Personal Capital's First-Time Home Buyer’s Guide

 

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Buying a home used to be an integral part of the “American Dream.”

Even though it may not always be the most central focus of realizing that dream any more, many Americans list buying a home as one of their top long-term financial goals. Recent studies found that 75% of Americans say that buying a home is a priority, and in 2017, 34% of American home buyers were first-time home buyers.

The Personal Capital First-Time Home Buyer’s Guide is designed to help you navigate the ins and outs of buying a first home. There are many things to consider before making such an important investment that will certainly impact your life – financial and otherwise – for years to come.

Anyone who has owned a home can likely attest that with ownership comes a lot of benefits, but it’s not without its potential drawbacks. Before making the leap, make sure you’ve given careful consideration as to how your home fits into your financial plans and investing strategy.

Note: This guide serves as an educational guide for those interested in buying a primary home to live in for the first time, and does not cover investment properties or vacation homes.


What to Consider When Buying a Home

There’s no doubt about it: buying a home is a big purchase.

It’s not the type of purchase you can easily return if it doesn’t end up working out for you – it’s a major investment. And its impact on your finances – now and in the future – is great.

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IS HOME OWNERSHIP RIGHT FOR YOU?

Since a home is likely the largest purchase most of us will ever make, doing extensive research is a wise use of time. The “right” choice is different for everyone. One big question – especially for those who live in pricey real estate markets – is: should I rent or buy?

When you’re young and don’t have much saved, renting may be the obvious choice. It’s less obvious later in life. If you are older with a substantial amount of cash to invest, you may want to consider whether it’s wiser to put it into a fixed asset (i.e., a house), or continue to have it work for you making money in the financial markets while you pay rent.

RENTING VS. BUYING

A big question is whether you should rent or buy. Homeownership is entirely different from renting. Do you enjoy picking up a phone to have someone else fix that clogged drain? Do you feel comfortable with a lawnmower and enjoy the reward of cutting your own grass?


Homeownership can include a step up in responsibilities. Many people feel pride in completing the necessary tasks of owning a home, whereas others look at the “to do” list and cower in fear.


A good rule of thumb is to buy a home if you’re going to live there for six-plus years and you would rather live in the place that you’d buy than the one you’d rent. And don’t forget that when you’re deciding on your mortgage, think about it in the context of your entire wealth picture.

THE CURRENT HOUSING MARKET

There’s an old adage: location, location, location. This plays such a crucial role in your housing search, and it goes beyond where you want to live and the area’s amenities. Your job plays a pivotal role in choosing location, but so do considerations such as property values, safety and crime rates, political views, education access, community, taxes, commuting costs (including the psychological toll and time spent away from family and friends), and more.

It’s often tempting to think about real estate from a speculative position, but home ownership can be riddled with costs like Realtor commissions (on both sides of the transaction), mortgage interest, insurance, private mortgage insurance (PMI), maintenance, property taxes, and more, which can cut deep into the profit of your purchase (or pocket) even in the fastest appreciating geographies.

UNDERSTAND THE CURRENT MARKET

While most of us have lived through the peak and subsequent burst of the 2008 real estate bubble, many of us still seem conditioned to believe that real estate is a guaranteed “win” after nearly another decade of rapid growth. But it’s easy to make emotional – and irrational – decisions when it comes to real estate.

If you’re considering a home purchase, you should keep in mind that many factors can drive the local market up or down: major employers come and go, weather events can leave lasting environmental changes, and zoning laws are always subject to change.

Working with a professional knowledgeable in the area you’re exploring can give you a good idea of market activity and pricing trends. Real estate agents will help you find homes, clarify local transaction fees, taxes, and commissions, and advise you on local zoning and rental rules. Loan advisors will help you analyze your options and determine which loan options you are eligible for given your employment profile, and which is most efficient from a budget and tax standpoint.

PERSONAL CAPITAL STRATEGY: HOUSING & RISK TOLERANCE

When the financial crisis hit, the average American saw their net worth greatly impacted because property accounted for a large majority of it. While each person’s risk tolerance is different, property – especially for first-time buyers or in expensive states – can end up comprising more than 50% of your net worth, which is probably ok in many cases. It’s good to remember, however, property is one of the least liquid investment classes. A registered financial advisor can help you determine how this type of investment fits into your overall financial strategy.


Home Finances

Perhaps the most important consideration when it comes to buying your home is how homeownership fits into your overall finances.

It’s not just about what you think you can afford at the outset – you also need to understand all the expenses associated with purchasing, maintaining, and keeping the home. The latter type of expenses aren’t generally one-and-done. You’ll want to consider not only your monthly mortgage, but other items, such as fees, taxes, insurance, homeowner dues (i.e., HOA fees), and other associated costs.

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YOUR LONG-TERM GOALS

Buying a home is an important long-term financial goal. But while it is important, it’s good to keep in mind that a home purchase competes for the same resources as your other long-term financial goals. Retirement, paying for your children’s education, saving for your estate, or a trip to Hawaii - all are valuable goals. But remember that the tradeoff always means less money for one or more of those goals - something you’ll have to evaluate carefully.

PERSONAL CAPITAL STRATEGY: QUESTIONS TO ASK YOURSELF

It’s good to ask yourself – and your partner (if applicable) – some questions to see whether you’re financially ready to bear the responsibility of homeownership. Some of these include:


  • What is your credit score and how might that impact a lender’s rate?
  • What other funding sources do you have, and will those be used for the home purchase?
  • What other liabilities do you have and how can those count against your home purchase?
  • Do you expect to have the same future income, and if not, how will that impact what you can afford?

Speaking with a financial advisor is a good way to figure out how this purchase can fit into your overall financial strategy

PRINCIPAL, INTEREST, TAXES, INSURANCE (PITI)

There can be quite a few considerations that go into your monthly home costs. One of the most important considerations related to your home buying journey is referred to as PITI, which stands for the sum of monthly principal, interest, taxes and insurance. Keep in mind that PITI may account for just some of your monthly expenses when owning a home. Depending on where you live and how you are paying for your home, there may be additional costs built in.

Usually your lender will calculate your monthly PITI and compare it to your monthly gross income to see if you are a viable candidate for a mortgage loan. This is often called the debt-to-income ratio. Other times, lenders can use PITI to require reserves in the event that you temporarily lose your income. In this case, your lender may require, say, two months of PITI, so you would need to place double the amount of your monthly PITI in a depository account (aka your escrow account).


 

PITI COMPONENTS

So what exactly goes into PITI? A very high-level overview of its components include:


Principal – This is the amount of your loan, so it is likely the cost of your home minus your down payment. You generally pay off a portion of this with your monthly mortgage payment, so the principal will drop as you pay your mortgage; however, some interest-only mortgages do not include the principal.


Interest – Just like the majority of other loans, the interest is the amount the lender charges you for borrowing money. Usually, the largest amount of your mortgage payment will go toward paying down interest, and then will shift to paying off your principal. If you have an adjustable-rate mortgage, then this can change the interest rate you pay eventually.


Taxes – Taxes also make up a part of many homeowners’ mortgages. Tax rates vary significantly from area to area, so you should figure out just how much of your PITI goes to taxes. See the section on taxes to learn more about what goes into the taxes you pay and what you should be considering when it comes to taxes.


Insurance – Your lender may require homeowner’s insurance as part of your PITI. Even if it’s not required, it’s good to keep in mind that homeowner’s insurance can cover numerous items associated with your home, from the property itself to what’s inside. You’ll want to make sure you are properly insured when it comes to your home, and that your policy is based on accurate and up-to-date information, and you carefully read what types of perils are and are not covered under your policy. Casualty insurance will cover a specifically named incident that happens in your home (.e.g., injuries sustained on your property for which you are liable, or if your home is vandalized or damaged). There are also regionally specific policies that are offered by the government – and are usually required by your lender.


Private Mortgage Insurance (PMI) - Your lender may require homeowner’s insurance as part of your PITI. In addition, if you put down less than 20% for a down payment – even with good credit - then your lender may also require insurance known as private mortgage insurance (PMI) to cover the risk lenders take in issuing small down payment mortgages, since smaller down payments are associated with higher chances of default. Though PMI payments can be canceled once you gain 20% equity in your home, building up to 20% can mean years of pricey PMI payments. Unlike mortgage payments, PMI does nothing to help grow or build equity – once the money is gone, it’s gone. If you have to put down less than 20% as a down payment, then try to make additional monthly payments to get out of the PMI as quickly as possible.


 

PERSONAL CAPITAL STRATEGY: CALCULATING PITI & 28%

Just like running a business, managing personal expenses and income ratios can help you meet your cash flow needs. When it comes to calculating what you can afford regarding your PITI, we generally recommend that 28% of your gross monthly income should be the maximum monthly cash outflow for costs associated with your PITI.


So why the magic number of 28%? Usually, this number is calculated by taking the principal and interest of your monthly mortgage payment and adding one-twelfth of your annual real estate taxes (i.e., one month of real estate taxes), as well as one-twelfth of your annual homeowner’s insurance premium (i.e., one month of your annual homeowner’s insurance) and one-twelfth of any annual association fees (i.e., one month of your annual HOA fees). Then you can divide this by your gross monthly income.

 

 

POTENTIAL PURCHASE COSTS

In addition to PITI, which is a recurring cost (usually monthly), there will be more one-off types of costs that you’ll need to keep in mind when you are purchasing your home. While some of these can be negotiated into the selling price, it’s good to know that these are also costs that can easily add up. Some of these include Realtor, closing, and title costs.

PERSONAL CAPITAL STRATEGY: TAPPING OTHER SOURCES

You may look into other sources of equity to help with affording your home. You could qualify for certain loans, like a VA loan, which can help greatly. While some people may have the option to take a loan from their 401k plan, anyone under the age of 59 ½ who qualifies as a first-time homebuyer can take up to $10,000 penalty-free for a first-time home purchase. However, you will still have to pay tax on the distributions.


We generally recommend looking across all your assets to try to find the best option from a risk management perspective. Borrowing from retirement can cause many challenges and you want to ensure you have full access to your retirement funds. Speak with a financial advisor to review which assets might be the best for you to use toward a home purchase.

POTENTIAL ONGOING COSTS

PITI may not be the only expense you need to factor in. First-time home buyers, especially, may encounter other costs that they haven’t had to pay before. Sometimes renters will see their expenses increase once they become homeowners. Some of these ongoing expenses include:

HOME MORTGAGE LOANS

Primary residence mortgage loans are used for buying a home to live in. There are different types of mortgage loans (also known simply as mortgages) you can take out, but the most common ones are fixed and variable (and there are even more variations within these types of mortgages). Each type of mortgage carries some benefits and some drawbacks that may apply to your unique financial situation. This is a simple, high-level overview of these types of mortgages. You’ll want to speak to a professional to understand the benefits and drawbacks of each mortgage type and which one may fit your needs the best.

FIXED VS. ADJUSTABLE-RATE MORTGAGES
LOAN PROGRAMS WITH SMALLER DOWN PAYMENTS

If you don’t have upfront liquidity to make a significant down payment, there are other options that may be beneficial to you. Some of these include:

97% LTV Programs: Fannie Mae and Freddie Mac programs allow qualified first-time buyers of a primary residence and those looking to refinance their primary residence to do so with as little as 3% down (there are loan maximums depending on where you live). If you qualify, you will be issued a fixed-rate mortgage, also known as a 97% loan-to-value (LTV) ratio. There are some considerations: you must live there for at least one year, and if the housing market declines, borrowers with low down payment mortgages are at higher risk of owing more on their mortgage than their property is worth. Minimal upfront equity also means higher risk of default.

FHA Loans: If you have a credit score of 580 or higher, you may want to consider a Federal Housing Administration (FHA) loan. This is an FHA-insured mortgage, which many first-time home buyers leverage because they don’t require down payments of more than 3.5%. Even if your credit score isn’t above 580, you may qualify for an FHA loan if you can make a 10% down payment (though it bears remembering that your interest rate will be higher the lower your credit score is). Note that you will also be responsible for PMI premiums.

THE CHANGING INTEREST RATE ENVIRONMENT

While no one can predict interest rate changes, changing interest rates can have a real impact on your mortgage. For example, with ARMs, rate increases may have a significant impact on monthly housing payments. If you are interested in a hybrid mortgage, you may want to consider refinancing your loan if it looks like rates are likely to rise significantly. Talk to your financial advisor to learn more.

MORTGAGE LENDERS & BROKERS

Unless you are one of the rare lucky folks who don’t need a loan for your home, some key players will be involved in your home purchase. Two of these include those who will help you access a mortgage loan: the mortgage lender and the mortgage broker. So, what is the difference between the two?

A mortgage lender typically is a licensed professional or financial institution that makes loans directly to you or through a third party. Lenders are regulated by state and federal agencies, which may go a long way toward trusting the process. In addition, working directly with a lender may help you save on some costs as well as iron out any difficulties that may arise during the process. On the other hand, lenders typically offer only their own programs, so you will likely want to shop around with different lenders for comparison.

A mortgage broker typically does not actually lend you the money, but will help you find a lender that will. Oftentimes, a mortgage broker works with many lenders to try to find you the best rate and terms. One potential drawback is that once your broker finds you a lender, your broker is typically out of the picture and you are responsible for staying in touch with your lender, which can sometimes prove to be difficult. There can also be some hidden costs associated with working with a broker, so be sure you know the loan process and ask questions along the way.


Home Buying & Your Portfolio

A primary home can be a wonderful investment, especially if you enjoy living in it.

Over the last 30 years or so, real estate has appreciated at a rate very close to that of inflation - a rate that is less than the historical appreciation of stocks*. Even so, the leverage of a mortgage and the tax benefits of the interest deduction can still make owning a home a good idea, as long as you can afford it and plan to live in it for at least six years.

*Based on the annualized return of the Case-Shiller Home Price Index (National) versus the US Consumer Price Index (from 1988 to 2018).

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YOUR MORTGAGE & INVESTING


Few areas of such importance are as largely ignored as the subject of when to pay off mortgage debt and how to think about it in relation to other investments. One question is: does it make more sense to pay off your home as soon as possible or make investments designed to fund your future lifestyle?

Generally speaking, there is a short answer to this question—invest first. Why? The answer is relatively simple: opportunity costs. Opportunity cost refers to a potential loss of value from other opportunities when you choose an alternative. In this case, most people these days have a mortgage with a relatively low interest rate, 3% or 4%, and that rate is locked in for 15 or 30 years. In contrast, a standard rate of return of a diversified portfolio from 12/31/2011 to 3/31/2018 is 7.6%1 (based on representative benchmarking) —greater than the borrowed mortgage rate.

It seems clear to choose the option that offers the higher rate of return. Unfortunately, like most things financially related, this simple answer comes with a few complications. For instance, the stock market does not deliver “average” annual returns in a neat and tidy package. When you choose to enter the financial markets and how long you plan to stay are significant factors. Your risk tolerance is another factor. The market can be unpredictable, and this volatility is one of the variables when weighing the benefits of paying off a mortgage or investing in the stock market.

There are also tax-related variables that impact your decision. For instance, if you no longer itemize due to the new increased standard deduction, your mortgage interest deduction has lost its traditional tax-return value, which may make paying off your mortgage early an attractive decision. When it comes to interest rates, the structure of your mortgage is an important factor. If you have a mortgage with an interest rate above 5.5%, you may want to investigate refinancing to take advantage of today’s lower interest rates. In other instances, hybrid mortgages — such as adjustable-rate mortgages or loans with balloon payments — could tip the scale toward paying off a mortgage.

1Based on the annualized return of the Case-Shiller Home Price Index (National) versus the US Consumer Price Index (from 1988 to 2018).


PERSONAL CAPITAL STRATEGY: RISK TOLERANCE & YOUR MORTGAGE

Some investors are simply too risk averse to tolerate market volatility. You may elect to pay off your mortgage, foregoing any possible excess annual stock market returns, because of the peace of mind it brings. The same applies if you simply cannot tolerate debt. Owning your home outright may mean more if you are debt-averse than any potential benefits from higher stock market returns. Or, you may have stronger risk tolerance and will weather market cycles by maintaining a diverse and balanced portfolio.


You can assess your risk tolerance by taking Personal Capital’s free interactive quiz by clicking here.

BONDS VS. YOUR MORTGAGE

When it comes to thinking about your mortgage in relation to your portfolio, it’s always helpful to think about what a mortgage is. A mortgage is debt with your home as collateral. Once you buy a property, a mortgage does not leverage the return of the house. The house remains leveraged at 1:1 on your balance sheet regardless of the level of your mortgage. A debt is the opposite of an asset, and borrowing money and paying an interest rate is the opposite of lending money and receiving an interest rate.

So, does it make sense to own bonds and have mortgage debt? If the interest rate on the bonds is meaningfully lower, the answer is probably no, but this depends a lot on the specific bonds you own. It also gets more complicated because of taxes, especially considering the change in the allowable deduction on mortgage interest rates. Also, you may be paying taxes on the bond investment. If the bond fund is owned in a taxable account, the yield may decrease.

A primary reason to not sell bonds to pay down your mortgage is simple: liquidity. Having liquid assets (like stocks and bonds) available can be important to take advantage of other investment opportunities or for life’s surprises. You may be able to re-leverage your mortgage with a home equity loan in the future, but this can be costly. Of course, many types of bonds pay higher yields than current mortgage rates

Most investors own bonds and have a mortgage – and this is acceptable. But it doesn’t make sense to have a high allocation to bonds that pay significantly less than your mortgage rate. This includes low-paying CDs and savings accounts that are not part of your emergency cash cushion. Don’t forget transaction costs and management fees when considering bond yields.

There is no magic number, but if you do reach a point in the future where your bonds are paying more than your mortgage, then this could be a good situation. You should likely never pay down your mortgage more than necessary if this occurs. Keep in mind that your home is likely a very important asset and your mortgage is a major liability.

STOCKS VS. YOUR MORTGAGE

If you back out real estate, many people have higher stock allocations than they realize. On the other hand, many people own stocks and also have mortgage debt. Usually they randomly fall into a particular asset allocation based on when they buy their house without thinking too much about it.

There is so much that impacts your stock allocation and its relationship to your mortgage. Taxes, mortgage interest rates, inflation, and – of course – the market and equity returns all play a crucial part in this relationship. Time horizon is also critical. What happens in 10 years will differ from what happens in 20- and 30-year periods. Much can change not only within the financial world at large, but within your own life and priorities.

When it comes to your mortgage and your stock allocation, one theory is that it’s better to keep a high mortgage and invest the money in stocks (rather than paying down your mortgage). Sometimes it is a lot better. The importance of this can hardly be overstated. And, this does not even account for the fact that a large portion of those mortgage payments will be reducing the amount of debt principal.

Still, it is not without risk. No matter what time period you look at, there is a small, but real risk of losing more than 50% of the value of your stock portfolio. This is a big game to play, so being conservative makes sense for most people. There is no guarantee stocks will go up. Therefore, some balance between the two strategies is optimal. But especially if you are still working, it can be a big mistake not to have a large portion of total net worth in stocks.

PERSONAL CAPITAL STRATEGY: STOCKS & YOUR MORTGAGE

Everyone’s situation and risk tolerance is different, but as long as you believe equities will perform reasonably better than your after-tax mortgage rate on average over time, it is usually better to maintain a relatively high mortgage balance and invest the money in stocks. But because there is some real risk of losing a lot with this strategy, it often does not make sense to be completely leveraged. The actual ratio should be dependent on current mortgage rates, equity expectations and other risk tolerance factors such as other assets, income and personal preference. It is important to have a strategic plan regarding this topic, because it will have a huge impact on your eventual net worth. Don’t just leave it to chance based on when you buy or upgrade your home.


Home Buying & Taxes

Owning property has advantages and disadvantages – and certainly many of the issues are tax related.

Taxes play a significant role in your home buying decision, whether it’s taxes involved on the purchase itself or taxes you pay down the road. To make it more complicated, tax reform has impacted several areas when it comes to taxes and housing.

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Housing Deductions

There are some important residential real estate taxation changes that tax reform has impacted, which in turn impacts your home buying process. They include mortgage interest deductions and property tax deductions.

Mortgage Interest Deductions

Before the 2017 tax reform, qualifying mortgage interest could be deducted as an itemized deduction on residential loans up to $1 million (plus another $100,000 of a home equity loan). This loan cap applied to a maximum of two houses – a primary home and a vacation home. Under prior law, the loan must be secured by the taxpayer’s main or second home, and the interest paid on the home equity loan or home equity lines of credit could be used to pay personal living expenses, such as credit card debts.

You can still potentially deduct interest on a home equity loan or a home equity line of credit as long as they are used to buy, build or substantially improve the taxpayer’s home that secures the loan. However, the interest expense on a home equity loan or a home equity line of credit used for anything other than these purposes is no longer tax deductible.

Itemizing Deductions for Qualifying Home Mortgages

In the past, if you itemized your deductions, you would likely deduct the interest you paid on a qualifying home mortgage, which reduces your taxable income. With the new tax law, many homeowners may no longer benefit from itemizing their deductions and instead can utilize the newly increased standard deduction amounts. If it still makes sense to itemize, however, just be aware the limit for deductible mortgage debt has decreased to $750,000. This applies to new loans taken out after December 15, 2017. (If you have a loan from before that date, you are grandfathered in under the former limit of $1 million.) If you have questions about whether the new tax law applies to you, check with a professional.

It’s interesting to note that many homeowners may not necessarily be impacted by this change. However, a cap of $750,000 in high-cost states, like California or New York, may be easily reached, even by those looking for relatively modest accommodations.

Capital Gains Exclusion

One quick thing to note when you are buying your home and thinking about resale value: Tax reform preserved the home sale capital gains exclusion of up to $250,000 for individuals and $500,000 for married couples filing jointly. This means you can still potentially shield profits on qualified home sales up to these amounts from federal income tax.

State & Local Property Taxes

Before tax reform, homeowners were able to deduct state and local (property) taxes from their federal tax bill. Now, if you are itemizing deductions on your tax return, then you may deduct property taxes you pay on your primary home as well as any other real estate you may own for personal purposes, but the deductions are limited to $10,000 (the combined total of state and local sales, income and property taxes is limited to the total $10,000). This change tends to impact certain markets. While homeowners in most parts of the country pay less than $10,000 annually in property taxes, taxpayers in states with high property taxes and high home prices could surely feel a wallet pinch.


Homeownership & Titling

There are several ways you can purchase your home.

The most common ways include owning the home yourself, with other people (joint ownership or tenants-in-common, also known as a TIC), or a living trust if you already have one set up. The way you title your home – or if there’s a gift involved in any of the process – can have consequences not only on your ownership but what happens to your home in the future.

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TYPES OF OWNERSHIP

Typically, there are several types of homeownership when it comes to your primary residence. These may include:

Sole Ownership – You are the one individual who owns the entire property and when you pass away, you can leave your property to your heirs through transfer documents or through your estate plan, which might contain a last will or a living trust. These estate planning documents instruct an executor or trustee to distribute your assets according to your wishes. If you do not have an estate plan, a court will follow so-called state “intestacy statutes” to assign assets to beneficiaries closest to you on your family tree. Having a current estate plan can help your heirs avoid intestacy and could also assist in distributing your portion of ownership in the additional property ownership methods below.

Joint Tenancy With Rights of Survivorship (JTWROS) – You and one or more persons own equal, undivided parts of the property. If you pass away, then your ownership interest passes along to the surviving joint owner(s). If one joint tenant breaks the joint tenancy by selling his or her interest to another person, the ownership would usually be changed to TIC for all parties.

Keep in mind, a married couple – or any joint tenants – may have different percentages of equity in a property amongst the joint owners. You should consult with an attorney if preserving your percentage of equity/ownership is important. Otherwise joint tenancy could provide that an unequal amount of equity passes to the remaining joint tenant(s) after your death or a divorce.

Tenancy in Common (TIC) – You own a property with one or more people; however, you and your co-owners can own the property in different percentages. While you are able to pass along your interest to your co-owner(s) when you pass, your interest doesn’t automatically pass along to the other(s), like it would through JTWROS. If your estate is not set up properly, this could mean that your interest will go through probate, and could cause further complications with the property.

Community Property – You own a property that you purchased with your spouse in a state that has community property laws (i.e., Alaska, Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin). Each of you would own half of the property, which you can leave through a last will or living trust to the surviving spouse or someone else.

Living Trust – You own the title to your home through a revocable living trust. Until you experience disability or death, you own the home just as other ownership methods mentioned above. In the event that you and/or your spouse become disabled or pass away, a successor trustee, which you designate in the trust, can continue to own the property for you or your family’s benefit, or sell the home so equity would be distributed to the appropriate heir(s).

Other Types of Ownership - While you can, most people don’t own don’t own their primary home as an LLC or other business partnership, though secondary or rental props are quite often titled this way.

In about half of the United States, a married couple can acquire property through tenancy by the entirety. This type of ownership can extend asset protection to assets of the marriage. If tenancy by the entirety is available, you may want to consider it for its useful asset protection over joint tenancy with right of survivorship.

 

Home Ownership & the Fine Print

The types of ways to own a home can be complicated and all come with various benefits and drawbacks depending on your wishes and financial status. Don’t forget that taxes play a huge part in how your property is transferred depending on the type of ownership you have. It’s good to consult a professional to understand all of the fine print that comes with owning property.

GIFTING A DOWN PAYMENT

Today, most lenders are looking for down payments of 10% to 20%. While they may take a sub-20% down payment, there are caveats involved (such as higher interest rates or other requirements, like mortgage insurance). Coming up with a down payment of that size – especially on higher-priced homes – can be challenging. Here is some helpful information when it comes to gifting or receiving a down payment.

Annual Gift Tax Exclusion - Your parent or any family member or friend can gift part or all of your down payment or future mortgage payments. While you can receive a gift of any amount of money at any time, the annual gift tax exclusion is the amount that can be given away per person per year without reducing the lifetime gift tax exemption. The annual gift tax exclusion is $15,000 in 2018, which increased from $14,000 in 2017.

Lifetime Gift Tax Exemption – The total amount that can be gifted over your entire lifetime can be free from tax as well, if the overall gifted amount does not exceed the lifetime gift tax/estate tax exemption, indexed for inflation and increased yearly. The exemption was $5.49 million in 2017, but tax reform increased the exemption to $11.18 million (per individual) in 2018. Any gifts over the annual exclusion would reduce the exemption you have left to provide to your heirs at your death.

For instance, each one of your parents can give you $15,000, which adds up to $30,000, per year. And if you are married, your spouse can also receive $30,000 per year, which, at the end of the day, comes to $60,000 that you can put toward a down payment – a not insignificant amount – that doesn’t require you to pay any taxes on that gift, thanks to the annual gift tax exclusion. In addition to helping with a down payment, your parents also reduce the size of their taxable estate.

Keep in mind, though, some states impose their own state estate taxes with lower exemptions than the federal gift tax/estate tax exemption limits.

LOAN vs. GIFT

If your down payment comes in the form of a gift, you’ll want to ensure that it’s recorded as a gift, and not in any way a loan, i.e., the gift giver doesn’t require any repayment. Your mortgage lender doesn’t want anyone down the road coming back claiming they need to be repaid, and you don’t want the gift counted as more debt in the qualifying process. In addition, it is helpful to clearly spell out any expectations if the gift “belongs” to a certain person within the purchasing party. For example, if a mother gifts a married couple a down payment, but clearly states it counts toward her daughter’s equity, then the mother and the couple should document the terms of this gift to the daughter, and the sale documents and titling of the home may need to be consistent with the expectations of this gift.

Parents sometimes claim their gift is a loan, but they should ensure that it’s treated as such; if there is no repayment within 10 years then this may imply the loan is a gift and the loan could be canceled in the future. Did their children make loan payments back? Is there paperwork reflecting a repayment schedule? If family or friends become your lender, consider working with an attorney to set up the loan officially. For example, does this “intra-family loan” have repayment terms that would be appropriate? Do you have a reasonable interest rate?

You can also ask a real estate attorney about utilizing a promissory note, which can be customized to document a contract between a buyer and the parent/person providing equity for the purchase. A promissory note can be as enforceable as a mortgage.

GRANDFATHERING

When we talk about "grandfathering” with real estate, we’re not speaking in familial terms. We’re instead talking about certain laws or conditions that you may be able to inherit – or be “grandfathered” when certain conditions are met.

For example, if you live in California, you may be familiar with Proposition 13. This is the proposition that allows parents to pass their homes to their children and in doing so, grandfather them in to their property tax rate without reappraisal. You can imagine some places that have been in families for generations have very low property tax! However, you’ll want to ensure that the rules are followed correctly. If you were to leave your home to your two children, say, and one ends up selling his half to his sibling, then it’s a child-to-child transfer, and one half of the property would get revalued and will likely be charged with higher property taxes.

Other states or municipalities might have other types of things that can be passed on, so even if it’s not preserving property tax, you’ll want to check whether there are there any kind of grandfathered-in stipulations (e.g., rent control or keeping an individual unit out of an HOA). You likely want to ensure – wherever you are – that anything you pass on to your heirs will be helpful.

These are the types of things that you normally want to address in estate planning through your will or living trust so it is done correctly. Done incorrectly, you might end up with the opposite of what you intended for your heirs. An attorney may be pricey at the beginning, but it’s a one-time cost to ensure you’re doing it right and eventually saving money beyond that over time.

ESTATE PLANS AND REAL ESTATE

It’s important to have an estate plan in place that clearly helps guide your heirs when you pass on your property. Having an estate plan is about deciding what to do with your estate (e.g. your assets) and what impact that ends up having on those who receive your property. Trusts can also be helpful in estate plans. Some older parents just pass on their real estate without a current estate plan or any stipulations in place. No matter who ends up getting property, setting up a current estate plan can ensure that your beneficiaries receive the share of the estate you wish to gift to each beneficiary.


Home Purchasing Strategies

There are so many steps that go into buying a house, it’s hard to keep track of all of them.

Professionals within the real estate industry can be key to helping you navigate this process. Whether it’s someone advising on the financial end or someone who is advising on the real estate side, a strong team of pros can be instrumental to your home buying success

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THE REAL ESTATE INDUSTRY

There are several names for those who help you with finding, negotiating and purchasing your property. While they may be used interchangeably, there are specific conditions each type must meet. For example, a real estate agent differs slightly from a Realtor, and both are different from a real estate broker.

WORKING WITH A REALTOR

So how do you know if you’re working with the right real estate professional? Here are some quick questions to ask yourself:

NEGOTIATION PRACTICES

Buying a home will test your negotiation skills, and can be a daunting task. After all, you want to ensure you’re getting the best deal, while the person who is selling you their home wants to ensure they’re getting the best deal. So what are some ways you can negotiate? Here are some ideas:

HOME EXPANSION

Many experts consider location to be the most important factor for buying a property with long-term appreciation value, but expanding a property also gives you another way to make money in real estate. Property expansion entails creating additional living space that adds to the property’s value when it’s sold.

The first step to this is buying a home with expansion potential. Its future selling price should be at least 50% more than the construction costs, based on the research you’ve done. If you decide to expand your home in a location with a high cost per square foot, and you can expand at a relatively low cost per square foot, then you could end up with added value onto your home. However, it’s good to keep in mind that spending a significant amount of money on building materials and quality oftentimes has diminishing returns. There is a tradeoff when it comes to this, and you’ll want to calculate the cost of expansion in relationship to the value add. And don’t forget, property taxes are based on the value you’ve created.

The second step is to consider local rezoning laws. How eager is your county to develop or build more on your current plot? Some counties are quick to act on their rezoning laws, whereas others may drag their feet. If you are in a historical district, you may be subject to very critical laws to keep the town looking uniform for years to come. These stringent laws may hinder all expansion projects

PERSONAL CAPITAL STRATEGY: HOME EXPANSION

There are some downsides to expansion to consider as well. When you expand a home, you create more value, and your home will be taxed on the value that you’ve created. However, these property taxes are based on the cost of construction and not on the market value of the property, which is subjective. Additionally, expansions oftentimes come from money that could be used for other investments. Many projects run over budget, so it’s prudent to include a contingency budget of 10% or more. Your real estate agent and general contractor will help you better estimate the costs in your neighborhood. And before beginning a home investment process, you should run realistic worst-case cash flow numbers to see how long you can survive before your money runs out. Having two years in cash flow is a good guideline.

REMODELING & RENOVATION

Remodeling and renovation are not the same as property expansion, and investing in these will most likely not get you a return on your investment when/if you sell. But it doesn’t mean these aren’t worth it; buying a cheaper home and then remodeling over time is one strategy to save money. In addition, renovations may give you the chance to rent out your home for more money, if that’s an avenue you choose to pursue.