not a big impact on rates as the news was in-line with expectations. What did have a strong impact on rates was the average hourly earnings data which showed an increase of 0.4% in August following the 0.3% gain in July. This puts the annual rate of pay increases at 2.9%, up from 2.7%, the highest rate of increase since June 2009, the month the recession ended. With the consumer price index measuring inflation at 2.9% the average American worker’s income is keeping pace with inflation. The wage data puts upward pressure on rates and more than reinforces future rate hikes from the Fed.

 

Rates for Friday September 7, 2018: After holding on last week following the strong GDP data, rates could not continue to hold following today’s labor market news. More workers getting more pay leads to more spending leads to higher prices which leads to higher interest rates. Today rates popped up on the labor news after remaining flat from Friday to Friday for the past three weeks. Not surprising, the surprise to me is they had not increased sooner. Lock your rate when you can as higher rates are lot more likely in the future.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.50%             Up 0.125%

30 year high-balance conforming                      4.75%      Up 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

With age comes experience and practicality. When our fifteen year old refrigerator decided to quit last Wednesday, Leslie and I looked at each other and said, “happy anniversary,” knowing a new fridge was going to be our 24th wedding anniversary present to each other. And sure enough this Tuesday, our anniversary date, a new one was delivered. Not to be completely unromantic I placed a bottle of nice vodka inside the present for her to enjoy. Somehow I don’t think I get away with a kitchen appliance and bottle of vodka for number twenty-five next year….

 

Have a great week,

 

Dennis

8-31-18: Should we buy a rental property?

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Question of the week:  Should we buy a rental property?

 

 Answer:  This is a common question for those of us in the real estate industries, as well as for professionals in other industries such as family attorneys, accountants and financial advisors. Looking to secure a long term investment many families would like to purchase a property to rent out for investment income and long term value appreciation.

 

Is it right for you?

 

As you can imagine, there are several factors to consider before deciding to purchase rental property. Here are some that come to mind, but certainly not a complete list.

 

The first question you must answer is, what are my expectations? Do you want positive monthly cash flow? Are you most concerned about long term appreciation and growth of your initial investment? Do you want a loss on your tax returns to off-set income? Each of these factors can be obtained, but each also has different requirements for how you purchase the property.

 

Positive cash flow can be very challenging in the California, especially if you are in a county that touches the Pacific Ocean. Cash flow is determined by what income the property will generate from rents minus the expenses of ownership: mortgage, taxes, insurance, maintenance and vacancy. Because real estate prices have grown it takes substantial down payment to achieve positive cash flow in most properties. For instance, if you are looking at purchasing a $500,000 home as a rental in an area where the market rents for the property are around $2500 can you achieve positive cash flow? The minimum down for a single family residence non-owner occupied loan is 20%, and today the rate is about 5.125% with that down payment. The monthly PITI is almost $2800—your cash flow is not positive. Putting 25% down the rate drops to 4.875% and your PITI drops to $2500 so you are cash flow neutral before maintenance and upkeep. Before closing costs you have invested $125,000 for neutral cash flow.

 

That said, if the property increases in value an average of 3% for the next five years your property has increased in value about $80,000 so on paper you have seen your initial down payment increase about 65%, from $500,000 to about $580,000. As well you have likely had depreciation on your taxes, that provided you with a loss on your tax returns for the property (if you are eligible to claim real estate losses) which has saved you tens of thousands of dollars in income taxes. So your monthly cash flow is neutral, perhaps slightly negative, but you have seen your investment grow in value and gained cash flow with your tax deductions.

 

Keep in mind the above scenario is based on finding a home for $500,000 in an area that rents for $2500 per month and would increase in value an average of 3% per year over five years. That said it appears this type of scenario checks the boxes for cash flow (after taxes), appreciation and deductions on your tax returns.

 

What are other factors to consider? Costs is a very important consideration. It costs money to purchase real estate, the rule of thumb is about 3% of the purchase price, and it costs money to sell real estate, the rule of thumb is about 8% depending on real estate commissions. So in the above scenario you have about $15,000 on top of your down payment to close the transaction and if you sell at the end of the five years your costs of sale are about $46,000. For your total investment of $140,000 your next gain in equity from the market is about $34,000 which is a  nice 24% return over the five years.

 

Keep in mind that $34,000 will be taxed as capital gains and any depreciation you claimed will be “recaptured”, a fancy term for taxed. Check with your tax preparer but depending on your income the taxes could exceed $10,000.

 

You can avoid the taxes by participating in an IRS tax deferred 1031 exchange, which entails selling the property and having the proceeds transferred to an escrow to purchase another property. You avoid the taxes, but you are not benefiting from the capital appreciation as it has to roll over into another property.

 

One mistake many first time investors, and some experienced, make with investment property is they care too much. Too often they want to purchase property they would want live in, or spend too much money on the property. I have seen clients spend tens of thousands of dollars to upgrade kitchens, bathrooms, floorings, etc, to be of the type and quality they would want, but for tenants who generally do not treat their homes the way they would if they owned it. If you want to get in the real estate rental market as a landlord you must remember that it is a business, you are buying an investment not a home and as such your objective is to provide a clean, safe property for rent. Putting in granite counter tops and solid oak cabinets will not increase the rents you can collect, perhaps it puts you at or near the top of the market for the area you are in, but if the market is $2500 you won’t be able to rent for $3000 just because of the nice kitchen.

 

Which brings me to the most popular way most families obtain their first piece of rental property: convert your existing home to a rental when you purchase your next home. This has many advantages. First, you save on closing costs. Second, you do not need a cash investment for the purchase of the property—though you will need one for the purchase of your new home. Third, the loan is already in place and likely at a lower rate than the current market for non-owner-occupied financing. Fourth, if you sell the property within three years of converting it to a rental you probably can avoid capital gains tax should the property appreciate.

 

Should you purchase a property for rental income and investment? The answer requires a lot of thought and research as to the short and long-term consequences. Before you make the decision consult with your tax preparer and investigate other options with the money you would be investing.  Compare possible rates of return in cash flow and appreciation, costs of acquisition and divestment, on-going costs of maintenance and loss of income, and the potential tax liabilities.

 

I am happy to be part of your investigation by running numbers and scenarios for different sales prices, down payments and types of properties if you are considering purchasing rental property.

 

Have a question? Ask me!

 

Lots of major economic news this week. On Tuesday the Conference Board reported that consumer confidence is at its highest level since October 2000. The higher confidence is supported by increases in personal spending and earnings in July. Spending increased 0.4%, the fifth month in a row for the primary economic engine for the country. The increase in spending was greater than the increase in personal incomes, which rose 0.3% in July, causing a slight downtick in the savings rate. The higher earnings, increased spending and tighter labor market caused prices measured by the PCE index to increase 2.3% in July, the highest level in six years. More importantly the index used by the Federal Reserve to gauge inflation, the PCE price index stripped of energy and food to reach 2.0%. The different pieces of data are each supportive of higher interest rates and collectively provide a strong push for higher rates.

 

Also putting upward pressure on rates, was the revision of 2nd quarter Gross Domestic Product released this week showing growth of 4.2%, revised upward from the initial report of 4.1%. A combination of tax cuts and consumer spending pushed corporate profits higher for the quarter helping push GDP growth.

 

Rates for Friday August 31, 2018: My economic training and experience is telling me that rates should have gone up this week based on the data. They are flat from last Friday, and have remained flat since the first Friday in August. Investors are tempering their decisions on bonds and mortgages waiting to see if a big shoe drops from the White House on tariffs with China and other nations. Earlier this week there was an apparent understanding with Mexico to revise our trade agreements, perhaps the same can occur with Canada, which would alter NAFTA. We will see how those negotiations and others go. If the result is positive in regards to no tariff wars and updated agreements we will definitely see rates go up–absent some other major issue or crisis.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.375%            Flat

30 year high-balance conforming                      4.50%               Flat

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

To slightly change the famous Alice Cooper song, Schools In ‘Til Summer. Our Long Beach Poly junior was a bit grumpy in the early hours of Wednesday morning seeing the wrong side of seven o’clock for the first time in months, I’m sure she was the only teenager or younger in the city in that frame of mind.

 

Hoping all your students have a successful year!

 

Have a great weekend,

 

Dennis

8-24-18: Do you have a will and trust? If yes, please read on. If no, please read on.

/in /by

Question of the week:  Do you have a will and trust? If yes, please read on. If no, please read on.

 

 Answer:  What did Prince and Aretha Franklin have in common besides prolific performers and writers? Both of these musical icons passed away without a will or trust. There could be many reasons why. Prince, who passed away suddenly, perhaps he thought he had more time to live and prepare an estate plan. Aretha could not have had such thoughts as she had been diagnosed with pancreatic cancer several years ago, a disease which median survival rate of one year or less. Now the attorneys in Minnesota and Michigan have a tremendous amount of work as they represent various potential heirs to large estates. Who gets the real estate, the rights to their royalties, family heirlooms and memorabilia?

 

Why they had no plans for their estates baffles the mind of anyone in the legal and financial industries who spend their careers encouraging their clients to have plans for their families and estates for when the inevitable happens.

 

There are many objections that many individuals and families raise for not preparing a will and or trust, some of the most common are, “I am still young,” “I do not own enough to worry about having a will,” “my family will know what to do.” Instead of “objections,” I should have said “excuses” as none of these are valid reasons not to have an estate plan that includes at minimum a will and ideally a will and trust.

 

If you have children you must, not “should” but must, have a legal written directive as to who will take care of your children should both parents become incapacitated, i.e. hit by a bus while on vacation in Mazatlan. A family consists of mom, dad and three children ages 12, 9 and 6. Mom and dad are on a long ski weekend in Utah and tragically killed in an avalanche. They each have two siblings. Where will the children live? Can they be kept together? What will happen with the home the family owned, who receives the proceeds? They had life insurance with only each other named as beneficiaries, how are those proceeds divided and ensure the children benefit? Eventually all these questions will be answered, but it will be expensive and the state, i.e. the courts, will be making the decisions for the family. It will take a lot of time and money at a time when everyone, especially the children will be deep in grief.

 

Will your family know what to do? What if your sister and your spouse’s sister do not get along and both feel they should be the guardians of your children should something tragic happen? How does that play out?  “Bob told me we would get the children and raise them.” “Well Susie told me we would get the children and raise them.” The children have lost both parents and now will be in the middle of a legal fight between their aunts.

 

Even if you do not have a home or significant assets, you should have a will and ideally a trust. The will determines how your assets are divided upon your passing, the trust determines whether the bulk of your assets are transferred as you wish or if the bulk, or majority, of your assets will go through probate and potentially be subject to higher taxes, leaving less for your intended heirs.

 

Age is not a consideration. While statistics indicate that you should live into your late seventies as that is the life expectancy in the United States, one must consider the key word in the phrase “life expectancy.” Accidents and diseases happen to people of all ages. Whether you are 28 or 78 it is strongly advised you have a plan in place that protects your assets for your heirs and dictates what happens to those assets.

 

Once you have a plan make sure you keep it current. Did you prepare your will and trust when your children were in elementary school and now one or more are over the age of 18? Did you prepare your plan more than five, ten, fifteen years ago? Laws have changed, especially in California regarding inheritance and trusts, is yours compatible with current laws?

 

I have too many clients who when I ask if they have a trust say, “We keep planning on doing this…” Well, no you haven’t been planning on doing it, you have avoided doing it. Planning is sitting down with an attorney and discussing all the issues and matters that need to be addressed, saying you need to do it is not planning.

 

Every family needs to have an estate plan, and most single adults as well. A proper comprehensive plan will cost a bit of money. For those who want to save money, or get a “deal” or “bargain,” keep in mind that you will never know if your trust and estate plan was properly prepared or was able to fulfill your intentions. But your family will know and the legacy you do not want to leave is them having to spend significant time and resources with attorneys and the courts because you wanted to save money when creating your estate plan.

 

Being an adult, a responsible adult, comes with responsibilities. Many of those responsibilities cost money. There are many areas where it is advised you do not scrimp, save or look for deals. Some that come to mind for you and your family are brain surgery, an unlicensed electrician re-wiring your home, or a car seat for your baby. Add to this list estate planning. Scrimp, save money or look for deals when it comes to the $5 daily Starbucks purchase, the eating lunch out every day, buying a new car every two years, flying business class, don’t try to get by on the cheap when planning your estate when the results will have tremendous impact on your heirs, and ultimately your legacy with your family.

 

Don’t be Prince or Aretha.

 

Need someone to talk to? Call  or email me.

 

Off my soapbox.

 

Have a question? Ask me!

 

Home sales softened in July. Data from the California Association of Realtors and the National Association of Realtors show existing home sales have softened in the number of sales and/or prices.  Nationally existing home sales dipped 0.7% in July from June and the annual rate dipped to the lowest level since February 2016. More locally, sales of existing single family homes in California dropped 0.9% from June to July and 3.4% from July 2017 to July 2018, the statewide single family median price was down 1.9% month over month and up 7.6% from last July. Even more locally…sales in Los Angeles County were down 20.3% for the month and down 0.9% for the year, the median priced home in July was $597,520, up 2% for the month and 5.5% for the year. Moving south to Orange County 5.8% fewer homes sold in July from June and 1.4% fewer than July 2017. The median Orange County home sold for $829,000, down 0.8% from June and up 5.6% from a year ago. Inventory is still very low which has the impact of restricting the number of sales and putting upward pressure on prices as long as there is demand—which there appears to be as the median homeowners in Los Angeles and Orange Counties “made” $31,280 and $44,000 respectively with the price increases from last year.  Between the higher prices and rates up around one-half of one percent (0.50%) from last July those who have been waiting to purchase a home have cost themselves quite a bit of money.

 

Rates for Friday August 24, 2018: Not a lot of economic news to move rates this week and all the domestic political talk did not impact markets. Looking ahead to next week there is potential for some rate impacting news, primarily the first revision of second quarter GDP and personal income and spending report which includes the inflation data the Fed uses for rates. If GDP is adjusted significantly higher and/or the inflation number comes in higher than June’s 0.4% price increase rates could bump up. Neither of these is expected to be reported, keyword “expected.”

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.375%            Flat

30 year high-balance conforming                      4.50%               Flat

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

 

Long time readers of the Weekly Rate & Market Update, actually original readers received the first year or so of the update monthly, have tangentially watched our daughters grow up. When I started the WR&MU our oldest was probably in kindergarten and youngest in pre-school. Tomorrow Leslie and our oldest board a JetBlue aircraft early in the morning and head to Boston where our daughter will be moving into her dorm room at Boston University to start her freshman year. Seems like a long time ago I was writing in this space about tooth fairies and braces, while also seeming like yesterday. Go Terriers!

 

Have a great weekend,

 

Dennis