If you’ve been unable to refinance your mortgage because your loan is underwater, you’ll be happy to learn that the Obama administration has announced sweeping changes aimed at helping homeowners like you. More specifically, if your loan was sold to Fannie Mae or Freddie Mac on or before May 31, 2009 and your loan-to-value ratio is 80% or higher, you could benefit.

The biggest change here is that they’re removing the old ceiling of 125% LTV ratio from the Home Affordable Refinance Program, which unilaterally excluded even the best borrowers if they lived in an area where home values had plummeted. To qualify, you have to be current on your loan payments, have no late payments in the past six months, or not more than one late payment in the past twelve months, and you cannot have previously refinanced under the HARP program.

As far as the lenders go, they no longer need to warranty their loans, which required them to buy back loans from Fannie Mae or Freddie Mac if the borrowers defaulted. This change will reduce lender liabilities and should make them more willing to work with borrowers. The White House is hoping that increased ability to refinance to a lower mortgage rate will keep people in their homes and spur spending as monthly mortgage obligations decrease.

Specific details will be made available to lenders by November 15th, though certain aspects of the program won’t go into effect until next year.

Source: Chicago Tribune

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Interest payments on home mortgages have long been tax deductible in the United States. In fact, prior to the Tax Reform Act of 1986, interest on all personal loans was tax deductible. The deductibility of loan interest dates back to the introduction of the income tax system in 1913 when, according to an article in the NY Times, it was difficult to distinguish between personal interest and business interest in a nation full of small proprietors.

Regardless of Congress’ initial intentions, the home mortgage interest deduction eventually became a stepping stone to home ownership. The reason for this is that it effectively decreases the cost of borrowing to buy a home. There are, however, some limitations that reduce the value of this deduction.

For starters, you must elect to itemize your deductions, and the mortgage interest (and other deductions) only reduce your tax bill to the extent that your itemized deductions exceed the standard deduction. Another limitation, but one which does not impact the majority of Americans, is that interest is only deductible on the first $1M of mortgage debt. A similar limit of $100k applies to home equity loans regardless of their purpose.

Another important thing to keep in mind is that an income tax deduction is very different from an income tax credit. Whereas the former reduces the amount of your income tax that is subject to taxes, the latter directly reduces your tax bill.

Take, for example, an individual in the 25% federal income tax bracket. For every $1000 in mortgage interest that they pay in excess of the standard deduction, their tax bill will be reduced by $250 (plus whatever state income tax benefits they might enjoy). In contrast, a $1000 tax credit would reduce their total tax bill by $1000.

While the home mortgage interest tax deduction is undoubtedly beneficial to those with mortgages, many people use it as an excuse to keep their mortgage when perhaps they shouldn’t. We could debate all day long whether or not you should pay off your mortgage early – with the alternative being to keep your mortgage in favor of putting extra money into your investments. In my opinion, the mortgage interest deduction should be just a small part of this decision.

Let’s consider a simple example…

The standard deduction for 2011 is $11,600 for married couples filing jointly. Let’s assume that a married couple buys a $300k house on January 1st with 20% down, resulting in a $240k fixed rate mortgage at 5%. Over the course of the first year, they will pay a total of $11,919.58 in mortgage interest. Let’s further assume that they donate $3k to charity and pay $3k in property taxes.

Taken together, these mortgage interest and charitable contributions add up to $17,919.58 in deductible expenses. Sounds great, right? Assuming that they’re in the 25% tax bracket, this works out to a tax savings of $4,479.90 — or does it?

The reality is that they would’ve been able to take the standard deduction regardless, so we really need to subtract that out to find out the marginal gain from itemizing. The standard deduction would have reduced their tax bill by $2,900 ($11,600 x 0.25) so they’re really only gaining $1,579.90 in additional tax savings.

That’s $1,579.90 tax savings in return for paying an extra $11,919.58 in interest — a 13% tax savings. While this 13% savings is far better than nothing, it’s nowhere near as good as one might expect based on their tax bracket. And if they hadn’t made that charitable contribution, the benefit would have been less.

As with anything, you’ll need to run the numbers and decide what’s best for you. Just be aware that when someone warns you not to pay off your mortgage because you’ll be giving up that huge tax deduction, the numbers aren’t nearly as good as you might think.

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About a year and a half ago, we paid off our mortgage. The issue of whether you should pay off your mortgage early or invest has always been a hot topic in financial circles, but I can tell you this much:

We haven’t regretted our decision to pay off our mortgage. Not even once.

Of course, just because we’ve paid off our mortgage doesn’t mean that we’re living for free. We still face a number of expenses, including property taxes, routine maintenance, homeowners insurance, etc. So just how much do these things really cost?

Let’s start with property taxes. Property taxes vary widely based on location, but around here they average about 1% of a home’s assessed value per year. Unfortunately, the only real way to combat this bill – aside from moving to a less expensive home – is to appeal your assessment. The good news is that this can be done. In fact, I’ve successfully appealed our assessment on more than one occasion.

Next up, insurance. Once again, rates vary based on a number of factors. While you could technically drop your homeowners policy once your mortgage is paid off, you’d be a fool to do so. You can, however, save on homeowners insurance by shopping around, increasing your deductible, etc. In our case, homeowners insurance runs roughly 0.2% of the value of our home per year.

Another big issue is maintenance. I’m talking here about things like painting, pest control, replacing your carpet and appliances, etc. The general rule of thumb is that you should budget roughly 1-2% of the value of your home per year for ongoing maintenance. Some years will be less, and others will be more – possibly much more.

In the six years we’ve lived in our house, the biggest maintenance issue we’ve dealt with has been replacing our water heater. Looking ahead, however, I’m expecting to have to replace the roof sometime in the next ten or so years.

There are, of course, other expenses that I haven’t factored in here such as lawn maintenance – either paying someone to cut your grass, or buying and maintaining a mower and associated equipment so you can do it yourself – utilities, HOA fees, etc. These things vary so widely based on your circumstances, however, that it’s hard to come up with a general rule of thumb.

Combining just the property taxes, homeowners insurance, and general home maintenance, we arrive at a rough estimate of 2.2%-3.2% of our home’s value per year. Given that our house is worth somewhere in the neighborhood of $325k, that means we’re facing roughly $7k-$10k in annual housing costs even in the absence of a mortgage payment, and that’s without considering utilities or lawn care.

I mainly bring this up to combat the overly-simplistic view that once you pay off your mortgage, you’ll be essentially living for free. The reality is that even without a mortgage payment, you’re still likely to face significant housing-related expenses.

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Over the past year or so, we’ve seen a lot of debate over the definition of wealthy. Much of this discussion has centered on whether or not individuals (or families) earning $250k or more per year are “rich” and should see their tax rates rise.

Without getting into the underlying politics, I think that one thing that most of us can agree on is that people with that kind of earning power are definitely not poor. Or are they? I recently ran across a story over on MSN Money that questioned whether or not $250k is enough to make ends meet.

For starters, I’ll just say this: Yes, $250k/year is clearly enough to make ends meet. As evidence, I offer the fact that less than 3% of American households earn that much, but most of use are getting by. I’d go so far as to say that if you’re earning that much and struggling, then you must be making some really bad decisions when it comes to managing your money.

And yet… When BDO USA, a national tax accounting firm, analyzed the finances of a hypothetical family of four (Mr. and Mrs. Jones and their two lovely children) living one of eight different locales, they concluded something entirely different:

It’s not exactly Easy Street for our $250,000-a-year family, especially when they live in high-tax areas on either coast. Even with an additional $3,000 in investment income, they end up in the red — after taxes, saving for retirement and their children’s education, and a middle-of-the-road cost of living — in seven out of the eight communities in the analysis.

They attribute these difficulties in large part to high levels of student loan debt, a pair of car loans, and a mortgage for 80% of the value of a “typical” home for a family of four. This “typical” home was a huge variable, as real estate prices varied widely across communities.

Taxes also take a big bite, and can vary widely based on where you live. And taxes aren’t the only thing that varies amongst locations. Other components of the cost-of-living vary widely from one locale to another, with groceries cost 72% more in New York vs. Idaho (for example). And those sorts of differences occur across the board in most spending categories.

Overall, the worst scenario included in the analysis was Glendale, CA, where Mr. and Mrs. Jones would wind up over $23k in the hole. Of course, this is a bit overblown, as the number crunching included $33k per year going into retirement accounts, and $8k per year in college savings. The best case scenario was Plano, TX, where the Jones family would nearly $5k left over at the end of the year.

Is $250k/year enough?

What do you think about all of this? Is $250k enough to make ends meet? If anything, I’d say that this is a perfect example of why it’s so dangerous to try to keep up with the proverbial Jones’.

Don’t break the bank paying for college, scale back on your house to reduce your mortgage payment (not to mention property taxes and maintenance), resist the temptation to borrow money for new cars (much less two of them), and so on.

Like I said above, if you can’t make ends meet on $250k/year, then you’re doing something very, very wrong.

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Well, guess what? If you took advantage of the original $7500 version of the first-time homebuyer tax credit, it’s time to start paying it back. Repayment is to be made in 15 equal annual installments starting with your 2010 income taxes. To make the payment, you’ll need to file IRS Form 5405 – coincidentally, this was the same form you used to claim the credit in the first place.

If you’re affected by this, you’ve probably already received “Notice CPO3a, Repaying your First-Time Homebuyer Credit,” listing the amount you have to re-pay. If you haven’t gotten this, or if you’ve misplaced it, then simply divide the total amount of your credit (you can look it up on your old tax return – you kept a copy, didn’t you?) and divide by 15. For those that qualified for the full credit, that works out to a repayment of $500/year.

Note that the 15 year “recapture period” only applies if the home you purchased continues to serve as your main home. If you convert your to a rental property or a second/vacation home, then you’ll need to pay the full unpaid amount on your next tax return. And if you sell your home to a third party, you have to repay the amount of the credit only up to the amount of the gain on your sale.

Other exceptions include the following:

• If you transfer your home as part of a divorce settlement, the spouse that keeps the home is responsible for the remaining repayments.
• If your home is destroyed or condemned and you purchase a replacement within two years, you’ll need to continue making repayments going forward.
• If you lose your home in a foreclosure sale, you’ll need to repay the credit up to the amount of your gain, if any.
• If you die, no further payments are due.

I’m not sure about you, but we bought our home back before the homebuyer credit was introduced, so this doesn’t apply to us. If it applies to you, be sure to be familiar with all of the repayment details – especially the possibility of having to make a lump sum repayment if you sell your home.

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For background, I should note that Bob and Sue were part-time homebuilders for the better part of the past decade. While Bob worked full time and Sue stayed home with the kids, they also built houses on the side. Every couple of years, they’d start building a new house. When it neared completion, they would put it along with their current house on the market, and then live in whichever one didn’t sell.

Raising the stakes

This worked so well for them for several rounds that they eventually decided to start building more expensive homes – homes that they couldn’t actually afford to live in themselves if they didn’t sell. Unfortunately for them, they made this decision right around 2007. I’m sure by now you can see where this is headed…

As their the mega-house they were building neared completion, the bottom dropped out of the housing market (and the economy in general). Real estate stopped selling almost overnight, and they were stuck with two houses. They put the new one on the market for awhile, but there were no potential buyers.

Eventually, they put their current house on the market in hopes of salvaging the situation. Their plan was still to sell the mega-house if they could. But if they couldn’t, they would buy time by selling their regular home and using the proceeds to keep themselves afloat. Since they couldn’t afford the mega-house in the long run, they’d move into it, but leave it on the market and move again went it (hopefully!) sold.

Hitting rock bottom

After a few stressful months, they sold their regular home and moved to the mega-house. Sue also went back to work to help makes ends meet, and it seemed like they’d be able to stay afloat, at least for awhile. Unfortunately, “awhile” recently ran out. They fell behind on their payments, and the bank ultimately foreclosed on them. They’ve lost nearly everything.

In retrospect, it’s easy to say that they should’ve just let the mega-house go when the market tanked. Sure, that would’ve ruined their credit, but they were already in a house that they loved, so why not dump the mega-house and move forward? Now they have no house, no credit, and presumably little to nothing in the way of savings.

Well, for starters, Bob and Sue were intent on “doing the right thing.” They got themselves into this mess, and they were intent on getting themselves out of it. I respect them for that even though they’re now paying a huge price. At the same time, I don’t think they wanted to admit to themselves just how big a hole they’d dug for themselves.

Lessons learned

With the story above as a backdrop, I wanted to share some financial lessons that can be learned from Bob and Sue’s plight. It’s too late for them to change course, but it’s not too late for others to learn from their mistakes.

Don’t be greedy

As much as it pains me to say it, Bob and Sue are victims of their own greed. Things were going so well for them that they decided to up the ante and start building huge homes that they couldn’t afford to keep. Sure, the profits would be bigger with their new strategy, but the risks were astronomically higher. In the end, they reached for the brass ring and wound up losing everything.

Respect risk

This is related to the point above, but it’s important enough to split out on its own… Risk is a funny thing. If you’ve ever read a financial book, you’re aware that “with risk comes reward.” But what many people often fail to realized is that investment risks are very real, and they’ll often rear their ugly head at the worst possible time.

It’s easy to be blinded by the potential upside, and to simply declare that they’re sufficiently risk tolerant to reach for higher returns. In Bob and Sue’s case, they let their risk/reward ratio got out of whack.

Let’s say they would’ve made $50-$100k by building and selling a “regular” house, and that the mega-house would generate $100-$200k in profits. In this case, they would’ve doubled their potential gain, but at what cost? Their downside risk went from being a manageable setback to complete financial disaster.

Leave a margin for error

And finally… Bob and Sue’s prospects apparently took a turn for the worse when he was laid off from his job. While they would have been able to pull this deal off if everything had gone perfectly, they didn’t have any wiggle room. And things didn’t go perfectly – the house didn’t sell, their income took a hit, and so on.

Unfortunately, even with Sue going back to work, they didn’t have enough cash reserves to carry them through the lean times. They took on such an extreme financial burden that they simply couldn’t make their plan work unless everything worked out perfectly – they had no margin for error.

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This is a guest post from Bailey Harris, who writes for the Home Insurance Blog. If you like what you see here, be sure to stop by and check it out.

Everyone knows that having an adequate insurance policy is a must for homeowners, but what if you rent? Many people overlook the value of a renter’s insurance policy, which can be a costly mistake.

Renter’s insurance works a lot like homeowners insurance. It replaces your stuff if it is damaged or stolen and protects your assets in the event of an accident or catastrophe. If you have been wondering whether or not you need renter’s insurance, the answer is probably yes.

Ask questions

Most renters’ belongings aren’t covered by the property owner’s insurance. You don’t want to be stuck with a lot of damaged property only to find out that your landlord’s insurance doesn’t apply to tenants. Don’t be afraid to ask your landlord if their insurance will cover you, and don’t be surprised when they tell you that you need to buy your own renter’s policy.

It may be required

Some landlords require tenants to carry insurance on their personal property. This is for the benefit of both parties and can save a lot of hassles down the line. If your rental unit is burglarized or burned to the ground, a renter’s policy will allow you to replace your stuff.

Pay now or pay later

Since it’s up to you to protect yourself, it’s in your best interest to buy a policy before disaster strikes. Whether you live in a high rise or a duplex, an accident or a thoughtless, careless neighbor could cost you everything you own. Maybe they’ll put burger on the grill and lose track of it, or maybe they’ll fall asleep with cigarette in their hand.

You have a lot to lose

Take a look around yourself and consider how much stuff you own. A big screen television, all of your furniture, a digital camera and/or camcorder, a DVD player, your clothing, your kitcheware, jewelry, the computer you’re reading this on, your printer and scanner…

The list goes on and on, and if you don’t take precautions you could lose it all and have nothing to show for it.

Adequate protection

Just like any other insurance policy, you have multiple options when it comes to choosing coverage, and the cost varies accordingly. If you’re the victim of a fire or a robbery, you’ll obviously want to make sure your belongings will be replaced.

Beyond the above, special circumstances (e.g., flooding or hurricanes) require additional coverage that should be specified in your policy. If you live in an area where those things could happen, you’ll need to make sure that you’re covered.

You should also consider getting replacement cost coverage rather than just insuring the present value of your belongings. If that brand new 50″ HDTV is stolen or damaged beyond repair, you’ll want your insurance policy to replace it without a lot of out-of-pocket expense.

Talk to your agent

To determine how much coverage you need, you’ll need to inventory your belongings. You might consider taking pictures or using a video camera to document what you own – just be sure to store these things somewhere other than your home.

Once you have an idea of how much much coverage you need, contact your insurance agent to get an idea of the cost. Discuss your options, and don’t be afraid to pin them down to specifics. Find out exactly what coverage you’ll need under any foreseeable circumstance.

Don’t forget liability insurance

Another thing to consider is that, if anything should happen to someone on your rented property, the injured party can come after you. A slip and fall in the kitchen could result in a financial nightmare. Make sure that your renter’s insurance policy offers some form of liability coverage.

It’s cheap

On the bright side, renter’s insurance is usually significantly less expensive than a homeowner’s insurance policy. The reason for this is that you don’t need to insure the structure – the property owner’s policy takes care of that. So go ahead and shop around for the coverage you need. If disaster strikes, you’ll be glad you took the time to buy renter’s insurance.

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This is a guest post by Emma Martin who writes for J.G. Wentworth, a settlement funding company and purchaser of future payments to individuals who hold assets in the form of structured settlements and annuities.

With so many homeowners trying to sell their properties before they get foreclosed on, buyers can find a lot of great deals on houses headed for default. Such transactions not only remove the financial burden from the previous owners, they also allow buyers to avoid some of the entanglements of a foreclosed property – e.g., a redemption period or the possibility that the previous owners will gut the home.

In short, a short sale is preferable to a foreclosure – even though you may pay a bit more than you would at auction. Here are a few tips for finding the best deals when you opt to purchase a short sale property.

1. Use a realtor

Although a short sale can seem like a screaming deal, there may be reasons that you don’t want to buy. A real estate agent can uncover this information for you. For example, they can find out if the property is going into foreclosure, or if the short sale is just a maneuver designed to help the owner sell.

You also need to know if there is a second mortgage on the home since, even if the homeowner and the original lender sign off on the sale, you may have to deal with the secondary lender as well. It pays to make sure your agent has experience with short sales to ensure that you don’t get the short end of the stick.

2. Don’t buy “as is”

Many homeowners offering short sales do so with an “as is” caveat. Don’t buy into a situation where damage and pre-existing problems become your sole responsibility, as your “cheap” property could be turn into a money pit.

Banks can often get away with this because they can afford to hold out, but homeowners desperate to sell (and recoup some of their costs) are more liable to give in to your demands if they don’t have other buyers on the hook. At the very least, you shouldn’t purchase a property if the seller won’t let you have it inspected.

3. Be prepared to wait

Buying a home that is close to foreclosure in a market in which home values have dropped significantly is not as easy as you might think. For starters, even if the homeowner accepts your bid, the bank that holds title may not. This could lead to weeks or months of negotiation before you come to common ground.

4. Never give cash

Any seller who asks you for cash or other payment up front is committing fraud. Since a short sale means that you are buying the house for less than what is owed to the bank, the homeowner will come out of the deal with no money. If demands for payment seem fishy, they probably are, so don’t fall prey to this common scheme.

5. Deal with the lender

Once the homeowner agrees to your purchase price and signs off on it, all further dealings will be conducted with the lender. They will also have to approve the terms of your offer and then you will pay them, not the homeowner, for title to the property.

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Have you ever thought about buying mortgage protection insurance? Do you even know what it is? My husband and I first heard about mortgage protection life insurance from our mortgage company. They’ve been sending out little sales pitches along with our mortgage statements.

I’m usually skeptical about programs and accounts advertised by banks, but on the surface having mortgage protection sounded like a good idea, so I decided to look into it and find out what it’s all about.

What is mortgage protection insurance?

As the name implies, mortgage protection insurance protects your mortgage in case of hardship. A typical policy will cover mortgage payments in the event of job loss or disability, and will pay off the mortgage balance in the event of death.

In short, you agree to pay your carrier predetermined regular payments in exchange for the peace of mind of having your mortgage taken care of for your loved ones. Many of the policies I’ve looked at pay the mortgage lender directly.

Types of mortgage protection policies

The first concern I had was the return on the policy. As you continue making payments on the policy, your mortgage balance is (hopefully)decreasing. What benefit is there for you? Based on general trends, I see this as being very profitable for insurance companies and not a great deal for homeowners who pay off their mortgage.

I found out that you can adjust your insurance policy to make it more worth your while.

Level benefit term policy

This sounds pretty much like a term life insurance policy. You can set it for a specific time period (such as 20-30 years) and pay a locked-in premium. This typically doesn’t give you the flexibility of a regular life insurance policy, though, as any benefits are intended to go specifically toward your mortgage.

Return of premium term policy

If you are still alive when your mortgage is paid off, this type of policy will return all premiums that you’ve paid. You won’t get any of the accrued interest, but that’s still a nice chunk of money to have once your biggest debt is paid off. The other downside is that you can be disqualified if you miss any payments.

Who Benefits the Most?

As with everything in the financial realm, you really have to look at the numbers and your circumstances to determine if mortgage protection insurance is right for you. Every family can come up with something different, so I’ll just share some information for you to look at on your own time.

Some borrowers find mortgage protection to be an easier policy to get than your typical life insurance, as a physical exam may not be required.

Rates, though, can be significantly higher than a term life insurance policy. Andy Albright of the National Agents Alliance estimated the average costs of mortgage protection:

The national average for a mortgage balance is $120,000. For such a mortgage, you would pay roughly $50/month for a bare minimum policy. If you want to add riders (such as “return of premium” or living benefits), you could end up paying as much as $150 a month.

That comes out to $600-$1,800 a year out of the policyholder’s pocket. Not surprisingly, only about 2% of American homeowners have mortgage insurance, Albright says.

For term life insurance a a 40-year-old non-smoker with a $500,000 term policy will pay somewhere between $352-$641 a year. That’s a significant savings for much higher coverage.

I honestly think that you should seriously consider getting term life insurance rather than a mortgage protection policy. It’s cheaper, and you can use the money saved to pay down your mortgage faster if you want.

If you’re concerned about disability, you can back up your standard life insurance policy with a long term disability insurance policy, which may be a good idea to have whether or not you have a mortgage.

Thoughts on mortgage protection insurance

I know many people have strong opinions on getting the right types and amount of insurance to protect their family. I’d like to get your take on it to make sure I’m weighing the pros and cons correctly.

How many of you have mortgage protection insurance? How hard or easy was it for you to obtain? What are the premiums like for you? Do you think it’s a good or a bad deal?

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About three weeks ago, we took a closer look at Dave Ramsey’s new mansion just south of Nashville. In case you missed it, his home spans more than 13k square feet (including a nearly 1500 sq ft garage!) and it has a total assessed value of just shy of $5M.

A common theme in the comments on that post was “Wow, I wonder how much it costs to maintain a place like that!” Well, I’m pleased to say that I can now provide a bit of insight into that question…

The good folks who published the original account have done a bit of digging*, and have learned that Dave’s electric bill has averaged $1285/month over the past year. Wow. Nearly $1300 on electricity alone. Then again, on a 13k sq ft house, maybe that’s a bargain?

What do you think? Surprised by how much it costs to power a home of this magnitude? Or did you think it would cost more?

Note: I was surprised to learn that this information is freely available. They simply called the local electrical utility and asked.

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I recently ran across an interesting article that provided details about Ramsey’s new mansion just south of Nashville (pictured below). Based on what they had to say, it seems that Dave has a taste for the finer things in life…

According to tax records, Dave’s house spans more than 13,307 square feet – not including the 1,454 square foot garage – and sits on a parcel of land that Dave bought or $1.5M back in 2008. Though the market value of the land has reportedly dropped to $750k, the total assessed value of his home is $4,909,200.

Curious what it look like on the inside?

From what we hear Dave’s home office, including the sliding library wall ladder, is made of solid mahogany. The shower in the master bathroom is rumored to have 18 shower heads and is larger than the jacuzzi tub. Cathedral ceilings throughout. The local who we spoke with felt the basement was by far the most impressive. Full bar with whiskey barrels built into the walls, media room and several bedrooms make up the broad lower basement level you see from the distance, wrapping around the tip of the mountain.

Oh, and if you’re wondering… There’s no record of a mortgage on the property.

If you’re interested in moving into the area, you can make an offer on Lee Ann Rimes’ house right next door. While the $6,499,900 price tag might seem a bit shocking, that’s a bargain compared to the original listing price of $6,950,000. Beyond that, she’s apparently never lived there, so it should be in great shape.

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This issue has been brought into sharper focus by recent developments in the ongoing foreclosure crisis. In fact, a number of major lenders have frozen their foreclosure proceedings due to concerns over the validity of their claims.

So… What would happen if a bank foreclosed on a home and ultimately sold it to someone else, only to later have a judge overturn their decision? What if you were the new owner, and the original owner came back to claim their home?

These are the questions that Ron Lieber tackled in his recent NY Times column. The short answer is that you’d be in trouble if you didn’t have title insurance. And such troubles aren’t limited to botched foreclosures.

What if the long-lost heirs of the original owner showed up on your doorstep stating that they never agreed to the sale of the property? Or maybe a contractor field a lien against the original owner, and now wants to make a claim against your house. While title insurance will protect your interest, there are a couple of potential gotchas.

• For starters, you need to be sure that your title insurance policy covers both the lender and you. If you take out a mortgage, you’ll be required to carry a policy to protect the lender, but not necessarily yourself.
• Second, title insurance policies typically only cover the purchase price of the home. Thus, if you buy a home on the cheap and spend a bunch of money fixing it up, you could wind up taking a hefty loss.

Ultimately, title insurance is a necessary evil. And guess what? If you refinance, you’ll need to buy a new policy. The good news is that you should be able to get your new policy for a reduced “re-issue” rate. If the title company doesn’t offer it to you at a reduced rate, ask them to do so.

Foreclosure moratorium?

While I was writing this, a story popped up on the local news talking about the possibility of a national moratorium on foreclosures. This talk is coming on the heels of reports of bank officials signing stacks of foreclosure documents without even reading them.

What do you think? Should lawmakers step in and halt foreclosures until we get things sorted out? Or should they just butt out and let the process run its course?

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As time has worn on, however, we’ve cooled on the idea. It’s funny, but now that we’re in a position to actually make that old dream a reality, it just doesn’t seem like a very good idea.

Cost of ownership

For starters, owning a second home can be a huge money pit. After all, you have to furnish it, pay taxes on it, insure it, pay for any repairs or maintenance issues that might crop up, buy a boat to tie to your dock, and so on.

And yes, I know… Many people view their vacation properties as an investment. At the same time, I’d be willing to bet that the vast majority of those with a second home are losing money on it.

The simple truth is that, unless you rent it out, you’re not likely to see much return on your investment. And if you do rent it out, then your desire to own a relaxing vacation property will have transformed you into a landlord.

Unnecessary headaches

Another problem is the amount of work that comes along with owning a second home. There’s grass to be cut, walls to be painted, and so forth. Before you know it, your formerly relaxing weekends will be spent maintaining not one, but two homes.

Freedom to travel

I’m also not crazy about is the idea of being tied down to one primary location for all (or most) of our vacations. While we love going to the beach, we also like variety. Sometimes we head to a lake, sometimes we go to the ocean, and we definitely like checking out new places.

If we had a vacation home, we’d feel obligated to make use of it, which brings us to my final point…

Guilt and regret

Finally, I’m not crazy about the feelings of guilt that would inevitably come from not using it enough. This is partly related to freedom to travel point, but it goes beyond that. If, for example, we decided to have a lazy weekend at home, I suspect we’d wind up feeling like we should be using our vacation home instead.

At the same time, if we were intent on renting it out to help offset the cost of ownership, we’d probably wind up feeling guilty if we used it during the high season. After all, that’s exactly when someone is most likely to want to rent it. We thus might wind up using it primarily during the least attractive times, and regretting that we couldn’t spend the days/weeks there.

The final analysis

Ultimately, we’ve moved from the “wish we had one” to the “no thanks” category when it comes to owning a vacation home. This isn’t to say that we won’t change our minds sometime down the road but, as things currently stand, we’re perfectly happy renting our fun.

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But what then? Once you’ve defaulted, you won’t be able to get a new mortgage for a long, long time. Well… According to a recent Bloomberg article, some homeowners are starting to “buy and bail.” In other words, they’ll acquire a new house before they walk away from the old one.

While “buy and bail” constitutes fraud if the borrower lies on their loan application, this strategy is most often employed by those with a big paycheck and relatively little debt, as they’re more likely to legitimately qualify for financing on a second home. Lenders are then left holding the bag.

What do you think?

Are there any circumstances under which you’d consider a strategic default?

Source: Bloomberg via Consumerist

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More specifically, they’re looking to extend the deadline for closing on your new home if you went under contract before the April 30th deadline. If, on the other hand, you’re currently shopping for a new home, this measure won’t help.

Apparently the fate of 200,000 prospective homebuyers hangs in the balance, as they got under contract in time but are struggling to close by the June 30th (today!) deadline. The Senate, who tried to pass something last week as part of a failed job creation bill, has since been pushing their own legislation.

Source: CNN/Money

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Some fraction of these people will (like us) be looking to pay down their mortgage loan with their tax refund. Instead of simply paying extra principal toward their mortgage, however, there’s another option to consider… They could recast, or re-amortize, their mortgage loan.

Each approach has pros and cons, and different people will arrive at different decisions depending on their goals and circumstances.

Shortening your mortgage term

I mentioned before that you can shorten your mortgage length paying extra principle on it every month. We’ve also covered some strategies for paying off your mortgage early. Making the extra payments can cut years off your mortgage and save you tens of thousand of dollars in interest, depending on your loan terms.

For example, with most 30 year fixed rate mortgages, you pay a huge amount of interest for the first seven years or so of your mortgage. As you get closer to the end of the life of the mortgage, more of your payments go towards principal.

The primary advantage with paying off your mortgage early (aside from peace of mind) is the big improvement in cash flow. Once your mortgage payment is gone, you’ll have hundreds (maybe a thousand or two) in extra cash each month that could be used for your other financial goals.

What is mortgage re-amortization/recasting?

Mortgage re-amortization is basically a loan modification that changes your monthly payments. Amortization refers to the paying off of a debt in installments over a set period of time. Instead of simply paying extra money towards principal, you may be able to use that money to reduce you balance due and re-calculate your monthly payments.

The advantage of re-amortization is thus that you can get lower monthly payments and have a slight, ongoing improvement in your household’s cash flow. It won’t be as big of a change as if you paid off the mortgage early, but you’ll get an immediate benefit.

You could then use the difference in the monthly payments to build your savings, pay down other debt, or build a retirement nest egg. Not all lenders offer this option, however, so check with your lender to see if you can recast your loan.

You should also check on what sort of fees are involved with, and what restrictions might be in place. Some lenders will allow you to do this multiple times, while others offer this as a one time deal.

Recasting vs. shortening your mortgage

You really have to know your plan for your mortgage and run the numbers to figure out the best option for you. If you plan on consistently over-paying your mortgage, then recasting won’t provide much of a benefit. If, however, you plan on just making a big payment once, and would rather reduce your monthly mortgage expenses instead of shortening the overall timeframe, then re-amortization may be something to consider.

Shortening your mortgage can have bigger costs up front as you’re putting more money in now, but your pay off will be on the huge decrease in your monthly expenses when it’s finished. You will also have saved tens of thousands of dollars in interest payments. Only you and your family have all the information needed to run the numbers properly and decide which option will put you ahead.

Sticking with paying off the mortgage early

When I looked at the numbers, recasting our mortgage wouldn’t make much of an impact on our cash flow. It would reduce our monthly housing expenses by only $50 or so. We think it would be better to just focus on going ahead and paying off our mortgage early. By focusing on getting a conservative mortgage amount, we’ve already created a little bit of a buffer between income and expenses.

Your thoughts

I’d love to hear your thoughts on this. If you had (say) $10,000 to pay down your mortgage, what would you do? Would you recast and go for lower monthly payments or would you shorten your mortgage? Why?

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Want to start a fight on a personal finance world? Just ask someone if it makes more sense to buy or rent a home. All of a sudden, you will have a debate like no other.

But should there really be a cut and dry answer to this question? Look at how many possible variables can go into this decision:

• Current state of overall housing market
• Current state of local housing market
• Cost of renting in your area
• Amount saved for a down payment
• Size of emergency fund
• Credit score
• The chances you will be fired from your job
• The chances you will have to relocate for your job
• The chances you want to change careers
• Your desire to move somewhere else
• Are you able to go from a two to one income household?
• Future earning ability
• Current interest rates
• Tax incentives
• Individual tax bracket
• Chances family outgrows house
• Handyman skills
• New appliances you will have to buy
• Quality of school districts
• Local property taxes
• Status of current debt (student loans, car payments)
• Risk tolerance
• Ability to save money
• Have you started saving for your kids college?
• A lot more, but you get the idea

My point is simply this: there is no right or wrong answer. There is no “rule of thumb” when it comes to buying vs. renting.

Why I bought a house at 24

The #1 reason that I chose to buy a house so young was because I wanted to own a house.

I didn’t buy a house because of the $8,000 tax credit or for the mortgage tax deduction. Nor did I buy a house because I was tired of paying rent.

The decision came down to my personal preference of owning rather then renting my home.

Do it the right way

By no means did I rush out and buy a house in a rush the day I decided that I wanted to become a homeowner.

I was patient. I researched local markets extensively. I worked on improving my credit score. I saved enough to avoid paying PMI for longer than two years.

My then fiancee and I (eventually) found a house that we both loved and could afford. We moved in right after our wedding.

To buy or to rent?

If you are contemplating buying a home, great. However, if you’re making this decision because you think it will increase your net worth now or in the future, not so great. There are far better places to invest than in real estate.

The decision to buy a home isn’t going to improve your financial life. However, it does have the potential to improve the overall quality of your life.

It has mine.

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At the same time, we’ve been assured that the economic recovery is underway. Then again, we’re still facing a significant number of mortgage resets over the next year or two. So what does the future of the housing market hold?

Given all of this uncertainty, I thought it would be interesting to run another poll, this time focusing on when the housing market will recover.

Yes, I do realize that real estate is highly localized, and that it’s difficult to give an answer for the market as a whole. Just do your best.

And, as always, please feel free to chime in with a comment to give some context to your answer.

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Shortly before its expiration, Congress acted to push the expiration date back to April 30, 2010. At the same time, they expanded the credit to include $6500 for existing homeowners who buy a new residence if they’ve lived in their current home for five of the past eight years.

Will the homebuyer credit be extended?

With the new expiration date looming, I’ve received several inquiries about whether or not the homebuyer tax credit will be once again extended. The short answers is that no, I haven’t heard anything about Congress acting to once again extend the homebuyer tax credit. Thus, if you’re not under contract by this coming Friday, you’re likely out of luck.

An exception for the military

The exception to this bit of bad news is that members of the military, foreign service, and intelligence communities may have an additional year to claim the credit. This extension applies to qualified service members who who served on official extended duty outside of the United States for at least 90 days between January 1, 2009 and April 30, 2010.

If you are interested, you can view current mortgage rates being offered by mortgage lenders.

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While looking at the breakdown of our most recent payment, I noticed that about 20% went towards our escrow account. Having never had a mortgage before, I was curious to find our more about escrow accounts and decided to check out the Housing and Urban Development website to get more information.

Our lender had us pre-pay the first year’s premiums for our homeowner’s insurance policy. Going forward, our payment also includes an allocation for our future insurance premiums as well as our property taxes. This money is deposited into an escrow account.

What is an escrow account?

When you purchase a home with a mortgage, lenders typically add certain stipulations to protect their investment. One of the main things that they’ll do is require you to pay into an account that is used to cover the insurance premium and property taxes. That way they can be 100% sure these things get taken care of.

The amount that a lender can require a homeowner to put into the escrow accounts is limited by the Real Estate Settlement Procedures Act (RESPA). More specifically, they can only maintain a cushion of 1/6 of your annual escrow payment. After making annual payments out of the escrow account, any surplus over $50 has to be returned to you within 30 days.

Estimating escrow payments

If you’re a numbers type person, you can get an idea of what your escrow payments should be by following HUD’s formula:

1. List all your annual obligations that will be paid out of your escrow account
2. Don’t forget to include flood insurance (if applicable), which may only be due every 3 years
3. Divide the sum total by 12 to arrive at your monthly obligation
4. Add in two month’s of escrow payments to allow for the RESPA cushion limit

This should give you a good feel for your maximum required escrow total. If you feel that your lender is taking too much for escrow payments, contact them to receive an explanation on the difference.

Advantage of escrow accounts

Aside from providing your lender with a measure of protection, escrow accounts can be a very convenient way of taking care of, and budgeting for, your tax and insurance obligations. Having a large property tax bill show up unannounced can ruin your budget, and having an escrow account relieves you of this possibility.

It’s also worth noting that, even if there is an error with a payment from your escrow account, you have some protection. If your county sends a letter to you because your property tax was paid late, for example, you should forward a copy of that to your lender because they’re responsible for the penalty.

Downside of escrow accounts

While having your property tax and home insurance premiums handled automatically can be convenient, there can be a downside. For the financially savvy, escrow accounts can have a big opportunity cost, as could be stashing away that money yourself in a high interest savings account. In theory, you could tuck away 1/12th of your insurance and tax bills every month and then pay them yourself.

After all, most of use handle our life insurance and car insurance premiums on our own. Why should homeowner’s insurance be any different? In this day and age of online bill pay, escrow accounts can seem redundant from the consumer’s perspective. Not only are you losing money in the form of unearned interest, but you’re also ceding control.

Closing thoughts

In the final analysis, I think that an escrow account is a handy tool — and if you have a mortgage, you probably don’t have a choice in the matter. What do you think? Either way, we can’t wait to pay off our mortgage, and we’re focusing on that goal.

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Only student loan and mortgage debt left

Remember the Jeep that I totaled and had in the shop for 8 months last year? Well, I didn’t technically own it until three days ago. Last August, I consolidated the amounts owed on my Jeep and the debt still owed on the credit cards that I shredded with a Lending Club loan of $11,000. It took less than seven months to settle those debts once we got focused.

Now the only affiliation I have with Lending Club is that of an investor extraordinaire, and I’m setting my sights on the next debt in line – I’m just not sure exactly which one to pick. Here’s a list of our remaining debts we have left:

• First mortgage = $118,950 at 5.5% fixed with 20 years remaining (recently refinanced)
• Second mortgage = $39,700 at 8.8% fixed with 27 years remaining
• My student loan = $31,850 at 6% fixed
• Her student loan = $34,200 at 4% fixed

Unless something unexpected happens, we should have at least $1,500 in extra cash to put toward our debts each month. This is above and beyond our regularly scheduled payments, so we should really be able to accelerate our debt reduction.

I was planning to shift our debt snowball to our secpnd mortgage until it dawned on me… What if the housing market rebounds?

Repay student loan first?

Should I repay my student loan before my second mortgage? Here are some of the factors that are influencing my thinking:

• The housing market might rebound. We plan to sell our home as soon as we can get what we owe on it. If we focus on the student loan and the market rebounds, then I can repay my mortgages with the proceeds from the house sale, and my student loan will have been greatly reduced.
• The mortgage interest deduction. If I repay my student loan first, I’ll still have a much larger interest deduction to claim come tax time 2010 and 2011.
• Student loan debt is not dischargeable. Not that I would ever file bankruptcy, but the simple fact that student loan debt is not dischargeable in bankruptcy makes me question if it would be wise to make this a priority over a second mortgage.
• The psychological factor. I’m the type of person who would rather focus on paying off a higher interest loan to realize the savings (i.e., our second mortgage), rather than paying off a smaller loan for a psychological boost.

Repay second mortgage first?

I’m already leaning toward paying off our second mortgage first, chiefly because the rate is 2.8% higher than my student loan rate, and 4.8% higher than my wife’s. So… If you think it’s better to pay off my student loan off first, you’ll need to convince me.

• Higher interest rate. As I mentioned above, our second mortgage interest rate is considerably higher than the rate on my student loan, so I stand to save more on interest paid by attacking this debt first.
• The housing market probably won’t rebound quickly. I’m not a real estate agent or an economist, but I believe that both would agree that the housing market will not rebound to 2007 values anytime soon.
• We want to sell ASAP. To be honest, I would like to sell my home tomorrow… And I certainly do not want to wait 5 – 10 years or possibly longer for the market to get our heads above water. By paying down this debt, we’ll be able to sell sooner.

Value of my home vs. amount owed

Lastly, I wanted to throw out some more numbers to help you understand the decision we’re facing. It’s important to keep in mind that I live in Michigan, and that our housing market is worse than most. My home was originally appraised at $170,000 in April of 2007, and our purchase price was $165,000. When we refinanced our first mortgage last week, the lender estimated the current value of the home at $120,000 though I’ve seen online estimates as low as $107,000.

Which should we pay off first?

If you were in my shoes, would you focus your debt sledgehammer on the second mortgage, thereby enabling us to sell our home and downsize ASAP? Or are we better off knocking attacking our student loan debt? Whichever you think is better, I’m very interested in hearing your reasoning.

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Oh well, our plan moving forward is to pay off our mortgage early and stay put until prices trend upward.

As an aside, if you want more information on buying a home vs. renting you can check out Laura’s view of the buy vs. rent dilemma, as well as my opinion on the same thing.

Mistake #1 – Zero down mortgage

So many new homeowners made the mistake of entering into a zero down mortgage. If you cannot afford a down payment of at least 20%, lenders typically require either a 2nd mortgage or carrying private mortgage insurance (PMI).

One positive result of the housing crisis has been a huge scaling back of the zero and low down payment mortgages, which has been a large contributing factor of plummeting home sales. Nowadays people who don’t have any money cannot buy houses. Go figure, right?

2nd mortgages and Private Mortgage Insurance (PMI):

Private mortgage insurance (PMI) is insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan. It is insurance to offset losses in the case where a mortgagor is unable to repay the loan and the lender is not able to recover its costs after foreclosure and sale of the mortgaged property. Typical rates are $55/mo. per $100,000 financed, or as high as $1,500/yr. for a typical $200,000 loan. (source)

A second mortgage (commonly used as an alternative to PMI) is a secured loan that is subordinate to another loan (your 1st mortgage) against the same property. The 2nd mortgage typically carries a significantly higher interest rate and is typically used as part or all of the 20% down payment. The higher rate is a reflection of increased risk to the lender, and results in much higher interest costs to the borrower over time.

We fell into this trap like so many others. We wanted to get into our new home now, and were ready to employ any creative financing necessary to make it happen… And so we entered into a 2nd mortgage for 25% of the purchase price (75/25 loan.)

To avoid a costly 2nd mortgages or PMI, save at least 20% of the purchase price of the home.

Mistake #2 – Buying high and selling low

Whether you’re trying to time the stock market or time real estate transactions, buying low and selling high should always be the goal. In a bad market the temptation to do the opposite can be powerful.

Take my housing situation, for example. I hate the fact that we have debt at all, and am very tempted to sell, despite the fact that we would have to take a loss! I’m tempted to sell our house for a loss and then rent for much less than our current mortgage payments and pay off our remaining debt while renting.

Though getting out from under the mortgages is tempting, I decided against it for mathematical reasons. If we were to sell now, we would not only lose money on the transaction, but we’d have to pay cash to our lender. If I could wind up even money, I would sell tomorrow. Instead, we are doing the next best thing… Making our 2nd mortgage the next victim of our debt snowball.

The faster we can reduce our amount owed, the sooner we can sell without any out-of-pocket costs. Our hope is that the housing market will bounce back in the mean time, affording us the option to sell for gain.

To avoid selling your home for less than you owe, increase mortgage principal payments and wait for the market to rebound.

It is worth mentioning that we cannot control market conditions, so we should spend our energy focusing on the factors that we can control:

1. Once you have high interest consumer debts under control, focus your debt snowball on reducing your mortgage – and look into refinancing your mortgage to see if rates are attractive as you may be able lock in a lower rate. If you have a 2nd mortgage, pay it off ASAP. Those of you with PMI should also focus on reducing your mortgage principal to speed your ability to drop the PMI once your principal is reduced below 80% of the home value.
2. Make property upgrades that raise the value more than the amount they cost to implement. DIY projects can cost very little, yet yield superb ROI.

In closing…

Most who fall victim to either of these housing and mortgage blunders end up paying dearly. I hope this article will help future homebuyers avoid the same mistakes. For our next home purchase, my wife and I intend to save 100% of our payment before buying… But that is a post for another day!

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Mortgage payments

For example, our first mortgage payment is due in March. Along with our mortgage payment, we’re also putting money into an escrow account to cover our property tax bill and home insurance premiums. While we budgeted for it and anticipated paying these costs, it still feels odd to have our housing bills mapped out for the next 30 years.

The mortgage payment itself (considering principle and interest) is much lower than the rent we were paying for our two bedroom apartments. The discrepancy between the cost to own and rent in our city is one of the big reasons we considered buying a house. If it was much cheaper to rent, we would’ve continue renting, either saving for a huge down payment (making the mortgage much smaller) or investing the difference for other goals.

Our goal is to pay an extra $150/month starting with our first payment for 2010 payments to help pay off our mortgage early and greatly reduce the amount of interest we pay over the life of the loan. If and when we can afford more, we’ll add to this amount accordingly, but we want to make sure we build up our emergency fund first.

Homeowners’ association fees

This is a new bill that I’m not too crazy about, but membership is mandatory with in our development. Our HOA fees covers water and sewage, pool and clubhouse access, lawn maintenance, and condo area upkeep. When we were looking at some older homes in the area, we found that the HOA dues were often higher and sometimes came with fewer amenities.

After reading some horror stories on HOAs, we asked some friends who live in a development by the same builder and with the same company running the HOA for their opinion. It turns out that they’ve been happy with their experience thus far, and the fees have remained consistent so far.

Property taxes

As I noted above, we’re paying into an escrow account every month to cover our property taxes (as well as our homeowner’s insurance). Property taxes are an unavoidable expense of being a home owner.

My best advice is to look at your city or county’s tax records online to get an idea of what you might expect to pay in taxes before you buy. While we were shopping around, I looked at different neighborhoods and researched the property taxes. As a result of this additional information, we actually ended up reducing the amount we were willing to spend on a new home just so we could stay within our budget.

Once you’ve bought your home, don’t let your guard down. Keep an eye on your property tax assessment, and don’t be afraid to appeal your home’s assessed value.

Your take

I’m curious to hear how you guys made the transition when you went from being renters to owners. What was the biggest financial adjustment you had to make as a home owner? If renting is a better option for you, I’d like to hear about that, too.

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Here’s the rundown:

1. New York, NY
2. Los Angeles, CA
3. White Plains, NY
4. San Francisco, CA
5. Honolulu, HI
6. Miami, FL
7. Chicago, IL
8. Boston, MA
9. Houston, TX
10. Washington, DC

While American cities haven’t traditionally ranked amongst the most expensive worldwide, New York moved from #22 in the world in 2008 to #8 in the world in 2009. If you’re interested in looking more broadly, you can find the complete, worldwide dataset from which the above list was generated by visiting this link.

Not surprisingly, the main reason that New York sits atop the US leaderboard is the high cost of housing. In fact, housing costs (as measured in terms of 2 bedroom luxury apartment rents) in New York are nearly double those of #2 Los Angeles. Of course, many Los Angeles residents also have to deal with long, costly commutes.

A couple of other interesting tidbits:

The city on this list with the most expensive cup of coffee (on average) was San Francisco at $4.50.

As for fast food hamburger meals, the highest cost was in White Plains, NY at an average of $6.29.

Where does your hometown rank?

I’m just thankful that we live in a place where I can earn a good income without facing an astronomical cost-of-living. According to an online cost-of-living calculator that I just dug up, New York is nearly twice as expensive as our hometown. Once again, housing makes up a disproportionate amount of that difference.

What about you? How does your hometown stack up?

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While hunting for a place, we found that getting a good deal on an apartment isn’t easy, though the process itself is straightforward. What follows is an overview of what we learned.

Formulate a search image

Since we were on a time crunch, we had to quickly come up with a list of what we needed in an apartment. We prioritized what we were looking for and used that to filter our options.

• Cost: We had a price range in mind when we started looking. The maximum we wanted to pay was our current apartment’s rent before the month-to-month pricing kicked in.
• Location: Commute time was another major factor for us. As you might imagine, some of the cheapest places were inconveniently located, but there were still some deals on apartments with good highway access.
• Neighborhood: We were looking for a relatively quiet neighborhood. We checked places during different times of the day to get an idea of how noisy it might be. Did you know that some police departments have a crime analyst that you can call for information on crime rates in a certain area? If you’re moving from another state, this can be a great way to weed out places before you even visit.
• Size: While don’t want to live in too small of a place, we decided that we could down size a bit if needed.

Cast a wide net to find an apartment

While most people don’t have the time to look at every apartment in the city, viewing a good sample can help you find a good deal. We used several sources when we were hunting for apartments.

Classifieds ads

I checked our local newspaper’s classifieds online and also used Craigslist to find a bunch of apartments within our price range. I found Craigslist to be a good way to find better-than-advertised specials.

Roadside signs

As we were taking care of errands or or otherwise running around town, we took note of any deals that were being advertised outside of apartment complexes. A few of them looked reasonable, so we wrote the info down for later. I was actually surprised how at how many offers were out there.

Friends

We also asked our friends for recommendation. If they liked a place and it was in our price range, we put it near the top of the list. I’m very grateful that our friends were open about their likes and dislikes. This insight really helped us narrow in on some great places. In fact, a friend’s brother lives in the apartment complex where we ended up signing a lease.

Negotiate your deal

Don’t fall in love with an apartment

You can have favorites, but don’t fall head over heels in love with any certain place until you iron out the details. If you do, you’ll wind up in a weaker position when it comes to negotiating. We took notes about the places we visited, including their monthly rent, move-in specials, size, and overall impressions.

It never hurts to ask

We considered a lot of places, but we had to make a decision quickly. All of our top picks were within our price range, but with so many apartments available, we thought it wouldn’t hurt to ask for a better deal.

I called our first choice and left a message for the manager. He called back and asked if we had picked them. I was honest and told him that we were considering them, but that the price wasn’t in line with our expectations. We wanted to apply to an apartment that day, so we just needed to see if they were willing to offer a better deal.

The manager told us that he could meet our price, and that we’d still get the move-in special. I was so relieved that we went ahead and applied to the complex that day and were approved. I think what helped us was that we weren’t rude when asking for a discount, and we also asked for an amount that would be reasonable for the area.

Your take

The money that we’ll be saving on rent will go back into our joint savings account until we find a new house and need to come up with another down payment.

I’m happy because we not only managed to find an apartment that would work for us while we house hunt, but we also lowered our monthly expenses. Do you have any tips for getting a great deal on an apartment?

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Q: When must I pay back the credit for the home I purchased in 2009?

A: Generally, there is no requirement to pay back the credit for a principal residence purchased in 2009. The obligation to repay the credit on a home purchased in 2009 arises only if the home ceases to be your principal residence within 36 months from the date of purchase. The full amount of the credit received becomes due on the return for the year the home ceased being your principal residence. (source)

Note that there are no exceptions for military personnel who are deployed and sell their home. If they move out during deployment but retain ownership, the deployment “may be” considered a temporary absence such that the home can technically remain their primary residence.

If you find yourself subject to the recapture provision, you are required to repay the credit in full as “additional tax” when you file your Federal income tax return for that year. See IRS Form 5405 for additional details.

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Even if you’re looking at new construction, however, you should hire an inspector to make sure everything was done correctly during the construction process. Don’t rely on the codes inspectors, as they’re often in a hurry and might miss something important. Paying for a home inspection is a small price to pay for peace of mind.

Finding a home inspector you can trust

I’m a big fan of calling around for recommendations as it’s hard to gauge a home inspector from an ad in the phone book or online. You can start by asking your realtor for recommendations and/or comments on home inspectors. Also check with any friends that have bought a house and find out how they liked their inspector.

I’m primarily interested in how thorough the inspector is and whether or not they’ll take the time to explain the results to me. If your friends are open, you might also consider asking them about the price. While you’re not necessarily looking at the lowest price, you don’t want to overpay for your home inspection and break your budget.

Home inspection prices vary according to region and building size. I’ve found that estimated costs in my area are typically $300-$450.

Ask questions

After you have a list of names, go ahead and call the inspectors. While making small talk, ask questions concerning the inspection and their qualifications. Any qualified professional will expect these types of questions and won’t be offended.

If you’re looking for solid questions to ask the potential home inspector, the Department of Housing and Urban Development has a nice resource. I found the questions helpful when calling.

• What does your inspection cover and how much does it cost?
• Are you specifically experienced in residential inspection?
• Do you maintain membership in a professional home inspector association?

Some states, such as North Carolina, have a license for home inspectors, but others don’t. If your state doesn’t have a license requirement, ask the home inspector if they’re a member of the American Society of Home Inspectors. Verify by check with the association yourself. It pays to be diligent.

Be there during the inspection

It’s always a good idea to be present during the inspection. That way the inspector can not only review the results, but they can also point out any particularly problematic areas. Just don’t get in the inspector’s way.

What does a typical home inspection include?

The standard home inspector’s report will cover the condition of the home’s heating system; central air conditioning system (temperature permitting); interior plumbing and electrical systems; the roof, attic and visible insulation; walls, ceilings, floors, windows and doors; the foundation, basement and structural components.

Source: American Society of Home Inspectors

Make the most of your time by taking notes and paying attention during the inspection. When you receive your report from the inspector, review anything that you don’t understand. You may not have the technical expertise, so take advantage of the fact that you’re paying them to help you.

Have you been through a home inspection?

If you’ve had a home inspected, how did it go? Was the inspector helpful? Did the inspector help you avoid a costly repair? Do you have any tips to share?

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Applying for a mortgage involves a thorough check into your finances to see if you really qualify for a mortgage loan. This process takes time, and waiting to the last minute could cost you the tax credit.

Before you apply for a loan, you should be familiar with some numbers that the lender will be examining closely. The better you look to them, the better your chances of getting a solid deal on your mortgage.

Credit score

One of the first things that a lender will look at is your credit score. Not only does your credit score influence whether or not you’ll get approved, but it can also influence your mortgage rate. Be sure to check your credit report well in advance of any loan application, and fix any errors that you see.

Buyer’s income

Lender have to verify your income, so be prepared to provide W-2s, pay stubs, tax returns, and bank statements. If you’ve recently landed a new job, you might also be asked for a letter from your employer verifying your new salary. In our case, we were asked for two years of tax returns and recent financial statements.

Lenders are also looking to see if the savings you have is a gift or if you have saved up for it. Receiving a gift from a relative isn’t necessarily a bad thing, but you’ll need a mortgage gift letter to prove that it’s not a loan that has to be repaid. Prospective lenders just want to know the full extent of your obligations.

Debt-to-income ratio

Your debt-to-income ratio is a number that lenders use to evaluate the amount of debt that you’re carrying. It’s calculated by taking your debt monthly debt obligations and dividing that total by your monthly income.

Lenders are looking for lower numbers, as you’ll be more likely to be in a position to pay your mortgage. Lenders used to want your total debt obligation (including your housing expenses) to be no more than 28% of your income, though this number drifted up as high as 36% or even 40% during the housing boom.

Improving your debt-to-income ratio

There are two basic ways to improve your debt-to-income ratio:

Decrease your debt: Before you apply for a mortgage, reduce your long-term debt such as your car loan or student loan debts. You should also pay down your credit cards and negotiate lower interest rates, starting with any that are behind. If you are having a hard time now with debt, adding a mortgage will be a disaster. Reduce your monthly expenses and put that money towards reducing your debt.

Increase your income: Building additional income streams can help you immensely in the long run, and not just with getting a mortgage. If you have a review coming up at work, prepare diligently, and include concrete examples of your worth to the company. If they don’t want to give you a raise per se, see if you can negotiate a bonus if you reach a performance goal.

Loan-to-value ratio

This is another number for lenders to asses the risk of loaning you the mortgage loan. The loan-to-value (LTV) ratio is the mortgage loan amount divided by the appraised value of the property (expressed as a percentage). An independent appraiser usually determines the property’s value. If the buyer has a high loan to value ratio, they can expect to pay private mortgage insurance.

Private mortgage insurance (PMI) can add to your monthly payments so having a larger down payment or piggybacking your mortgage loan can lower your payments.

Cash Reserves

I read about this one in a few books covering mortgages, but I personally haven’t noticed this from our lender. Some lenders examine how much cash you have on hand to see if you’ll be able to weather any emergencies that arise. The cash reserves that we have are for the down payment as well as some for our emergency fund.

Closing thoughts

While it’s gotten harder to get a mortgage over the past year or so, that’s a good thing. It means that lenders are checking to make sure that borrowers can handle their mortgages. As much as I hate paperwork and filling out form after form (after form!), I also understand what’s at stake, and why the bank is being careful.

Have you noticed a change in mortgage standards?

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The housing market has been down for two years or more in much of the country, but many home buyers are continuing with the practice of buying a new home before selling the old one. While this was a common practice a few years ago in a stronger market, it makes little sense now.

Selling a house in this market is substantially more difficult than buying a new one.

If you insist on delaying the sale of your current home until you put a contract on a new one, then you’ll face the very real possibility of carrying house payments on two mortgaged properties at the same time. This is a situation that should be avoided at all costs in this market.

The downside of the real estate double deal

Below are some common entanglements you might face by not selling your house before buying a new one.

Qualifying for a new mortgage. A mortgage approval is much harder to obtain when the potential exists for carrying mortgages on two houses. Your lender will be aware of the situation, and may be less flexible in your terms. Either that, or they might not approve your loan at all. Since most buyers purchase at the upper range of affordability, the possibility of carrying two properties may be viewed as an unacceptable risk.

Sale of prior residence clause. If the lender wants you to sell your current home before closing on the new one, they will add this condition to your approval. Real estate agents don’t like it, and sellers like it even less. It makes the closing on your new home contingent on the sale of your old one —- a deal dependent on another deal. If your lender requires the sale of your current home, your offer on a new home may not be accepted.

The Simultaneous Close. This is typically the most desired outcome. You close on the old and new homes on the same day. This is the perfect world outcome, but much more difficult to pull off than most people think. It’s very stressful on all parties, and can be sabotaged by a laundry list of potential issues with EITHER transaction. This is the classic, “it ain’t over until it’s over” trap, that may cause sleepless nights and significant delays in closing.

Wiping out your liquid assets. There are numerous expenses that accompany the purchase of a new home that don’t show up on a closing statement. Costs of the move, new furniture, minor repairs to the new home and the “whoops, we didn’t know we would need to buy (or fix) that!” Now add an extra monthly mortgage payment to the mix, and how long do you think your liquid assets will hold out?

A forced rental situation. Renting out your old house to cancel the payment on it might make sense short term, but having tenants will make it much harder to eventually sell your house. Your tenant might not be open to real estate agents showing the house, and also might not keep it in salable condition.

Foreclosure. Carrying two mortgaged properties simultaneously is a major cause of foreclosure. Even if nothing goes wrong, the double payments might prove to be too much for you to handle.

Common reasons for not selling first

Over my many years in the mortgage industry, I’ve heard the following offered as reasons for buying the new house before selling the old one.

“My house is in (pick one) top condition/a top neighborhood/a top school district, so it’ll sell fast.” Most home sellers aren’t objective when assessing the salability of their homes, and tend to be overly optimistic. Note: seller optimism is not a factor in the marketability of your house.

“I don’t want to make a double move.” A double move is a temporary problem, and one you have some control over. It’s not uncommon to go a year or more carrying two house payments! That’s serious money.

“We might not be able to find another house quickly if we sell ours first.” For all the same reasons it’s difficult to sell a house in today’s market, it’s much easier to buy one.

“What if we sell our house, then can’t get a mortgage for one that we want to buy?’ You can and should obtain a mortgage pre-approval before entering into any home buying situation, so the risk here is remote at best.

The unspoken fear of being homeless. Okay, I’ve never actually heard this one, but I suspect that (perhaps in the dark of the night) people might have a pang of fear that selling their house before buying a new one could leave them out on the street. Given that you’ll have a loan pre-approval before doing anything anyway, this isn’t something to be feared — especially not in this market!

The alternatives

Simply getting a contract offer on your house isn’t always sufficient. Contracts can fall through for more reasons than you can imagine, as can the buyer’s mortgage approval. The cleanest way to enter the purchase of a new home is to fully dispose of the old one first. Below are some suggestions on how to accomplish this.

Before using any of these suggestions, it is strongly recommended that you first consult a qualified real estate attorney in your area as laws and practices vary by jurisdiction.

Sell your house with a delayed closing date. You can accept a contract on your current home and set the closing date 30, 45 or 60 days from receipt of a contingency-free mortgage approval from your buyer. At that point, you’ll have a solid buyer as well as time to find your new home, and you may be able to pull off the coveted simultaneous close.

Add a short-term rental provision to the contract on your current home. Add a clause to the sale of your old home that permits you to stay in the house as a rent-paying tenant for 30-60 days following the close. Use this time to secure your next home. You’ll avoid a double move, have the cash from closing in hand, and can make a clean offer on a new property.

Move into an extended stay hotel and put your furniture in storage. This requires a double move, but also eliminates the uncertainty pf being able to sell the old home. It also makes your a more attractive buyer. Yes, it will cost more, but it’s a solid defensive strategy that guarantees you won’t be stuck with two mortgages.

Sell your house, and take a lease purchase on a new home. This strategy also enables you to sell your old home and enter the market as an unencumbered buyer. You get a chance to “test drive” the new house and neighborhood, and you avoid the double move. There are now more lease purchases available than there have been in recent memory, and one might imagine that any property that’s been listed for sale for more than a few months might be a candidate for such an offer even if it’s not being presented as such by the sellers.

No doubt any of the above will create some problems, but you’ll be accepting smaller, short-term problems rather than risking larger, more costly problems later.

Do you know of anyone who’s been trapped with two homes for more than a couple of months? Are you in this position now?

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As we get closer to closing, we’ll also receive a HUD-1 Settlement Statement, which is a form used in the United States for disclosure of fees that the lender or broker is charging. The purpose of the HUD-1 statement is to help borrowers understand the total costs of buying their home. These documents are a great resource to give you an idea of upcoming expenses and costs.

Always ask questions

I’ve heard from my friends and read from others that they wished they ad asked more questions when buying their home. Unfortunately, they usually come to this realization after they realize that they could’ve gotten a better loan. Instead of relying on what a lender tells you, check out these resources:

• HUD’s Site on Buying a Home and Closing Costs
• Consumer’s Guide to Mortgage Lock-Ins
• Consumer’s Guide to Mortgage Settlement Costs
• Five Tips for Shopping for a Mortgage
• Looking for the Best Mortgage: Shop, Compare, Negotiate

Remember, no broker or lender has to give you the best deal. They are trying to make a profit, and that might involve higher rates and/or fees than you would otherwise have to pay. Be sure to ask questions, and don’t be afraid to comparison shop. It’s your name on that loan, and you’ll be the one responsible for it.

Is your interest rate adjustable or fixed?

It’s in your best interest to understand the term of your loan, your interest rate, whether it is fixed or adjustable, and whether or not you will have any balloon payments in your future — you should generally avoid loans that require balloon payments.

Fixed-rate loans generally have repayment terms of 15, 20, or 30 years.

Adjustable-rate loans, also known as variable-rate loans, usually offer a lower initial interest rate than fixed-rate loans. The interest rate fluctuates over the life of the loan based on market conditions, but the loan agreement generally sets maximum and minimum rates.

Source: Federal Reserve

Run all your numbers before agreeing settling on a lender and loan. Ask them to walk you through and show you how much your monthly payments could be a year from now, five years from now, and so forth. In the case of a fixed-rate loan, the principal and interest payments won’t change over the life of the loan.

How much are your settlement costs?

Besides your down payment, there are a number of costs associated with closing on your new house. Becoming familiar with the typical costs and fees will put you in a better position.

Loan origination fees: Borrowers might be asked to pay this fee in return for the brokers/lenders handling your loan. It typically ranges from 1- 1.5% of the house’s cost, though some lenders offer lower flat rates.

Hazard/homeowners insurance premiums: Lenders expect you to pay your first year’s premiums in advance. Going forward, they will also (most likely) collect a portion of your annual premium along with your monthly mortgage payment and place it in your escrow account.

Title insurance: The title insurance come into play if there’s ever a dispute of who really owns the property. While you have to find a company that meets your lender’s requirements, you can search to find a good deal on your title insurance premiums.

Just make sure the coverage you get is adequate. Some cheaper policies may have exclusions that can hurt you — e.g., they might only protect the lender’s interests.

Pest inspection: Depending on where you live, your new home might need to be inspected prior to closing for termites and other pests that might damage your house.

Credit report: Lenders will pull your credit report to make sure you’re a financially worthy candidate. The cost for doing this is typically passed on to the borrower.

Other settlement costs: You also have to consider processing fee, underwriting fee, document review (I’m not kidding!), tax service fee, commitment fee, wire transfer fees, overnight shipping fees, and a few more. There are a lot of fees involved, so review your Good Faith Estimate carefully to see what you should expect.

Closing thoughts

If you’re thinking of purchasing a new home, keep the settlement costs in mind when formulating an offer. Remember, you’ll have to bring enough cash to the closing table for both your down payment and your settlement costs.

Your settlement statement will also give you a pretty good idea of your complete cost of home ownership. Of course, this doesn’t include incidentals like new furniture and your monthly utility bills, but it gives you a pretty good baseline.

And remember… If you have any questions about fees, ask before you sign anything. Don’t be afraid to negotiate a better deal — if something doesn’t make sense to you, try to get it reduced or removed. Being an informed buyer is the best course of action.

If you’ve bought a home, what surprised you about the settlement costs and/or the closing process? Do you have any tips or tricks? Anything that we should be sure to do/avoid? Please share your thoughts in the comments.

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Is it better to pay money monthly that is applied to your escrow or your principal? I would like to pay the equivalent of one extra mortgage payment a year, but I’m not sure where to apply it.

The short answer is that you want the extra payments to apply to your mortgage principal — that’s the amount that you still owe the lender. In most cases, your lender will automatically apply any overage to your mortgage principal. That’s not always the case, however, so it’s best to check with them to be sure.

The longer answer is that your monthly mortgage payment likely consists of four parts: principal, interest, taxes, and insurance. This is where the acronym PITI comes from. The reason that your lender collects taxes and insurance is that they want to protect their investment (your home) from both disaster and tax complications by making 100% sure that both bills get paid.

What the heck is escrow?

So where does escrow come in? Well… The term escrow refers to a legal arrangement in which a third-party takes possession of money or property until certain obligations have been met. In the real estate world, the “extra” funds that your lender collects are placed in an escrow account until your tax and/or insurance bills come due. At that point, the funds are disbursed to cover your obligations.

More generally, escrow services are often used to reduce risk in business deals when the two parties don’t fully trust each other. For example, if a particularly valuable asset is being sold, the buyer will often transfer their money to an escrow agent instead of paying the seller directly. The escrow agent will then hold the funds until the asset has been transferred, at which point the seller will get paid.

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Why do you need homeowner’s insurance for a condo?

Homeowner’s insurance provides protection in the event of a loss such as a fire or burglary. You are most likely required to have it if you’re carrying a mortgage, as your lender will want the property protected.

Even if your lender recommends a company, you’re free to shop around as long as you meet their minimum requirements for insurance coverage. In addition to property protection, you’ll also get some level of liability protection that covers claims from people injured while on your property.

Your cost will vary based on the amount of coverage you sign up for and the amount of your deductible. We decided to look at a $500 deductible for now, which means we’re responsible for the first $500 of any claim.

What special about homeowner’s insurance for a condo?

I found out quickly that condo insurance is cheaper than home insurance. This is because your homeowner’s association will pay for the common areas in case of damage. Any additional coverage depends on the home association rules. To be honest, I found it difficult to quickly scan and find the answer in our HOA manual, so I called them instead.

While some associations do pay for the exterior of the structure, ours only pays for the common areas. MSN ran a story about condominium insurance and an insurance agent explaining how structural coverage can vary depending on your HOA’s “master” policy:

• Bare walls in. These policies cover all real property from the exterior framing inward but do not cover fixtures or installations within a condo unit. Features such as counter tops, bathroom and kitchen fixtures, and flooring are not covered. If your condo association has this kind of master policy, you’ll probably have a greater need for individual coverage…
• All in. These policies cover fixtures, installations or additions within the interior surfaces of the perimeter walls, floors and ceilings of individual units. Condo owners under an all-in plan will probably have a more limited need for individual coverage…

Check with your HOA to get an idea of what type of coverage you need.

Contact Information for Insurance Companies

Insure.com offers an online home insurance quote form on its site. While it asks you some questions on discounts and coverage, you might want to call some companies directly to speak with an agent.

When calling or e-mailing for a quote, be prepared to ask for discounts. Some things that may lower your premiums include:

• Smoke detectors
• Alarm system
• Distance to the nearest fire station (closer = better)
• Distance to nearest fire hydrant
• Fire extinguishers (believe it or not, we got one as a gift!)

Also check to see if you can qualify for an alumni discount. Finally, if you have other policies with the same carrier (such as car insurance), check on the availability of a multi-policy discount.

Your take

Who do you have insurance with? Are you happy with your coverage, rates, and/or service? What discounts have you received on your home insurance? Do you have any other tips?

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Since this is our first time buying a home, we wanted to be as thorough as possible. After all, this is a huge commitment. I wanted to share some of our thought processes for why we chose this particular place.

Deciding on our price range

We wanted to be conservative with the mortgage, so even though we were approved for more, we only looked at properties costing no more than 2.5x our annual income. Since there are guarantees in life, we wanted to be sure our mortgage bill won’t turn into a huge financial burden.

The total amount of the mortgage for the townhouse we chose is approximately twice our annual income. We decided to go with the lower number because we wanted a mortgage that we could afford, leaving some wiggle room for other bills.

Besides the mortgage, we knew we had to look at the other expenses related to owning a place. We started with a spreadsheet template, modified it a bit, and then used it to compare our options.

Home buying costs beyond the mortgage

Property Tax: To get an idea of what our property taxes would look like, I decided to look up the public tax records of homes that were comparable to what we were considering. Our city has the data on their website, so it only took 10-15 minutes to look everything up.

Private Mortgage Insurance: Since our down payment is going to be 10%, we’re going to have to pay PMI. This allows us to purchase the place without 20% down by protecting our lender in the event of a default. When we receive our $8,000 first time homeowner’s buyers tax credit, it’ll go towards our mortgage principal.

Homeowner Association Fees: While hunting for possible homes, we kept tabs on how much the homeowner association fees were and what they covered. We noted that most association fees covered trash and sewage. Some, but not all, also included landscaping. One townhome condominium complex didn’t include landscaping, and the agent commented that they hoped people would pay an additional fee for the maintenance crew to do the yard work.

One advantage we had was the fact that our friends lived in a development by the same builder and had the same homeowner association company managing it. Thus, we knew what we were getting into. I also checked out some of the HOA bylaws and asked them questions about how they operated. I’ve heard some horror stories about HOAs, and I want to avoid that sort of mess.

Our Place

After looking at the spreadsheet, we narrowed our options and decided on one specific home. We had a back up in mind, but fortunately the numbers fell in line for the place we wanted. After factoring in the extra costs of home ownshership, this new place should be well within our budget.

Your Thoughts

We still have a ways to go before we buy and move into our home. We’re hoping that it goes smoothly, but we’ll try to roll with any punches. I’d love to hear your thoughts and stories with the home buying process. Do you have any tips to share? Do you have any regrets? What should we look out for?

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I don’t have any firsthand knowledge of ING Direct mortgages, but I was curious enough to go take a look. For starters, it doesn’t look like ING Direct offers traditional, fixed-rate mortgages. Instead, they offer a so-called “Easy Orange” mortgage as well as standard 5/1 and 7/1 adjustable rate mortgages (ARMs).

Inside the “Easy Orange” mortgage

The “Easy Orange” mortgage is a five year, fixed rate loan with monthly payments based on a 30 year payback period. Instead of making monthly payments, however, you make biweekly payments corresponding to half the monthly amount. This accelerates the repayment schedule, and helps you pay off your mortgage early.

At the end of five years, you can re-lock at the then-current rate for another five years. The downside here is that re-locking appears to cost the equivalent of two biweekly payments. The upfront lender costs are all wrapped up into $395 processing fee when you sign your original loan documents.

Inside the “Orange Mortgage”

The “Orange Mortgage” is an ARM that comes in two flavors — 5/1 or 7/1. In other words, the rates are initially fixed for five or seven years, after which time they adjust annually. As above, these loans are amortized over 30 years, and the total lender costs are wrapped up into a $395 processing fee.

Thoughts on ING Direct mortgages

Personally, I’m not crazy about ARMs. Instead, we’ve always used 15 or 30 year fixed-rate mortgages. While I’m aware of the arguments in favor of ARMs, I don’t like the uncertainty associated with them. This is especially true when rates are as low as they have been in recent years.

Speaking of rates, the Easy Orange loan had a 4.25% rate and the 5/1 and 7/1 ARMs were at 4.5% and 4.75%, respectively*. I just checked around, and these rates appear to be fairly competitive. Note, however, that these rates require a 75% loan-to-value (LTV) ratio or less. Thus, you’ll need to come up with a 25% down payment (or have at least 25% equity in the case of a refinance).

As I said above, I don’t have any firsthand experience with mortgages from ING Direct. This is where you come in… If you’ve ever borrowed from ING Direct, please weigh in. Likewise, if you’ve considered using them in the past, but decided against it, I’d like to hear why.

*Note: Rates as of 8/10/09.

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There’s always someone trying to find a silver lining when the skies are gloomy and gray. So it is with home foreclosures. Amidst all of the hand-wringing and sad tales of people who have lost their homes, there are those who see half-full glasses sitting on the counters of empty houses.

Some say that it’s time to buy these foreclosures. After all, properties that have been foreclosed upon are often sold by banks for a fraction of their full value. With the real estate market somewhere near its probable bottom, this is a good time to stock up on investment properties at a cut rate.

It’s enough to get a would-be real estate tycoon excited. And it does. Encouraged by those who advocating foreclosure purchases (and who are often selling guides or putting on seminars to teach you how), many novice players in the real estate field are gambling on bank-owned homes.

Is buying a foreclosure a good idea?

In some cases, it probably is a good idea to buy foreclosed properties. There are amazing bargains during a market downturn like the one we’re currently experiencing and there’s a strong probability that some of these cheap buys will turn into high-margin moneymakers for their owners within a year or two.

Those success stories, however, will be tempered with some very disturbing tales of woe. Buying a foreclosed home comes with a special set of risks and may not be an appropriate investment for those with little or no experience in the field.

Maintenance nightmares

There’s the question of upkeep, of course. This is a serious issue with foreclosure properties on multiple levels. First, by the very nature of the situation, you’re dealing with a property that was maintained by someone who was unable to make mortgage payments. It’s not a stretch to imagine that maintenance concerns weren’t addressed when the owner wasn’t able to make his or her payments.

Second, the banks who hold foreclosed property don’t have that old “pride in ownership” thing working for them. Banks are property managers and they often allow foreclosure properties to slip in terms of care and maintenance. By the time a home is “up to snuff” it may no longer be a bargain.

The ugly economy that has contributed to the rash of foreclosures we’ve seen adds another risk to the purchase process. Many homes are partially or completely gutted by owners during the foreclosure process in order to raise money.

There are homes in which floors have been completely removed, cabinets have been torn from the walls, and even kitchen sinks have been yanked out and sold. These owner-gutted properties often don’t turn out to be a great bargain after the new owners handle necessary renovation and repair.

Foreclosed homes are generally sold “as is”, meaning that the buyer assumes a great deal of risk in the transaction. An example of this is the story of a couple who bought a foreclosure only to discover that it had a serious mold problem. A lawsuit ensued, and this foray into foreclosure-land failed to turn into a profitable investment.

Look before you leap

If you’re a newcomer to the world of foreclosures, you might want to think twice before jumping in. If you’re convinced that you can find that perfect investment property, however, enter the arena with the right plan. Be careful, demand a full inspection prior to escrow, and consult with realty professionals who’ll help you to mitigate your risks.

It’s wonderful that some people will find that half-full glass on the kitchen counter of a foreclosure property. Unfortunately, too many buyers will learn that the kitchen counters, and maybe even the pipes beneath them, have been ripped out.

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The decision of whether or not to buy a condo, townhouse, or house can be overwhelming. Today I want to take a look at how to break down a potential home purchase and examine the effects of your decision on you and your family.

Renting is a waste of money

You might feel pressure from others to buy a home as soon as possible. After all, “If you rent, you’re just throwing your money away.”

While I’m sure that people have good intentions when they say such things, it’s still a huge generalization that doesn’t take into account your individual circumstances. If you’re in an area where renting is much cheaper than owning, then you might be better served by renting.

If you’re not sure if that’s the case for you, run the numbers on the this calculator from the NY Times. This can give you an idea of how long it would take to break even if you buy vs. rent a home in your area.

Another thing to keep in mind is that renting is a great way to try out a new living arrangement without (literally) mortgaging your future on a relative unknown.

Opportunity cost

Homeowners pay an opportunity cost in the form of all the other things they could be doing with their money if they were renting a cheaper place. When people buy a home, it’s often larger than their previous rental, and generally more expensive. Besides paying the mortgage, you have to add the cost of taxes, home insurance, and possibly home association dues.

It’s also important to keep in mind that any extra money you spend on your mortgage, homeowner’s insurance, property taxes, and maintenance is money you can’t set aside to invest. Can you afford to pay a mortgage and still invest? If not, you may want to continue renting until your finances are stronger.

While you might be tempted by all the “good deals” produced by the current housing slowdown, you still might not be able to afford the long-term costs of owning a home. How much can a house end up costing you? Yahoo! Finance had an article by David Crook where he ran the numbers on home ownership costs:

You can easily end up spending three times the purchase price of a house. Today’s buyer of a typical $300,000 single-family home who takes out a 30-year loan will end up paying the price of the house again just in interest.

Add 30 years of property taxes, homeowner’s insurance, regular maintenance and a couple of big-ticket repairs or improvements, and the total cost of buying the home could easily top out at well over $1 million.

You’re pre-approved for a mortgage of $XXX,XXX

Just because your bank tells you something doesn’t mean it’s in your best interest to listen to them. We’ve been pre-approved for a much higher amount than we’re looking to spend. We’ve given our realtor a target price range around 65-70% of the amount the bank will give us. We want to continue to live below of our means, and we’d love to be able to afford a place with one income.

Instead of taking whatever they offer, get a mortgage that you can afford. Use a home affordability calculator – don’t just rely on what a bank or a mortgage broker tells you, as they’re often a bit aggressive with the numbers. My advice is to be conservative, and keep your mortgage payment below 25% of your net monthly income. This gives you a bit more wiggle room, as you also have to pay insurance, taxes, and maintenance with a house.

Take advantage of the $8,000 tax credit

If you can afford a home, the $8,000 tax credit for first-time homebuyers is a great incentive. In case you’re not familiar with this credit, you have to make your purchase between January 1st, 2009 and before November 30th, 2009 and you have to stay in your home for three years.

This is a refundable tax credit, and it’s phased out for individuals with AGI of $75k or higher or couples with AGI of $150k or higher. Here’s some info on how to claim it. Just be sure to look before you leap… Are you willing to spend $232,100 (the median price of new homes) just to get an extra $8,000 back form the IRS? We’re not, and I hope you aren’t, either.

Be willing to wait

We’ve decided that if none of the homes in our price range meet our criteria, then we’ll wait a bit longer and build up a larger down payment. When we do end up buying a house, we plan on staying there for a long time. Thus, it’s important for us to make a smart decision.

One of the big reasons that we rented a cheaper apartment was to be able to save some cash. We pay about $150/month less than our friends, which gives us some money to save with. We’re living below our means, and slowly building our savings.

Your thoughts

Do you rent or own a home? What factors did you consider when deciding whether or not to buy? Are you happy with your decision? What (if anything) would you have done differently if you could do it over again?

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In addition to increasing the maximum tax credit from $8,000 to $15,000 (with a max of 10% of the home’s purchase), Isakson’s proposal would also make the credit available to all purchasers of a primary residence, not just first-time homebuyers. The income caps ($75k for individuals, $150k for couples) would also be eliminated.

As a former Realtor himself, Isakson has argued that “we don’t have a recession in first-time home buyers. We have a recession in the move-up market.” Thus, he believes that it’s time to expand the credit beyond just first-time homebuyers.

Interestingly, Isakson’s bill is backed by a bipartisan group of co-sponsors, including Lamar Alexander (R-TN), Jim Bunning (R-KY), Chris Dodd (D-CT), John Ensign (R-NV), Joe Lieberman (I-CT), Lisa Murkowski (R-AK), James Risch (R-ID), and David Vitter (R-LA). Not surprisingly, he has also picked up endorsements from a couple of real estate industry groups.

While I suspect that this program would actually work from the standpoint of getting people to buy/sell houses, at least in the short term, I’m not a big fan of throwing another $32B at the problem. What do you think?

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This time around, the slow real estate market resulted in a year-over-year decrease of about 4%. While any little bit helps when it comes to property taxes, this decrease was considerably less than for other homes on our street. Curious as to why that was, I decided to look closer.

In reviewing the change, I think I might have discovered the culprit… The county seems to think that our house is significantly larger than it really is. Even after accounting for the addition (completed in late 2007), the supposed square footage of our house somehow increased by another 400 sq. ft. during the past year.

Last night, I drafted a letter to the County Board of Tax Assessors outlining our case. Assuming that things proceed like they did last year, we should have a response within about a week. If we’re not happy at that point, we have the option of appearing before the Board of Equalization. Hopefully it won’t come to that.

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The source for these thoughts is a recent book called “The Frugal Millionaires,” which profiles 70 anonymous millionaires and their thoughts about money. Interestingly, just like with our prior discussion here on FCN, there are ‘frugal millionaires’ on both sides of the fence. Here’s a taste of what they had to say…

Thoughts in favor of keeping your mortgage…

“When it comes to residences, mortgages can be a way for someone to save cash for investing and therefore possibly allow them to earn a higher rate of investment return than one is paying in mortgage interest.”

“If you can have money at a cheap rate then a mortgage is a great decision…”

“If the money is cheap, it can be smart to arbitrage the cost of the mortgage vs. the benefits of a tax deduction and market gains…”

“The US government tax system is set up to reward those who have mortgages…”

“If the government is going to pay you to own a home, why turn them down…”

Thoughts in favor of paying off your mortgage…

“If you want absolute peace of mind, don’t have any debt…”

“For many people the advantage of the ‘interest deduction’ is a myth perpetuated by by real estate agents, mortgage brokers, and even your friends…”

“Mortgages lose their interest rate deduction efficiency as they get older. This [is because] you are paying more principal towards the end of the loan…”

“Take opportunities to pay off a little of the capital on your mortgage whenever you can — even if it seems like an insignificant amount.”

“I prefer not to have one and say get rid of them as fast as you can. Debt will kill you.”

“There’s a great feeling in living in a home you own outright.”

What say you?

While I know that I number of you have weighed in on this already, I still thought it would be worth asking… As I’ve noted previously, we’re doing a bit of both. We’re paying down our mortgage ahead of schedule, but we’re not committing every last penny to the effort. Instead, we’re directing a sizable chunk of our ‘discretionary’ funds to our investment portfolio.

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What’s a “no-cost” mortgage refinance?

A “no-cost” refinance is one in which the lender or broker covers the closing costs on your new mortgage. Depending on where you live, you can expect to pay 2-3% of the loan amount when closing a typical mortgage, so this is a great deal. Right? Well…

The reason I keep putting the term “no-cost” in quotes is because there actually is a cost — you just don’t typically see it. In other words, the lender doesn’t eliminate the costs, they simply convert them into another form. In most cases, this means that you’ll wind up paying a higher interest rate.

It works like this… Just as you can buy points to reduce your mortgage rate, you can increase your mortgage rate in return for negative points. Each point is equal to 1% of the loan amount. By accepting a higher than market rate on your loan, you can generate cash back that lender can use to cover the closing costs.

Clearly, this approach is most beneficial to those with a short time horizon, as they’ll enjoy the upfront cost savings without having to live with that higher rate for very long. If you decide that the “no-cost” option is best for you, be sure to get a full rundown of the costs that are covered so you can make a meaningful comparison across lenders — not everyone covers all the same things.

“No-cash” is not the same as “no-cost”

Perhaps the biggest mistake that you can make when shopping for a “no-cost” refinance is to wind up with a “no-cash” deal instead. While the names sound very similar, these are very, very different products. With a “no-cash” refinance, the closing costs are rolled into the balance of the new loan.

Because there aren’t any negative points involved with a “no-cash” refinance, the rate will likely appear more competitive on a “no-cost” refinance. Unfortunately, you’ll wind up paying the fees yourself over time plus interest.

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Check your credit

Given all that’s transpired over the past year or so, it should come as no surprise that your credit score is more important than ever when it comes to getting a great deal on a mortgage. As such, your first step should be to check your credit report and fix any errors that you find. Just be sure to give yourself enough lead time to get things sorted out. Here’s why…

I recently ran across a panicked letter that I faxed to Chase back in 2001. As it turns out, I checked our credit report before applying for our first mortgage and discovered a delinquency that had never happened. When I contested this with the credit bureau, Chase came back claiming that the information was accurate. Thus, the black mark stayed on our record.

Because I didn’t discover this problem until the last minute, time was running short, and I had to quickly resolve the problem directly with Chase. I ended up faxing them a letter the day before we applied for our mortgage explaining the situation and essentially begging them to help us out. In the end, we got the problem taken care of, but we could’ve avoided a lot of stress by simply starting sooner.

Beyond making sure your credit report is accurate, you might also want to check out your credit score itself. Unfortunately, while you’re legally entitled to free access to your credit report, the same is not true of your credit score. The good news is that you can get a free peek at your credit score if you’re willing to jump through some hoops… Simply sign up for a free trial at FreeCreditReport.com or MyFICO. Just be sure to cancel before you get charged.

Get the lay of the land

If you haven’t already decided what sort of mortgage you’re looking for, online mortgage marketplaces are a great way to get a feel for the prevailing rates on different types of mortgage – you can quickly compare rates on fixed vs. adjustable rate mortgages, 15 vs. 30 year terms, etc. With that info in hand, it’s much easier to identify the best option for your situation.

Find the best mortgage rate

Once you know what you’re looking for, check the mortgage rates offered by your local bank or credit union. Their rates may or may not be competitive, but you’ll never know if you don’t ask. Beyond that, you should consider asking friends or family if they can recommend a reputable mortgage broker.

While a mortgage broker isn’t absolutely necessary, working with one can make finding the best mortgage deal much easier. Ideally, you should contact more than one broker and see what they can offer you. Just be sure to ask for a “good-faith estimate” from each so you can make an informed comparison based on the full rundown of rates, fees, etc.

Once you’ve found what appears to be the best deal, start shopping it around. Go back to your bank, any other brokers that you’ve had contact with, etc. and see if they can beat it. Even if they can’t beat the rate, they might be able to sweeten the deal by knocking some money off your closing costs, etc. Remember, you’re looking for the best overall deal, not just the lowest rate. A bit of extra work here can pay huge dividends.

Of course, you should also be comparing these offers back to the rates that you found online. Just be careful… I’ve found that some lenders are less than honorable when it comes to making good on the rock bottom rates that they advertise online.

Some words of warning

If you’re buying new construction, you might feel some pressure to use the builder’s “preferred” lender. While they’ll likely offer to throw in some freebies if you use their guy, you probably won’t get the best overall deal if you simply say “yes.” Instead, negotiate with them on this point.

When we bought our first house, we agreed to use the builder’s lender, but only if they matched the best deal we could find. We also negotiated to get the freebies even if their mortgage guy couldn’t match our best deal. This put a lot of pressure on them to deliver, and they ultimately came through.

Finally, when it comes time to close, be sure to read everything they put in front of you. You might feel like uncomfortable making the closing attorney sit there while you read through all the paperwork, but that’s their job. If you simply can’t stomach doing this, you at least need to go over your HUD-1 settlement statement (which lists all the details of your deal) with a fine-toothed comb.

When we bought our first house, we had an 80/10/10 “piggyback” mortgage. While everything was fine with our first mortgage, the settlement statement listed the wrong (higher) rate for our second mortgage. Obviously, this could’ve caused a lot of trouble if we hadn’t been paying attention.

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Why you should pay off your mortgage early

One of the biggest advantages of paying off your mortgage early is peace of mind. Once you’ve paid it off, you’ll wake up every morning and fall asleep every night knowing that the roof over your head is 100% yours. For many people, you can’t put a price on that sort of security.

Beyond the comfort/security aspect, paying off your mortgage early is a bit like locking in a guaranteed investment return. For every dollar that you pay early, you’re “earning” the interest that you would’ve otherwise paid on it over the balance of the loan period. This sounds great, right? Well…

The flip side of the “guaranteed investment return” argument is that mortgage interest rates are often quite low, and interest payments on a mortgage are also tax deductible (for those that itemize). These factors make early payments lose a bit of their luster.

Another advantage of paying off your mortgage early is that doing so protects you from yourself. While paying the minimum on your mortgage and investing the difference might sound like a great idea, there are no guarantees that you’ll actually follow through on the second part of the equation.

To see how long it might take you to payoff your mortgage, there’s a mortgage payoff calculator at this site for mortgage calculators

Why you shouldn’t pay off your mortgage early

The biggest downside to paying off your mortgage early is the (potentially large) opportunity cost that you’ll face. By this I mean that you’ll be giving up investment returns that might significantly outpace your mortgage interest rate.

In other words, why pay off a 5% mortgage when you could be earning 8-10% on that money? Of course, one only has to look at the past year to know the answer… Those sort of returns aren’t guaranteed, whereas the mortgage savings are.

Another important point to consider is the effect of inflation. Over time, inflation erodes the value of the dollar. This means that your future mortgage payments will effectively cost less than they do now, as the money you’ll be sending in won’t be worth as much in terms of “real” buying power.

What are we doing?

Instead of pretending to know what’s best in your situation, I though I’d tell you what we’re doing. We’ve actually gone back and forth on this issue, but ultimately decided to do a bit of both. And yes, I know that answer is a total cop-out, but it is what it is.

We are currently in the fortunate position of being able to max out our retirement accounts while having enough left over to put some extra cash toward our mortgage and to work on building up a non-retirement portfolio, so… That’s exactly what we’re doing. I view it as a bit of extra diversification.

A bit over a year ago, we refinanced from a 30 year fixed rate mortgage down to a 15 year fixed rate mortgage. In doing so, we cut our time horizon in half. Beyond that, we’ve been sending in an extra principal payment every month, further reducing the time until we’re mortgage-free.

Admittedly, this hasn’t been an easy decision for us, and we’re still tempted to waver at times. After all, now is a great time to refinance, and I also suspect that there’s a good bit of inflation looming just around the corner.

Given the above, we’ve been tempted to refinance into a rock bottom 30 year fixed rate mortgage and pay it off as slowly as possible while we focus on building our investment portfolio. However, a wise man recently reminded me that “pigs get fat, but hogs get slaughtered.” In other words, it pays to be greedy, but not too greedy. In the end, we opted to stay the course.

What about you?

Where do you stand on the mortgage pre-payment issue? Are you looking to get out of debt come hell or high water? Or are you paying off your mortgage on schedule while focusing on your investments?

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Of course, those same housing troubles have now (arguably) created a lot of opportunities. In many areas, home prices have fallen dramatically, and the number of foreclosures has skyrocketed.

Given the above, a recent article in Money Magazine that provided tips for buying a foreclosed home piqued my interest. For starters, they pointed out that (nor surprisingly) it’s easier than ever to find foreclosed homes. Beyond that, they offered the following four tips on the mechanics of the process.

Tips for buying a foreclosed home

• It’s best to buy from a bank. If you buy a foreclosed home at auction, prior to repossession by the bank, you may have to pay cash, and you may not be able to inspect it. You might also discover that there are existing liens against it. When a back repossesses a home, they should clear any outstanding liens.
• Bring in a contractor before you buy. Foreclosed homes have often been abandoned, and possibly vandalized. Instead of simply relying on a home inspector to point out the flaws, bring in a contractor and ask for an estimate of how much it will cost to fix everything.
• Bid low. Banks often list their foreclosures at market prices, so be prepared to haggle with them. If the home you’re interested in has been on the market for awhile, or if the bank has a large number of foreclosures on hand, they’ll be more willing to deal.
• Be prepared to wait. Many lenders are dealing with a huge number of properties, and it might take them awhile to respond. According to the article, the wait can be as long as three months (!) in some cases.

Having never been through the process myself, there’s not a whole lot I can add to this. Obviously, it’s very important to do you homework, as making a mistake could be very costly. If you’ve been through the process of buying a foreclosed home, I’d love to hear your thoughts.

Source: Money Magazine

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Sure, you could argue that these states (or at least California and Florida) are quite large, and thus account for a disproportionate number of housing units, rendering these numbers meaningless, but consider this… California accounts for just 10% of the nation’s housing units, but it had 34% of the foreclosures in 2008.

You might also argue that expressing this in terms of dollar losses as opposed to actual foreclosures tends to skew things a bit. For example, the median home value in California in 2007 was 8.3x the median income, whereas the median home value nationally was just 3.2x the median income. In other words, prices had farther to fall in California than elsewhere, so perhaps the dollar amounts are inflated.

Looking at the raw numbers, however, reveals that these four states still account for a disproportionate number of actual foreclosures. In fact, there were just over 2.3M properties foreclosed on nationwide during 2008, with nearly half of these (just over 1.1M) happening in these four states alone.

This kind of puts things in perspective, doesn’t it? Sure, there are still other locales that are really hurting, and the housing market sucks in general, but the foreclosure crisis doesn’t appear to be nearly as widespread as the media would have us believe.

Hat tip: Reason.com

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In hopes of answering a few FAQs, here are some tidbits from the instructions:

Who Can Claim the Credit

In general, you can claim this credit if you purchased you main home located in the United States after April 8, 2008, and before December 1, 2009 and you (and/or your spouse if you are married) did not own any other main home during the 3-year period ending on the date of purchase. If you build a home, you are assumed to have purchased it on the first day that you occupied it.

Who Cannot Claim the Credit

You cannot claim the credit if your modified adjusted gross income (MAGI) is $95k or more ($170k or more for married filing jointly). You are also excluded if you are a non-resident alien, your home is located outside the United States, you acquired the home gift or inheritance, or you purchased it from a related person. There are also a few other somewhat esoteric exclusion, so be sure to read the form carefully.

Details of the Credit

For homes purchased in 2008… The credit will still be little more than an interest-free loan which will have to be paid back in 15 equal installments starting in 2010. If your home ceases to be your main home before the 15 years is up, you’ll have to pay back the balance in the year in which you move.

For homes purchased in 2009… The repayment requirement is waived as long as it’s your main home for the 36 month period beginning on the purchase date. If your home ceases to be your main home within that 36 month period, you’ll have to pay back the credit in the year in which that happens. There are some exceptions, so be sure to read the instructions carefully.

The amount of the credit is the smaller of $7500 ($8000 for homes purchased in 2009) or 10% of the purchase price of the home. You get the full amount if your MAGI is less than $75k ($150k for married filing jointly). The credit is gradually phased out from $75k-$95k ($150k-$170k for married filing jointly).

What This Means for You

If you’re using a tax pro, make sure they’re up to speed on these changes. They should be, but you can never be too careful. If you’re using tax prep software such as TurboTax or TaxCut, be sure to download any updates (the online versions should be automatically updated). If you do your taxes by hand, be sure to download and use the latest version of IRS Form 5405.

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That’s a pretty tall order, but I’ll take a whack at it.

Taking the Tax Credit

Changes to the first-time homebuyer tax credit have been fast and furious over the past week or so and, frankly, I’m getting a bit worn out from talking about it. If you’re sick of hearing about it, feel free to skip down to the next section. But if not, please read on…

In the beginning, it was essentially a $7,500 interest free loan. Then the House of Representatives decided to remove the repayment requirement. The Senate then followed up by increasing it to a $15,000 tax credit with no repayment requirement and no first-time homebuyer limitation. But then… When the House and Senate got together to work through their differences, it got knocked back down to an $8,000 first-time homebuyer credit.

As of right now, the details surrounding this are still somewhat murky. It sounds like it will apply to homes purchases between January 1 and August 31 of this year, and that the income limits will be $75k for single filers and $150k for joint filers. My best advice here is to simply keep your ears open and listen for details as they come available. There should be more info soon.

Getting a Great Deal on a Mortgage

Unfortunately the 4% mortgages that were floated by the Senate never materialized. Nonetheless, there are still great deals to be had when it comes to finding a mortgage. Given that lenders have become increasingly risk averse, one major factor in landing a great mortgage rate will be having a high credit score. Unfortunately, while there are things you can do to improve your credit score, they all take time. Thus, if your score is currently in the crapper, finding a low rate might be tough.

The only other advice that I can offer here is to ask around and find a reputable mortgage broker. If you get multiple recommendations, all the better. Contact them all to establish a relationship and see what they have to offer. Then, when you get closer to actually buying a house, take the best offer that you can get and shop it around to the other brokers. See if they’ll beat it. Many brokers are hungry for business, and will do whatever they can to win you over. Beyond finding a low rate, you might be able to get some concessions on closing costs, etc.

Getting a Great Deal on a House

Real estate is so intensely local that it’s hard to give good advice from afar. On top of that, there’s a lot of disagreement about where we are with regard to finding the bottom of the market. That being said, I can offer one fairly generic tip, and that is to keep a close on how long various properties have been on the market. One trick that many realtors/sellers will use is to de-list and then re-list a property that has been on the market for awhile. With a fresh listing date, it won’t look like it’s been on the market as long, but that doesn’t make the sellers any less desperate to sell.

What About You?

Do you have any tips to add to what I’ve written above? If so, please don’t hesitate to share them in the comments.

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Presumably, borrowers would be required to meet stringent loan requirements of the kind the lending industry reinstated in the aftermath of the meltdown from subprime mortgages, which required little documentation of income or other evidence of ability to pay.

It’ll be interesting to see how this develops. While we currently have a 15 year mortgage that we’ve been paying down ahead of schedule, it would be awfully hard to turn down a 30 year fixed rate mortgage at 4%. Talk about an inflation hedge!

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“Refundable first-time home buyer credit. Last year, Congress provided taxpayers with a refundable tax credit that was equivalent to an interest-free loan equal to 10 percent of the purchase of a home (up to $7,500) by first-time home buyers. The provision applies to homes purchased on or after April 9, 2008 and before July 1, 2009. Taxpayers receiving this tax credit are currently required to repay any amount received under this provision back to the government over 15 years in equal installments, or, if earlier, when the home is sold. The credit phases out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return). The bill would eliminate the repayment obligation for taxpayers that purchase homes after January 1, 2009. The provision would retain the credit recapture if the house is sold within three years of purchase. This proposal is estimated to cost $2.562 billion over 10 years.”

As frustrating and unfair as this change will seem to people that took advantage of the credit in 2008, the limitation of this change to 2009 actually makes sense. After all, the goal is to get people to go out and buy houses, which means that people that have already taken the plunge aren’t the target audience.

Thanks to Ross for digging this up!

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We are debating about whether or not to take the $7500 from the government for being first time home owners. In 2 years, we will have to start paying “them” back $500 for the next 15 years. If we were to sell our house in that time and not make a profit, the debt would be forgiven. I’m not sure I want to owe anyone anything, but hubby thinks of it as an interest free loan… What’s your take on this?

Oddly enough, I was in the process of writing about the first time homebuyer credit when her question rolled in. Weird. Anyway…

The First Time Homebuyer Tax Credit

When it was first proposed in the “Housing Rescue Bill,” the first time homebuyer tax credit was, as Heather noted, little more than an interest free loan (more on this below).

According to IRS guidance, the credit:

• Applies to homes purchased after April 8, 2008 and before July 1, 2009
• Reduced a taxpayer’s tax bill or increases their refund dollar-for-dollar
• Is fully refundable, meaning that you can get it even if you owe not taxes

The amount of the credit is 10% of the purchase price of the home in question, up to a maximum of $7,500 for single taxpayers, or married couples filing jointly. There are, however, a couple of catches…

For starters, the credit is phased out based on your modified adjusted gross income (MAGI). For married couples filing jointly, the credit phases out between $150k-$170k. For all others, the phase out range is $75k-$95k.

The other problem is that it’s not really a credit. Rather, this “credit” has to be paid back in equal installments over the next 15 years along with your taxes. Not such a great credit anymore, huh?

That’s the bad news. The good news is that changes may be afoot…

Conversion to a True Credit?

House Democrats recently outlined their $835 billion economic stimulus package, and one of the things that they’re hoping to do is make the homebuyer tax credit a true credit — with no repayment necessary. Of course, this is still subject to negotiations between the House and Senate, and to passage of the economic stimulus package itself, but…

If it happens, buyers who qualified for the credit in 2008, or those who do so in 2009, will be relieved of the repayment requirement. Is this enough to make you go out and buy a house? Probably not. But if you’re buying one anyway, be sure to take advantage.

Update: The Senate just passed an amendment to the stimulus bill that would create a $15,000 tax credit with no repayment requirement. Moreover, it would be available to all purchasers, not just first-time homebuyers.

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