How HOA Payments Reduce Your Buying Power

buying powerIf you buy a condo or town home, there is almost always a homeowner’s association (HOA) that charges a monthly fee. What the fee buys you varies, but typical benefits are exterior maintenance, water, trash, and sometimes amenities such as a pool, tennis courts and club house.

The issue with HOA payments is they reduce your buying power, which is the amount of house you acquire for your monthly payment.

How You Lose Buying Power
Most people have a total monthly payment (TMP) they can afford, say $1200. If your HOA fee is $335, it takes $335 from the TMP. This leaves $865 for the rest of the TMP. If your HOA fee is $167, it leaves $1,033 for your TMP. Obviously you can borrow more with $1,033 a month than with $865, so that’s how the HOA fee impacts how much house you can buy.

Impact On Buying Power
What can you buy for $865 per month with a $335 HOA fee?

  • A $155,000 condo with 3.5% down and 4.5% interest creates a monthly payment of $840.18 (Principle + Interest + Mortgage Insurance)
  • You also need $77.83 for taxes and about $20 for insurance
  • $335 HOA fee
  • TMP = $1264

What can you buy for $1,033 per month with at $167 HOA fee?

  • A $175,000 house with 3.5% down and 4.5% interest creates a monthly payment of $948.55 (PI + MI)
  • You need $88.92 for taxes and about $20 for insurance
  • $167 HOA fee
  • TMT = $1,165.87

As a seller with a high HOA fee, you are competing against properties that are 11% higher priced, most likely with more features, more square footage, perhaps newer, or in better locations. As a buyer, you are bypassing properties that are 11% higher in price.

Another consideration is property appreciation. Since HOAs tend to increase over time, they put a drag on appreciation as they rise.

That being said, when a property is RIGHT for you, then that is your major consideration, not the HOA fee; it becomes something you live with to have the house you want.

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Tips on Home Equity Loans

home-equity-loan-interest-rateBack in 2005, this was on the radio all the time: “take the equity out of your house and put it to use.” The announcer would tell you everything you could do with that money that was locked inside your house like a vein of gold just waiting to be mined.

Only here’s what they didn’t tell you: you weren’t “taking out equity;” you were taking out a loan, and loans must be paid back.

What is EQUITY?
Equity is the difference between your home’s fair market value and the outstanding balance of your mortgage. In other words, it’s the amount of the house that you own, rather than the bank. For example, if you have 20% equity in your $200,000 home, then the bank owns the remaining 80% of the house.

If you “take out the equity” – or give up your 20% ownership – where does the money come from? A BANK! A bank loans you the money and your debt increases by that amount. Bankers call them Home Equity Loans.

Smart Tips on Home Equity Loans
Kim Martin, a very experienced banker with Capital West Bank in Fort Collins, has some home equity loan tips for you.

  • Start with a HIGH amount of equity in your home – don’t do it if you have less than than 20% equity in house
  • Keep at least 20% equity in your house – don’t borrow more than that
  • Pay yourself back ASAP – in a couple of years, if possible

Interest Rates on Home Equity Loans
Many people are not aware that you pay higher interest rates on home equity loans than mortgages. For that reason, the price tag on home equity loans adds up fast. For example, let’s say you borrow $10,000 at 6% for 10 years. Amortized over the term of the loan, you will pay $3,322 in interest.

Because it is expensive money, Kim Martin recommends that you be very careful with home equity loans. Only take them out for really good reasons.

Good Reasons For Home Equity Loans
Here are a couple of good uses for home equity loans.

  • Sensible Remodel Projects – Kitchen and bath remodels are best because you get dollar for dollar payback, or close to it. Make sure the projects are in keeping with your neighborhood.
  • Investment Property – Use your equity for down payments on rental property. This is “good debt” because your tenants pay the mortgage for you (assuming your investment cash flows).

Dumb Uses of Home Equity Loans
Back in the 2000’s, people would take out home equity loans for all manner of bad reasons:

  • Vacations
  • Toys – boats, motorcycles, trucks, campers
  • Home Over-improvements – “dream projects” beyond the scope of the neighborhood, such as pools, spas, professional-grade shops, lavish bathrooms and kitchens, tricked-out basements
  • Risky Investments – stocks, businesses
  • Loans to family members

The best rule of thumb is, if you can’t pay cash for vacations and toys, don’t buy them. Wait until you save the money; don’t mortgage your home and your future on a trip to Mexico.

Maybe There Is No Other Option
Sometimes people find themselves in really tough situations and they turn to their home equity when there is no other option. Common reasons are huge medical bills and college tuition. If you find yourself painted into a corner, just be very cautious because, for many people, such moves only delay the inevitable; often they lead to bankruptcies and financial disasters.

When Home Equity Loans Catch Up With You
All good things must come to an end, so they say, and it’s true with home equity loans. It catches up with you when you sell your house; the loans come due and must be paid off. I’ve sold several houses where people had zero or very little equity. Usually the sellers come to the Closing with a check to settle their debts.

So be careful when you hear ads on the radio touting what all you can do with that equity in your house. If it sounds too good to be true, it probably is.

What Makes Mortgage Rates Rise And Fall? 10-Year Treasuries

mortgage-rates2-300x249Homebuyers are always interested in mortgage interest rates because it makes a difference in their monthly payments and their buying power. A 1% increase in mortgage interest rates can decrease buying power by 10%! That’s the difference between buying a $180,000 house or a $200,000 house.

Why do mortgage rates fluctuate? Mortgage rates are directly impacted by the rates offered on 10-year US Treasury Bonds.

When rates on 10-year treasuries rise, then mortgage rates rise. When 10-year treasury rates fall, then your mortgage rate falls along with it. And the change is almost instantaneous.

Why Are Mortgage Rates and US Treasury Rates So Tightly Connected?
Home mortgages are bundled by Mortgage Aggregators (mostly Freddie Mac, Fannie Mae, Ginnie Mae) into investments called Mortgage Backed Securities. These investments have an implied government backing (which means safety) so they get a AAA rating. This AAA rating puts Mortgage Backed Securities in competition with US Treasury Bonds.

10-year US Treasury Bills and Mortgage Backed Securities compete head-to-head for investors who want safe, secure medium-term investments. Therefore the two investments must offer competitive returns to attract the investor’s money.

Mortgage rates follow treasury rates. So watch the 10-year US Treasury Bond rates and you’ll know which way mortgage rates are going.

Why Do Mortgages Compete with 10-year Treasuries and Not 30-year?
Investors compare 30-year home mortgages to10-year treasuries and not 30-year treasuries because statistics show that most home mortgages only last for seven years. Homeowners sell the house or refinance the loan, which results in a payoff of the mortgage. Therefore the best correlation is the 10-year US Treasury Bond.

Mortgage Interest Rates Since 2008 and Beyond
Since 2008, mortgage interest rates have been historically low. In 2013, rates were only 3.5%! In 2014, rates have risen to 4.5% or so. However, consider that in the 1980’s, mortgages were as high as 18%…so the 4.5% looks really good by comparison, right?

Since 2010 the Federal Reserve has spent $85 million per month, much of it on 10-year Treasuries. The effect of these purchases is to artificially push down treasury rates, and thus mortgage rates. In 2014 the FED began slowing down their Treasury note purchases, driving up treasury interest rates, so it’s logical that mortgage rates will increase as well. How high will mortgage rates go? No one has a crystal ball to tell us the answer.

My advice is to take advantage of the artificially low mortgage rate environment while you can, if you are in the market to buy a house or refinance. You don’t want to be the person in 10 years who is complaining about missing the opportunity for a cheap loan.

Mortgage Rules Changes Are Coming in 2014

Mortgage_rulesThe world of mortgage lending has changed significantly since the housing bubble burst. Mortgage lenders have returned to traditional loan standards that require extensive documentation of income and assets for a loan approval.

Government regulatory agencies also continue to react to the housing crisis, with more adjustments to mortgage requirements set to go into effect in 2014:

Qualified Mortgage Rules

Whether you’re thinking of buying a home or mulling over refinancing your mortgage, Jan. 10, 2014, could be an important date for you to remember. The Consumer Financial Protection Bureau is in the process of implementing regulations to meet goals set forth by the Dodd-Frank Act in Congress, which was meant to correct the errors that led to the housing crisis. The CFPB’s “Qualified Mortgage,” or QM, rules go into effect in January. Essentially, these rules require lenders to prove borrowers’ ability to repay a loan by meeting several guidelines, including a maximum debt-to-income ratio of 43 percent. While many lenders already limit borrowers to a similar maximum debt-to-income ratio, the new rules won’t allow for any compensating circumstances such as significant cash reserves or a large down payment to be considered in order to offset a higher debt ratio.

If you have credit problems or a high debt-to-income ratio, you may want to push through your loan application for a refinance or home purchase to make sure you close your loan before the new rules go into effect. However, many lenders are already using QM standards in order to make sure they’re in compliance with the regulation. Mortgages that don’t meet QM standards will have to be held by the lender rather than sold to Fannie Mae and Freddie Mac, so most lenders are careful to meet the new standards.

The 3 Percent Rule

The new QM requirements also limit fees for originating a loan to no more than 3 percent of the loan amount. If you’re financing a more costly home, such as a $400,000 home or more, the lender can easily keep fees under 3 percent, which in this case would be $12,000. However, if you’re refinancing a smaller loan balance or purchasing a less expensive home — for example, for $80,000 — the lender might find it more difficult to keep all fees under $2,400. Mortgage lenders are less likely to offer loans for smaller amounts since they won’t always recoup their costs and make enough profit to pay their staff. If you need a small loan, you may want to push to get it closed before Jan. 10, 2014.

Self-Employed Borrowers

One particular group of borrowers will most likely be impacted by the QM rules: self-employed borrowers. These borrowers already are heavily scrutinized and find it more difficult to obtain a mortgage because they must prove their income based on tax returns and profit-and-loss statements, rather than standard paystubs and W2 forms. The “ability-to-repay” feature of QM rules requires all borrowers to prove they have the cash flow to make payments on their mortgage. Self-employed borrowers often have fluctuating income and rely on cash reserves to pay bills in-between payments, but the emphasis on cash flow can make it harder for lenders to approve a loan even for someone with significant funds in the bank.

Potential Lower Loan Limits

The Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced in October that plans to reduce the maximum loan limits for conventional conforming loans will be delayed until later in 2014. Typically, loan limits are adjusted on Jan. 1 of each year, but the agency decided to wait to see the impact of the introduction of QM rules before making changes. Currently, the limits are $417,000 in most housing markets and rise to $625,500 in high cost areas. If you need a mortgage near these limits, it would be wise to close your loan earlier in 2014 rather than later in case limits are lowered.

If you would like a referral to a qualified lender, please contact me. 

Reprinted from Realtor.com, December 2013

Breaking Down the Home Mortgage Deduction

Sacred-CowThe home mortgage deduction is one of the few tax write-offs available to the middle class, and it reduces the cost of home ownership. For that reason, it has become a “sacred cow” to many people.

While popular and worthwhile, the perceived value of the home mortgage deduction may be greater than its actual value. Let’s break down the home mortgage deduction and see what it is and what it is it not.

Tax Credit vs Tax Deduction
You need to understand the difference between a tax DEDUCTION and a tax CREDIT. A deduction reduces the amount of your income tax that is subject to taxes, and a credit directly reduces your tax bill. Say you are in the 25% federal income tax bracket. For every $1000 in mortgage interest you pay (over the standard deduction), your tax bill will be reduced by $250. In contrast, a $1000 tax credit would reduce your total tax bill by $1000.

Itemizing Deductions
To take advantage of the home mortgage deduction, you must itemize your deductions. To be eligible to itemize deductions, the dollar value of your itemized deductions must exceed the value of the standard deduction, which was $11,900 for married joint filers in 2012.

If you have a $193,000 loan that is five years old, you will pay $8,104 in interest. So you need $3,796 more deductions before you can itemize and take the home mortgage deduction. If you don’t, then you have to take the standard deduction and you cannot take advantage of the home mortgage deduction.

According to USA Today, only about 25% of tax payers are able to itemize deductions and take advantage of home mortgage deductions. Most of these tax payers are in high cost of housing states, such as California, Hawaii, Washington, Virginia, Maryland and Nevada.

Amortization and Interest
Another concept you need to understand is amortization. It’s the mathematical system that banks use to calculate the payback schedule of interest and principle. In general, the early years of the loan are heavily weighted to paying interest and light on principle. Latter years of the loan are light on interest and heavy on principle.

Using the $193,000 loan example, in the second year your interest payments are $8,562.49 and principle payment are $3,172.35. In the 16th year of the loan you pay $5,785.42 in interest and $5,949.42 in principle, about even. By the 30th year of the loan, the interest payments are $577.30 and the principle payments are $11,157.53.

As the years go by, the value of the home interest deduction diminishes because it gets harder to beat the standard deduction.

Early Loan Payoff
At some point, you may find yourself in position to pay off your loan early. No mortgage payment sounds great, but people worry about the trade-off of losing their home mortgage deduction. There are three things to consider.

1. What is your tax bracket? From our tax deduction example, we know that if your tax bracket is 25%, you get about .25 in benefit for every $1 in tax you pay. So in essence, you are spending a dollar to save a quarter. On the other hand, without a mortgage payment, you’d pay .25 to the IRS and keep .75 for yourself.

2. How many years do you have left on your loan? From our amortization example, we know that if you are past the mid-point of your loan you pay less interest and more principle every year. Therefore there’s less and less interest to deduct as time goes on. Most people in position to pay off mortgages are past the mid-point of their loan.

3. Do your take standard or itemized deductions? If you don’t have enough deductions to itemize, then you can’t take advantage of the home mortgage deduction anyway. So why keep paying interest to the bank?

Did you know that on a $193,000 30-year loan, you will end up paying $159,044.95 in interest! By shaving five years off the loan you’ll save at least $5266 in interest, which goes directly into your pocket. The deduction on that interest: only $1316 (assuming a 25% tax bracket).

Summary
The home mortgage tax deduction is a great thing; if you have to have a mortgage you might as well get to write off the interest. However, talk to your CPA and financial advisor to decide if the deduction is a good financial tool for you.

Types of Home Loans

Home-Equity-Loan-3Unless you are blessed with a large bank account that allows you to pay cash for your house, you’ll have to borrow some money. There are two basic types of loans you can pick from. The difference between them is how much of a down payment you make.

The down payment is a big factor because, to banks, down payments indicate risk. Large down payments mean a more secure loan because you have more “skin in the game.” To calculate risk, banks use a Loan-to-Value ratio. For example, if you have a $200,000 house with a $180,000 loan, the LTV ratio is 90% ($180,000 / $200,000).

Loans with an LTV of more than 80% require Mortgage Insurance, which insures the lender against you defaulting on the loan. Mortgage insurance is an additional cost to you, but it’s a trade-off for a lower down payment.

Conventional Loans
Back in the day, conventional loans were the gold-standard. The security for the loan is provided solely by the mortgage. House appraisals are very important to the lender, as are the borrower’s credit history and income reliability.

Traditionally, you put 20% down (for an 80% LTV ratio) with conventional loans. Today conventional loans can be obtained for 10%, 5% and even as little as 3.5% down, although very few banks offer programs with low down payments. Also be aware that down payments of less than 20% require some mortgage insurance. Check with your banker for details.

FHA / VA Loans
The terms “FHA and VA loans” refer to loans insured by the Federal Housing Administration (FHA) and Veteran’s Administration (VA). The FHA and VA do not lend money. Loans are made by FHA and VA approved institutions.

The big selling points of FHA and VA loans are that they only require a 3.5% down payment, and they are widely available. With FHA and VA loans you will have to buy mortgage insurance. There is an up-front premium charged at closing, which can be financed. And there is an annual premium, usually charged monthly.

Mortgage insurance is expensive, as much as 1.75% of the loan. There is light at the end of the tunnel. By law, when you accumulate 22% equity in the property (based on the purchase price of the home) you no longer need mortgage insurance.

For a list of lenders that I like to work with, email me at: gary.clark@century21.com

Seven Things NOT to Do When Applying for a Mortgage

So you applied for a mortgage because you are buying a home. Congratulations! Applying for a mortgage is the most important step in the home buying process (see my blog “What Bankers Want from Homebuyers When Applying for a Mortgage”).

If you want to keep your underwriter happy, you need to be careful during the underwriting process. It is possible to mistakenly, inadvertently, or accidentally lose your loan. I’ve seen nice people with pre-qualification letters lose houses because they could not get loans. Why? It was due to something they did after getting the pre-qualification letter.

Here are seven things NOT TO DO when you are applying for a loan. This list was provided by William Griffiths, a mortgage loan officer with First National Bank.

Don’t Buy or Lease an Automobile
Lenders look closely at your debt-to-income ratio. A large payment, such as a car lease, or purchase can greatly impact those ratios and prevent you from qualifying for a home loan.

Don’t Increase the Balances Owed on Credit Cards
If the new purchases increase the amount of debt you are responsible for on a monthly basis, there is a possibility this may disqualify you from getting a loan.

Don’t Move Assets from One Bank to Another
Transfers from one account to another show up as a new deposit and complicate the application process, as you must then disclose and document the source of funds for each new account. The lender can verify each account as it currently exists. You can consolidate your accounts later if you need to.

Don’t Change Jobs
A new job may involve a probation period which must be satisfied before income from the new job can be considered for qualification purposes. A new job may pay commission, overtime, or bonus income versus a guaranteed salary. Income other than a guaranteed salary must have a minimum of one-two years history before you can use it for qualifying.

Don’t Run Your Own Credit Report
This will show up as an inquiry on your lender’s credit report. Inquiries can lower your credit score. All inquiries must be explained in writing, i.e. do you have new or more debt.

Don’t Consolidate Bills
If this needs to be done, ask your underwriter for advice on the best way to do it.\

Don’t Pack or Ship Information Needed for a Loan Application
Paperwork such as W-2s, bank statements, divorce decrees, and tax returns should not be packed if you are moving. Finding copies could take weeks and delay the closing date on your new home.