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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

5-11-18: Should I use funds from my 401(k) to buy my new home?

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Question of the week:  Should I use funds from my 401(k) to buy my new home?

 

Answer: This is a great question that has come up a few times recently as home prices continue to climb and for many families down payment is a barrier to home ownership.

 

“Should” is the key word, and as with most of our questions of the week the answer varies from person to person, family to family.

 

Before we answer “should,” let’s answer “can.”

 

If you have a 401(k) retirement account through your employer it has several rules, regulations and policies as to how the your account must be handled, including access to funds. Since the money was put into the account before taxes, all the money in your account has accumulated with no taxes being paid. Therefore when the money does come out of the account it will probably be taxed, unless the money is borrowed to be repaid and you do not violate any of the rules and policies of either the plan or the IRS.

 

Most 401(k) plans allow loans to participants for hardship, medical or education costs and the purchase of a primary residence. Note, “most,” so your plan may not allow loans. One of the provisions of any 401(k) loan is that if it is not repaid on time you will be subject to taxes, and penalties if you are under 59 ½ years of age.

 

Assuming your plan allows you to borrow money for the purchase of your home, here is how it usually works.

 

The maximum amount allowed to be borrowed is either $50,000 or 50% of your 401(k) balance, whichever is less.

 

You must repay the loan with interest that is paid to yourself, at a rate that is set by your 401(k) policy, typically Prime + X. So if your plan has the interest on the loan is Prime + 1 today your rate would be 4.75% + 1 = 5.75%.

 

The term of repayment varies from plan to plan, most plans have a maximum repayment period of five years, with exceptions for home loans that can be up to ten year amortization periods.

 

Your repayment is made via your paycheck with after tax dollars. You can, and should, continue to make 401(k) contributions during your repayment period.

 

If your employment terminates and there is a balance due on the loan you either need to repay the balance or face tax consequences on the unpaid balance. For instance, you are offered a job with another company that is a fantastic opportunity, but you have a $6500 balance due on your 401(k) loan. Your options are to leave the company and roll the 401(k) into another account, either the 401(k) with your new employer if they allow it, or into a rollover IRA, without repaying the loan. In this case the $6500 will be taxable and if you are under 59 ½ you will have a penalty. Or, you can contact the plan administrator, find out who and how to make out a check and pay off the loan, and then transfer the account. Most plans allow you 60-90 days to make arrangements for your employer sponsored retirement account.

 

The funds for your loan are taken from the funds, or investments, within your 401(k) at your direction. You are borrowing $25,000 for the purchase of your new home, and you have your 401(k) invested in four different mutual funds and company stock. You direct your administrator to take $5000 from each of the funds and the stock account to fund your loan. As you repay the loan most plans allow you to direct the payments back into the funds from which they were taken in the same proportion to which they were liquidated, so your account allocation will still be the same as before the loan was funded.

 

Now that we know the “how,” let’s look at the “should.”

 

There are many that argue against borrowing from your 401(k) for any reason, and there are many that argue it is not a bad idea, and in fact can be a good idea. For disclosure purposes, I purchased my first home by borrowing $7500 from my 401(k) for the down payment. It was one of the best financial decisions I ever made.

 

One argument, and perhaps the one made most frequently, against borrowing the money is that you lose the growth opportunity of those funds invested in the market and growing tax free. This is true, if you take $25,000 from your 401(k) those funds are not subject to any market growth or dividend reinvestment while they being repaid; this also means that the funds are not subject to any declines in market value while they are outstanding. Lost in this argument is the interest you will be repaying yourself. If the interest rate you are paying is equal to or greater than market performance plus and dividends then there is no net loss to your account during the period. If the market grows at a significantly greater rate than your interest rate on the loan then your opportunity costs are the gains in your investments less the percentage you are paying.

 

Also lost in this argument is the accumulation of equity in the home you are purchasing during the period to loan is outstanding. So the true cost, or benefit of the transaction is the difference between the gain in value of the funds in your 401(k) less the combined gain in market value of your home plus the rate of interest on your 401(k) loan. As an example, the $7500 I borrowed to purchase my first home resulted in substantial equity growth that we then used to purchase our current home—the $7500 invest in 1994 is worth considerably more today than the growth of $7500 in the market during the time period.

 

Another argument against borrowing against your retirement account to purchase a home is that you are hurting your retirement. This may be true depending on your age and how long until you retire, how much you borrow, whether you are able to repay the loan before retirement to avoid a large tax liability, and what is the status of the home you purchase. If you are young, working for a long time and are able to repay the loan with plenty of time until your retirement and your home value rises then you are not worse off, in fact may be better off, by purchasing your home by leveraging your retirement account.

 

Bill and Sue are in their late 30’s, have been unable to purchase a home as they do not have enough money saved for down payment and closing costs. They each borrow $25,000 from their 401(k)’s and purchase a $500,000 with 10% down payment. They are able to repay their respective loans in five years. In twenty years when both kids are out of college they are getting close to retirement. Their home is not paid off, they took out some equity for college costs, but they have a lot of equity.  They plan on retiring in about five to ten years and looking at their home value, and costs for homes near where both their kids are living, discover they will probably be able to sell their home and purchase their retirement home without needing a mortgage. They enter retirement with no housing cost—typically the primary cost in retirement—except property taxes and insurance, and retirement accounts that have grown during their years of employment.

 

Some of the advantages of 401(k) loans used to purchase homes. There are usually no transactions costs, perhaps a $25 processing fee. Most loan programs do not count a 401(k) loan repayment against you for qualifying purposes. There is no qualification process for the funds, as long as you have the money in your account and the plan allows it you can borrow it. Funds are usually available within two weeks or less of your reqest.

 

Should you borrow from your 401(k) to purchase your new home? Maybe. Give me a call to discuss your situation and I can help you make that determination.

 

Have a question? Ask me!

 

Inflation concerns are a bit abated with the Producer and Consumer Price Index data from April, both of which were lower than expectations. On the wholesale side PPI showed 0.1% growth in the month and is up 2.6% year over year. For consumers the CPI was up 0.2% for the month and 2.5% for year. With the tame inflation data for April, investors’ concerns about inflation forcing rates up are dampened and the data announcements had no impact on rates.

 

Rates for Friday May 11, 2018:  Week to week we are flat once again, three Fridays in a row with the same rate shows some rate stability and what is probably the new “normal” for mortgage rates.

 

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.

 

Spoil the moms! Your own, your children’s, your neighbor’s, your brother in-law’s, spoil them all this weekend. And remember what my mom always said, “every day should be mother’s day, not just one day a year…”

 

Have a great week,

 

Dennis

4-27-18: Should I buy the home I rent?

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Question of the week:  Should I buy the home I rent?

 

Answer: This question has a reverse side as well, “Should I sell my rental property to the tenant?”

 

I have a client who contacted me the other day about wanting to sell a home she rents out because the tenant has given notice. She is nearing the end of the time frame of living in a home two out of prior five years to avoid capital gains and the time is perfect. I asked if she contacted the tenant about purchasing the home, however the tenant is giving notice because they had already entered a contract—otherwise did not think of asking to buy the home or they would have.

 

This was a missed opportunity for both parties. When they decided they wanted to own their own home the tenant should have informed the landlord, who gladly would have worked with them to see if the right price and terms could be found, saving each party a lot of time and expenses.

 

What are the opportunities for the landlord and tenant in having the tenant purchase their rental home from their landlord?

 

From the landlord side, there are several advantages to selling to your tenant.

 

For most landlords selling their rental property the status of the tenant is a primary factor in how the process will proceed. If it is a single-family residence then the buyer will almost always be looking to owner occupy the property, so the property needs to be vacant.

 

Typically, the dwelling should be vacant during the marketing period to maximize the ability to show the property to the most buyers and encourage offers. If you have a long-term lease with the tenant you will need to wait until the lease is nearing termination and provide notice that the lease will not be renewed and the tenant must vacate. If the lease is month-to-month you will need to give the tenant a 30 day notice to vacate. Depending on your tenant at this point it can get sticky if your tenant decides to not vacate on time. In California, the tenant has significant rights to delay vacating the property and can prolong any eviction process for a very long time. Several times over the years I have witnessed landlords paying tenants to vacate properties to get the process over and property vacant for sale or closing.

 

If you tenant is cooperative and does vacate the property you will continue to have costs, mortgage, taxes, insurance, maintenance, until you close escrow with a buyer, without receiving any rent. Depending on many factors you could have a vacant, non-revenue producing property for two, three, four or more months.

 

Speaking of maintenance, when selling to the tenant there may be some repair work requested by the tenant-buyer following a home inspection, however there will not be the costs of preparing the home for showing. No landscaping for curb appeal, refreshing flooring, painting, or other touch-ups most sellers go through before marketing their home to try to maximize value.

When selling to your tenant you have a bit more control of the escrow period, which can be especially important if your intention is to purchase a new rental property, rolling over your proceeds in what is known as a 1031 Exchange to postpone capital gains taxes. When participating in a 1031 Exchange there are time frames to identify your “up-leg” and close on that transaction, if you miss them then your gains from the sale of the property are subject to capital gains. If your sale is an open market sale with two or three other transactions that you have little to no control over it is more difficult to extend the closing date of the sale of your rental property if you need more time to find and close on your up-leg.

 

Your costs of sale can be significantly lower selling to your tenant than going on the open market. You can have more control over timing of the transaction. If you are considering selling your rental property it is advisable you contact the tenant to see if they are willing and able to purchase the home.

 

From the tenant’s perspective purchasing the home you have been renting also has several advantages to going to the open market.

 

One big plus is you do not have to pack, move and unpack. You will not have the added expenses that occur when you move, new shower curtains, dustbins, pieces of furniture, lamps, fixtures, etc. Of course, now that the home is yours you may want to make some changes, however we have found most tenants who purchase their rental home make fewer changes and spend less than those who move into a new home.

 

Familiarity is another major benefit. If you like your neighbors and neighborhood you become a homeowner and still go to the same store for groceries, walk to your local coffee shop to meet friends, go to the same schools for your kids and the same dog park with Phideau.

 

Utilities, seemingly a small thing, but no getting set up with gas, electrical, cable. Dealing with timing to meet vendors or pay deposits.

 

Not every home is perfect, even if you purchase a newly constructed home there can be, and usually are, some issues. Purchasing the home you have lived in for a while you already know the quirks and issues, some of which your landlord may be willing to fix as part of the transaction.

 

A major plus, does not always happens but usually does, is the tenant-discount. Because the landlord does not have to have the property vacant, require your cooperation to show the property if on the market while you are still living there, nor spend the funds to get it “market-ready,” we typically see some discount to market for the tenant-buyer. Some landlords have refused to offer any discount and see their tenants leave the property instead of purchasing the home and the landlord later regrets trying to maximize price instead of maximizing combination of total costs and efficiency of the sale.

 

One more consideration both tenants and landlords should consider, rent control. In more and more cities throughout the state, and at the state level, the rent control movement has been gaining momentum. I will not use this space to present the case that rent control does the exact opposite of what it is intended to do, however it is something to consider if you are a tenant or landlord.

 

From the landlord side, if you have owned a single family home as a rental in an area that appears somewhat likely to be under rent control you will want to consider all options for the future. This includes the option of selling the property, getting out of the landlord business and paying your taxes, or selling the property and going through a 1031 Exchange to purchase a rental property in an area where there is less of a chance that rent control will be enacted. If the option that appeals to you most is selling the property, contact your tenant. If the tenant does want to, or cannot, buy the property then start the process of putting the home on the market.

 

From the tenant side, if rent control goes into effect your options down the road become somewhat restricted as there will likely be fewer units on the market for you to rent when the time comes and the rent you will be paying will likely be significantly higher. If you are in an area where rent control appears to be likely and you have been thinking about purchasing a home in the somewhat near future, say one to two years, then consider moving up that time frame. Call a mortgage professional (I would be an appropriate call…) to get pre-qualified and determine your purchasing power. I can also provide a ballpark price range for the home and if there is a near match and you like the home you have been renting then contact the landlord and make an offer. If the landlord does not want to sell then you know your price and we can hit the open market to see what is available.

 

If you are in a residential rental relationship, as landlord or tenant, and are considering severing that relationship by selling or buying please contact me and I can assist you with options and other professionals who can assist you.

 

Have a question? Ask me!

 

Not great but very good. That was the news this morning from the Commerce Department when it released its first estimate of GDP growth for the first quarter of 2018. The estimate showed economic growth of 2.3%, below the 2.9% growth for the final three months of 2017 but higher than the 2.0% estimate many expected. Part of the slower growth was a slowdown in durable goods purchases, namely vehicles, perhaps a hangover from the huge amount sold post hurricane season in Texas and Florida. By beating expectations the news is slightly mortgage rate unfriendly.

 

Costs going up. The cost of employing the average worker climbed the fastest in a decade in the first quarter, increasing 0.8%. Add to this extremely low unemployment, layoffs near a five decade low and some scarcity in qualified labor and the expectation is for wage inflation to start to impact prices for consumers. This is not friendly news for mortgage rates as higher costs and inflation lead to higher interest rates.

 

Rates for Friday April 27, 2018: The benchmark 10-year Treasury note broke through the 3% mark for the first time since December 2013, in doing so dragged other fixed rates on bonds and mortgages up as well. With very strong employment markets and solid economic growth, what looks like peace potentially breaking out on the Korean Peninsula, there is nothing currently on the horizon to cause rates to drop. We see rates climb again this week from last Friday and it is apparent we have broken out of the prior range; now the question is when will rates level out? We could see rates increase another one-quarter of one-percent before this happens.

 

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

30 year conforming                                            4.49%       Up 0.115%

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.

 

Pretty remarkable footage of South Korean President Moon Jae-in and North Korean leader Kim Jong Un meeting at their border today and shaking hands. This is historic and appears to heading to being this generation’s version of the Berlin Wall being torn down. There is historic correlation between the Berlin Wall and the separation of Korea.

 

Korea had been ruled by the Japanese since the 1910’s when it invaded and occupied the county. North Korea and South Korea were created in 1945 as part of the treaties ending World War II, with the Japanese removed from the peninsula and Russia and the United States occupying the peninsula, Russia the northern part and the United States the southern part—the dividing line the infamous 38th parallel. This was the same manner in which Germany, and Berlin, were divided after the war with the exception that France and England joined in those divisions.

 

In 1950 the North Korean Army sent troops over the 38th parallel and the Korean War began. The armed conflict ended in 1953 when an armistice was signed by the representatives from the United Nations, North Korea and the People’s Republic of China. The armistice has been in effect these past 65 years but no peace treaty has ever been signed between the two countries, meaning they have continued to technically be at war.

 

The world watches and hopes that the Korean leaders are able to walk the path to peace and put an end to the tensions and potential for more armed conflict.

 

Have a great week,

 

Dennis