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6-22-18: We are thinking about buying a vacation home, what should we know?

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Question of the week:  We are thinking about buying a vacation home, what should we know?

 

Answer: With summer upon us and families travelling many may be considering purchasing a vacation home where they like to spend…well their vacations! Between June and September it is not unusual for us to get a few inquiries from clients considering purchasing a vacation home, some with different motivations that others.

 

In mortgage industry parlance a vacation home is known as a second home, which also follows the tax policies of the federal government and the states. As you can imagine there are sections of the tax code that deal with second homes and how you can, or must, treat them when filing taxes.

 

Traditionally a family would purchase a second home in the mountains, at the lake, by the ocean, wherever they enjoyed vacationing. Often the family vacation home would be passed down a generation or two. In more recent years second homes are typically still near traditional vacation or resort areas but not infrequently may be condominiums as well as detached dwellings.

 

The basic lending rules for second homes are similar to the rules for primary residences. You can purchase a second home with only 10% down, the cost of the loan in terms of rates and fees is the same as with a primary residence.

 

There are some factors to consider when getting a mortgage for a second home. First, since it is to be used as a residence you must be able to qualify for the total housing payment for your current residence plus the second home you are purchasing. Second, the second home must be “geographically distant” from your primary residence. If you live in a neighborhood on the eastside of Long Beach and want to purchase a condo in downtown Long Beach as a second home you will have a hard time finding a lender that would approve the transaction as a second home.

 

Some lenders require second homes to be traditional resort or vacation areas, for instance Mammoth would be such an area, Fresno would not. However, we often approve second home transactions for clients who have a very strong reason for the second home in a non-vacation region. For instance, a client whose primary home in in Ontario but works in Long Beach and purchases a small condo in Long Beach near his job for use during the week. Or the professor at Cal Poly San Luis Obispo whose wife and children live in Northern California. To qualify as a second home it has to be very obvious as to the intent, if you find yourself trying to stretch into a viable explanation then chances are the underwriters will have a difficult believe the property will be used as a residence and not a rental or investment property.

 

Regarding rentals, we see an increasing number of second home owners using various services to provide revenue when they are not using the property via short-term rentals—aka AirBnB or VRBO for example. If you are approved for a second home mortgage  there is a rider to the deed (mortgage) that you will sign that has several clauses:

 

  • Must be located a reasonable distance away from the borrower’s principal residence
  • Must be occupied by the borrower for some portion of the year
  • Is restricted to 1-unit dwellings • Must be suitable for year-round occupancy
  • The borrower must have exclusive control over the property
  • Must not be rental property or a timeshare arrangement
  • Cannot be subject to any agreements that give a management firm control over the occupancy of the property
  • When a property is classified as a second home, rental income may not be used to qualify the borrower

 

Like with your primary residence, you can convert a second home to an investment property in the future, as long as you have fulfilled the intent to occupy that you have agreed to as part of your application process and by signing the Trust Deed. Should the lender be able to determine that you never intended to use the property as a residence they can issue a Notice of Default and demand the mortgage be paid in full.

 

For those nearing retirement, purchasing a second home where you are considering living in retirement can be a very good financial decision. We have had many clients over the years purchase a second home while they are still working. The advantages are the ability to qualify for a mortgage and leverage the purchase while you are still working, probably a lower price on the property than it may cost you in five, ten, fifteen years when you will retire, and the ability to enjoy the property and determine if it is the right place for you to spend your years in retirement. If you discover the property or location is not just right you have time to sell, or rent, the property and look for a better property and/or location for retirement.

 

When the time comes to retire you may decide to sell your current primary residence, possibly using the proceeds of the sale to pay off your retirement home and enter retirement without the number cost for retirees: housing.

 

If you, or someone you know, have been considering purchasing a second home please contact me to run the numbers and options for you and your family.

 

Have a question? Ask me!

 

 

Rates for Friday June 22, 2018:  Not a lot of economic news this week impacting mortgage rates. The conforming rate edged up for the first time in six weeks as investors have been a bit schizophrenic trying to determine their best course of action with global trade issues and markets. Meanwhile the high-balance rate edged down a touch after last week’s rise. These are interesting times which means the most prudent course of action is to lock in your interest rate through your closing period as soon as you are able.

 

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                      4.625%             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 think one of the toughest weeks for parents is that first week of summer vacation for your kids when you still have your weekday morning routine culminating with leaving for work and your kids have no routine, except possibly stay in bed while you go about your routine. I am very routine oriented so any changes in routine, for me or the house, tends to throw my rhythm off for a while. At least my nightly routine is not affected since I have been going to bed before the kids and Leslie since they were in middle school—we have three night owls and one early bird in the house.

 

I hope your routines and summer rhythms are in sync and enable you to enjoy the summer of 2018 to the fullest.

 

Have a great week,

 

Dennis

Weekly Rate & Market Update 11-3-17: Should we be worried about the new tax plan that will cut the mortgage deduction?

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 Question of the week:  Should we be worried about the new tax plan that will cut the mortgage deduction?

 

Answer:  With the biggest tax reform plan working its way through the House of Representatives and the Senate it is no surprise that various aspects of what have been released and talked about so far have been a hot conversation topic. Last week at meeting with a group of professionals from family law attorneys to CPAs to business owners we discussed various parts of what had been floated through the media for almost an hour. The only consensus was that we were debating what we don’t know since until both houses in Congress agree on a bill, pass it and present it to the President everything is negotiable.

 

That said….the two features of the plan presented to the House of Representatives that impacts the housing markets are deductions for mortgage interest and property taxes; under the plan released this week both would be reduced from the current tax code allowable deductions.

 

Currently if you own a home with a mortgage you have the opportunity to deduct the interest paid on the mortgage and property taxes. “Opportunity” basically means there are limitations on the deductions. First, in order to claim deductions for property taxes and mortgage interest on your primary (and possible second/vacation home) residence you must itemize your deductions and they must exceed the standard deduction given to tax filers (for married couples $12,700 in 2017). If you meet these criteria then you can deduct all property taxes paid to the local tax authority. Second, a married couple can deduct interest paid on a mortgage used to acquire, build or substantially improve the property up to one million dollars of mortgage liens. For example if you own a home with a $1.3 million mortgage at 4% interest you can deduct $40,000 in interest paid, not the full $52,000 you actually paid in interest.

 

The current plan that will be debated in the House and put through many separate committees before a final bill is presented for a vote increases the standard deduction to $24,000 for married couples and limits the mortgage interest deduction to interest paid on mortgages up to $500,000 and the property tax deduction to a total of $10,000.

 

What does this mean in plain English and simple math?

 

Before we do some math, let’s answer the question: What is a tax deduction? Many people confuse a tax deduction with a tax credit, the difference is that deduction is an amount that reduces your taxable income and a credit is an amount that reduces your tax obligation.

 

Note I am not a tax professional, all examples are very fundamental calculations and used for comparative purposes only.

 

For example if you and your spouse make $80,000 and file your taxes with the standard deduction of $12,700 for 2017. Before the deduction your tax bracket is the 25% tier based on your $80,000 taxable income. After the tax bracket your taxable income drops to $67,300, and your top out at the 15% tax bracket. The deduction saves you approximately $2300 in federal income tax from about $11,500 without any deduction to approximately $9200 after the standard deduction is applied.

 

The deduction lowers your income, which can change your upper tax bracket and lowers your tax liability.

 

A tax credit is applied to your income tax liability directly after your taxes are calculated. Using the same couple above, during the year they installed energy efficient rated windows for a total of $4000. The federal tax code allows a credit of 10% of qualified windows installed on a primary residence, up to a maximum of $200. This lowers the tax obligation from about $9200 to $9000—the credit results in a direct reduction of taxes owed.

 

Back to the tax proposal.

 

Currently if you have a mortgage used to purchase your home with a balance of $600,000 and a rate of 4% you will pay approximately $24,000 in mortgage interest. Since this exceed the standard deduction for a married couple, is a mortgage on your primary residence and the mortgage is under $1 million you can deduct the $24,000 from your income when you file your taxes.

 

To qualify for the $600,000 you may make around $140,000 as a couple. Taking the interest deduction you taxable income drops from $140,000 to $116,000. You are still in the 25% tax bracket, absent any other deductions, so you save 25% of $24,000 in taxes, or $6,000.

 

Under the new proposal you will only be able to deduct the interest on the first $500,000 of the mortgage, $20,000, so you lose $4000 in deductions from your income. In this scenario your tax obligation will drop $5000 instead of $6000 so the tax proposal as written costs you $1000 more in taxes for the year.

 

Similar calculations can be made for property taxes if your annual tax bill exceeds the proposed $10,000 limit.

 

A couple of points regarding this discussion. First, tax reform is constant in our nation’s history. Every President and Congress from 1789 has passed changes to the tax code, some small and some quite major. Any changes in the tax code made by the current 115th Congress and signed into law by President Trump will be subject to future changes as a result of elections changing members of Congress and residents of the White House.

 

Second, at this stage in the process everything is negotiable. What is in the tax plan today may not be in the tax plan tomorrow. What items in the plan are in there for purposes of negotiation? If some members of Congress want the mortgage interest and property tax deductions levels to increase what are they willing to give up to get their way? Increase the proposed corporate tax rate? Change the elimination of the estate tax to a higher level of tax exemption?

 

Third, in California we look at taxes in a whole different light than most of the country for a couple of reasons. Our property values are significantly higher than most of the country so our mortgages are higher and our property taxes are higher in dollars paid (several states have higher percentage of property taxes) so limiting those deduction will impact Californians more than those who own homes in Oklahoma, Utah or Kentucky. So, while collectively we may be against the reduction in the deduction limits for interest and property taxes in California, through much of the country the limitations have little to no impact and is more than offset by the increase in the standard deduction. We are represented by 53 Representatives (12% of the total) and two Senators (2% of the total), and while it is the largest state contingent in Congress it still represents just 12% of the population and many Representatives and Senators representing the 88% of the population see more advantages to their constituents than detriments.

 

Taxes are the ultimate political tool and tax reform is only political. As the plan works through Congress I am going to assume that the mortgage interest and property taxes proposals will be amended—maybe trade a higher mortgage deduction for eliminating the property tax deduction, or raise both limits and trade for something else, or…..the Republican majority cannot keep the party members together and the plan collapses completely and we see no changes to the tax code.

 

At this point it is all speculation, I hope I have been able to present a fairly clear and understandable example of the potential impact of the proposed changes to the tax plan that could impact California homeowners that you can use to sort out future proposals and potential personal impact.

 

Have a question? Ask me!

 

Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.

 

The first week of the month means labor data. October saw Americans earning more and spending more—both good news for the economy—but prices are stagnant—which is not great news. Workers saw income increase 0.4% for the month and led by a surge in durable good spending due to hurricanes increased spending by 1% from September. Prices were flat going up only 0.1% for the month and 1.3% from last October, well below the Fed’s inflation rate. The news is mixed for mortgage rates as the stronger earnings and spending would tend to push rates up but the low prices keep rates down.

 

More workers, a lot more, is the news from the Labor Department’s October report. Total payrolls increased by 261,000 workers, 252,000 in the private sector. This is a very large increase, however much of it is the result of those displaced by hurricanes going back to work. For example, restaurants lost 98,000 workers in September and gained 89,000 in October. There was a dark cloud in the report and that is wages not increasing for the month. Overall the report is mortgage rate neutral.

 

Big news for the Federal Reserve yesterday when Trump nominated Jerome Powell to replace Fed chief Janet Yellen when her term expires in February. Powell is considered a moderate and unlikely to change any current policies of the Federal Reserve is confirmed for the post by the Senate.

 

Rates for Friday November 3, 2017: Rates are flat for conforming and dip back down on high balance loans after ticking up last week. All eyes, ears and noses are focused on Congress and the debates, negotiations and horse-trading over the tax bill. Depending on what moves through the process investors may react by fleeing to safety, rates drop, or loading up on equities in private companies, rates increase. Stay tuned, there should be plenty for office water cooler and weekend barbecue discussions.

 

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

30 year conforming                                            3.75%           Flat

30 year high-balance conforming                   3.875%        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.

 

What was more depressing for you, the outcome of the Game 7 or the amount of candy left over in your bowl for Trick-or-Treaters on Tuesday night? My disappointment was less in the outcome of the game on Tuesday than the lack of a great game that kept us on the edge of our seats all night. Congratulations to the Astros. Two things for baseball fans, right now every team is tied for first place, including my Phillies, and its only 102 until pitchers and catchers begin to report for Spring Training!

 

Have a great week,

 

Dennis