Jay's Mortgage and Investors Blog

My mother has an expression about associations: "You lay around with dogs long enough, you start smelling like them."  The good news is that the expression works both ways.

A common sense belief is that wealthy people are more likely to own their homes outright than their middle or lower class counterparts.  And that's the funny thing about common beliefs, they are usually wrong.

How is this for an eye opening reality: 55.5% of the Wealthy have a primary mortgage vs. 44.6% of the overall population.  Stated differently, wealthy people are 25% more likely to carry a mortgage on their home.

We talk about mortgages as "good debt" quite a bit around here.  Mortgages are considered good debt because the interest that a lender charges is a tax-deductible expense for the homeowner.  There are very few other debts that behave that way.  Certainly, your car loan and credit card debt is not tax-deductible!

Because mortgage interest is tax-deductible, the "bottom line" interest cost is not as high as the mortgage note's interest rate.  For example, if you are in the 28% tax bracket and your mortgage rate is 6.00%, your "bottom line" interest rate is 4.32%.

You can do this math yourself on your own mortgage or the mortgage you are looking to get.  Take the interest rate, multiply it by your tax bracket, then subtract that figure from your interest rate, and bingo.  All of a sudden, that 8.00% rate doesn't look so bad.

The wealthy understand this concept and some choose to take a proactive approach with their financial planners and if you have one I recommend speaking with them.  If the "bottom line" mortgage rate is really 4.32%, the financial planner will try to earn a guaranteed, post-tax return of greater than 4.32%.  If the financial planner is successful, he has turned his wealthy client into a wealthier client and protected their investments and assets.

If the financial planner can accomplish this goal, the wealthy client is now operating like a bank: borrowing at a low rate (mortgage), lending at a high rate (guaranteed investment).  The spread in interest rate is pure profit.  This is not a new concept for wealth managers, but it is a concept that has never been available to the "average homeowner". Until Now!

Many wealthy individuals do own their homes outright, by the way.  That maybe part of a larger financial plan, too.  But, because mortgage rates are relatively low, many prefer to put their money into investments that earn returns. 

It is better to have enough money earning interest in an account to pay off your house in full, than it is to have your house paid off in full with no money earning interest at all.  The first option continuously increases wealth; the second option squanders wealth because of inflation.

If we look at the wealthy as a group, we see that they behave in the exact opposite manner from the non-wealthy.  So, it appears that my mom has a point.

Note: Just to clarify why I take my mother seriously on this, she is a Certified Financial Planner. It pays to pay attention to the people you know that have the training to give the best advice even if they are family and you don't always agree.

How often have you been involved in a real estate transaction and decided to put down a large down payment just to "get the deal done"?  After all, you're a good risk and expect to get a loan whenever you want it.  You'll just refinance the loan later and "pull cash out"

It would be easy for me to shake my head and suggest that you are getting poor financial advice...that would be easy.  You might be violating the tax code if you deducted that interest from the larger loan if you took it out after 90 days from the close of escrow.   AND...you probably got away with it...up until next year.

A few things you should know about the deductibility of mortgage interest:

1- It is limited to $1.1 million.
2- You must itemize (Schedule A) to receive that deduction.
3- A fully-amortizing loan reduces your Acquisition Indebtedness each month.
4- An interest-only loan does not reduce your Acquisition Indebtedness; it remains level.
5- You are entitled to a $100,000 over the Acquisition Indebtedness as a home equity exclusion for tax deductibility.

Now, here's the catch.  The IRS monitors your interest paid on mortgages through a Form 1098.  The IRS has no formal system to monitor the segregation of debt (how much was the Acquisition Indebtedness, how much is covered under the home equity exclusion, and how much is not deductible)...UNTIL NOW.

In 2007, lenders are required to report cash-out refinance transactions.  That includes any and all refinanced loans that exceed the original Acquisition Indebtedness.  This means that if you bought a home in 2000 with a $250,000 loan against it and have subsequently increased that debt to $400,000, your qualifying debt for interest will be capped at $350,000, more if you paid down the loan through an amortized loan.  In California, that applies to MANY refinance transactions for homes owned more than three years.

Why is the IRS doing this?  Well, follow the money.  The IRS has overlooked this common ignorance of the tax code because it really didn't affect the average Joe...until NOW.  The real estate boom gave homeowners a chance to use their home like an ATM and withdraw cash.  Now, the IRS wants it's pound of flesh.  If you've refinanced and pulled out cash over and above $100,00 above your Acquisition Indebtedness, you had better start paying attention to your deductibility of mortgage interest ...because Uncle Sam is...next year.

Mortgage planning encompasses this information and works with your tax professional to ensure that you get the largest tax-deduction available.  You can always opt against that advice and put down a larger down payment.  Wouldn't you like to make an educated choice?

Ask the mortgage salesman your Realtor recommended why she didn't tell you about this when you bought your home; she could cost you a lot of money next year.

I am seeing a large jump in the number of clients inquiring about the tax deferal benefits of 1031 xchanges. Accordingly, I'm going to provide an overview of the strategy.

In a typical 1031 Exchange, the client sells a commercial or investment property and acquires replacement property of equal or greater value within 180 days. The use of a Qualified Intermediary, is a safe harbor requirement to facilitate a valid tax deferred exchange. Before beginning any exchange process, be sure and consult with a tax or financial advisor.

Step One: Sale of the Relinquished Property - Before the sale of the first property the exchanger must complete the documentation prepared by the intermediary. On closing, the proceeds are delivered directly to the Qualified Intermediary.

Step Two: Identification of the Replacement Property - The exchanger must identify the property to be purchased within 45 days following the sale of the Relinquished Property. The taxpayer may generally identify up to three properties as potential Replacement Properties, or more properties subject to certain limitations.

Step Three: Purchase of the Replacement Property - The exchanger must obtain the Replacement Property within 180 days following the sale of the Relinquished Property, which must be one or more of the identified properties. On closing, the proceeds are paid directly by the Qualified Intermediary, and the exchanger receives the Deed to the Replacement Property.

To be sure, there are other types of exchanges, such as reverse exchanges, improvement exchanges, and personal property exchanges, and most qualified intermediary's provide unparalleled expertise for all exchanges of real property, with a simplified and streamlined process.

Not only is it the greatest expense, but in prior consumer surveys the consumer feels they have the least amount of 'control' over their housing related expenses.  Energy costs, property taxes, home owners insurance, and mortgage interest, all tend to create a feeling that housing expenses are totally outside their control, which is an pretty accurate statement for most home owners.  Their options are to sell the house and rent, or to consider more closely monitoring their housing related expenses, controlling the things they can control, and letting the rest go.  That's a form of liability management, just helping people consider what they can, and clarifying for them what they can't.

One interesting consideration of the Consumer Expenditure Survey study is the expenses are considered interest only for all expenses, so principal does not show up as an expense to the consumer, yet they do feel it in their overall cash flow.  As you can see from the chart, the level of pain is relatively higher for the lower income earners, but still makes up over 30% for the high income earner.  This trend is actually pushing home ownership rates in the US down, and putting more pressure on rents, as the median rent in the US jumped 6% in 2006 after staying relatively flat for many years.  If that increases, selling and renting becomes less attractive as well.

When you consider the emotional impact of the lost equity, you can see why consumers want more guidance if their real wealth declines, even if it is simply letting them know that things will be ok.  The upcoming adjustable mortgage resets in the first quarter of this year will continue to put upward pressure on housing related expenses and further challenge savings ability of the typical consumer.

Here is a great story about why title insurance is really a small price to pay:

Wildwood was always the "party town" of the Jersey shore.  High school and college students used to head down to Wildwood to celebrate their newfound freedom as adults.  You all know how that goes; raucous parties which made it difficult for Wildwood to establish itself as a "family friendly" vacation place.  I guess Mayor Fred Wager and the town council decided that the riches from Casino gaming (allowed only in Atlantic City) were the answer to their problems.

The town council agreed to deed a parking lot to the Delaware Indian tribe who would pay the city $8 million annually in rent.  The tribe also agreed not to operate restaurants, nightclubs, etc.  Just a gaming hall.  Well, this set up tremendous drama because New Jersey state law only authorizes casino gaming in Atlantic City (and takes a 8% tax on all receipts).  Other ancillary businesses were not happy about Wildwood encroaching upon the monopoly Atlantic City had.

Don't stop reading, yet.  Here's where it gets funny.

The state talked about intervening.  It seems that the Delaware Indian tribe  sued the city and state claiming that Wildwood sat on ancestral tribal grounds.  Well, the tribe's law firm must have had some good researchers because they found a problem in the chain of title.

It seems that all land sales and treaties have to be ratified by the US Congress.  Somehow, someway, some bright young law clerk discovered that Congress never ratified a treaty for the sale of the land from (you guessed it, the predecessor of the Delaware tribe) in the early 1800s.  It further stated that all the land from Princeton south, in the State of New Jersey was affected by this non-ratified treaty. 

New Jersey in the most densely populated state.  It affected some 6 million people and some 2 million households.  Close to 7 million pieces of property would be subject to a HUGE title claim.

A year later, the tribe withdrew the lawsuit.   

Do you think title policies are a bargain now?

This is just a huge example of why we get title insurance on every transaction we do. Even in private party transactions it is 100% recommended.

Banks foreclose on homes with lots of equity and try to "workout" the loans with the homes with no equity. 

Doesn't that seem counterintuitive?  Actually, it doesn't if you look at it from a banker's perspective.  Which piece of collateral is more likely to cover the debt?  The answer is simple; the piece of property you can sell at a low price and move quickly. For the banker its a business and not a home and he is going to do what works in their favor first.

Why do I recommend to clients that they always have their properties leveraged to the maximum amount allowable or within their budget?  Simple, I try to protect our clients from the four most common reasons that trigger foreclosure:

1- Divorce
2- Disability
3- Death
4- Loss of Job

Keeping a home leveraged through available credit in a home loan insures liquidity.  If prices drop, we've already "locked in" a profit.  If prices rise, we can "reset" the line after our annual review.

Liquidity means that mortgage payments can be made if one of the "Big Four" hits you.  If you use up all of your equity, the bank will be more apt to negotiate "workout terms" with you rather than rushing you to foreclosure.

This is not a new concept and with today's credit crisis might seem completely backwards. However with some education on how some of these systems work and with an open mind to new ideas I can show you just how you could actually pay off your home faster (if you choose too) and raise your net worth at the same time. The more and more financial advisors and professionals that see these concepts for themselves the more believe in the processes behind them. Why do they believe in them? Because there is nothing new about the processes at all it just the way they are put together. Let me show you how to accelerate the growth of your net worth and increase the safety of your largest investment. By knowing these concepts and processes you can insure yourself against the possibility of foreclosure or having to sell your home against your will. Knowledge is power.

A mortgage planner is a mortgage professional who provides a consultation to their client that is in alignment with their long and short term financial goals. The Mortgage Planner can also perform the duties of a loan officer, such as originating a home loan. Mortgage Planners have a philosophy to help their clients properly manage their mortgages, as it is most people's largest investment and debt. Mortgage Planners can also assist in credit optimization, real estate portfolio planning, debt reduction stategies, and for the more sophisticated client a mortgage planner may instruct and educate their clients on the benefits of arbitrage (borrowing at one rate and investing at another rate for profit) with the purpose of increasing safety, liquidity and rate of return.

If you have questions about any of these or would like to look at your options please contact me at jay@txmortgage.com.

In football, the quarterbacks have the ability to call an audible, or change the play right before the ball is hiked. Debt consolidation is a great way for you to call an audible if debt has blitzed your pocketbook.

For even the wealthiest individuals, debt is a part of life. Most people own a mortgage, a car, and/or other properties. There's always something to buy, and someone always willing to lend them the money to buy them.

That's fine, as long as your debt doesn't exceed your income level over a given period of time. Life is full of unexpected changes and challenges. However, there may be a time when you find yourself too heavily in the red. At that point, a debt consolidation loan can save the day and your sanity.

 Here are the benefits:

1. Lower interest rate, lower long-term interest costs

2. Tax-deductibility is a plus

3. Consolidation means one payment

4. Peace of mind

Friday, November 09, 2007

As the reverse mortgage continues to grow in popularity a recent survey showed senior citizens understood reverse mortgages better than they did any other home-loan product. But, there are still myths and misinformation about these unique loan programs.

These are the corrections to the most frequent myths spreading misunderstanding among senior citizens and their children.

Myth 1. - The bank takes the house OR the borrower can lose the house.

With a reverse mortgage, YOU the borrower retains title to the home throughout the life of the reverse mortgage.  You cannot, as a result of the reverse mortgage be forced out of your home, as long as property charges, such as taxes and insurance, are paid and the home is maintained in reasonable living condition.

Only when the last borrower permanently moves out of the home, the loan must be repaid. Most properties secured by reverse mortgages still have equity when a maturity event occurs and therefore the borrower or his/her heirs choose to sell the home to repay the loan and preserve this equity for the benefit of the borrower or his/her estate.

Myth 2. - The home must be paid off or be debt-free to qualify for a reverse mortgage.

Reverse mortgages convert home equity into a liquid form such as cash or a line of credit. As long as there is sufficient equity in the property, the homeowner may be eligible for a reverse mortgage. In fact, many seniors use a reverse mortgage to pay off an existing mortgage in order to eliminate a required monthly mortgage payment.

Myth 3. - When a reverse mortgage becomes due, the bank sells the home.

The borrower is in control of the home and retains title, not the bank or lender. So while it’s common for the borrower or the heirs to sell the home to repay the loan, it’s a decision the borrower or his heirs make. The borrower or the heirs might also refinance the home in order to repay the loan.

Myth 4. - It’s cheaper to move to a smaller house.

While this strategy might be right for different reasons, seniors need to analyze their costs carefully before making this assumption. The process of selling a home and moving into a new home can have a high cost. The typical real estate commission of 6% on a $200,000 home would be $12,000. Add moving costs, and the undertaking to find a new home and the decision is not quite as cut and dry and in the end could end up costing you a lot more. 

Myth 5. - Children want the home or don’t feel comfortable with a reverse mortgage.

I encouraged seniors to talk with their children about reverse mortgages. Many baby boomers are faced with trying to plan for their retirement and pay for their children’s education. Often, the children of many seniors are happy that their parents have a financial solution available to help them live more independently and financially secure. I also advise seniors to remember that this is to improve their quality of life and may have the same effect for their children due to them being able to absorb those extra costs for healthcare that may otherwise fall on their children.

Myth 6. - The borrower could end up owing more than the home is worth.

This is a huge misunderstanding. Two of the greatest safeguards for reverse mortgages are that they are structured so that the borrower or his estate can never owe more than the value of the home upon repayment. This is often referred to as being non-recourse. In addition, the HECM (Home Equity Conversion Mortgage) products are insured by the Federal Housing Administration, an arm of the U.S. Department of Housing and Urban Development (HUD). 

Myth 7. - Reverse mortgage proceeds will impact Social Security and Medicare benefits.

A reverse mortgage will generally not affect regular Social Security payments or Medicare benefits. Depending upon the borrower’s situation, a reverse mortgage may affect benefits one receives, if any, from the Federal Supplemental Security Income (SSI) program, or state-administered programs like Medicaid. I recommended that the borrower speak with his or her Certified Financial Planner, financial advisor, CPA and appropriate governmental agencies. Contact me if you would like a recommendation.

Myth 8. - There are restrictions on how the money is used.

WRONG! Actually there are no restrictions. The cash proceeds from the reverse mortgage can be used for any purpose you can imagine.  I recommend that the borrower speak to a Certified Financial Planner. Many seniors have used reverse mortgages to travel, pay off debts, help their kids, make a luxury purchase or as in most cases just live more comfortably.

Myth 9. - Once the proceeds are received, taxes will need to be paid.

The cash proceeds from a reverse mortgage are tax free because it is already your money. It is recommended that the borrower consult with a financial advisor.

Myth 10. - Reverse mortgages are only for seniors in need, or for the ‘house rich, cash poor.’

The reverse mortgage is an excellent financial planning tool that has been used by homeowners from all walks of life to enhance their retirement years. Increasingly, lenders are seeing interest and growth among jumbo reverse mortgages geared toward borrowers whose homes exceed the FHA lending limits, which peak above $200,000 in Texas for a single family home. Many seniors with multi-million dollar homes are using reverse mortgages as part of their estate or legacy planning in conjunction with qualified advice from Certified Financial Planners.

While these should put your mind at ease about the misunderstandings that have followed reverse mortgages it does not replace getting good advice and understanding all the facts for your own particular situation. Please contact me at jay@txmortgage.com with any questions you may have.