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Tax Reform and You

By now, you have already seen dozens of articles about the recently-passed “Tax Reform and Jobs Act.” While it has not yet been signed into law, there is a great deal of speculation about the final bill. Specifically, people wonder about how the changes will affect the ownership of real estate.

Every situation is different, and you can’t rely on the on-line calculators that claim to show you how much you’ll save under the tax plan. Taxation is necessarily complex, but this article should give you some guidance about how to arrive at your own conclusions—based on the actual bill, not on some pundit or politician’s speculation about it.

The up-front disclaimer

Your humble author is not a CPA, tax preparer or tax lawyer. While I make every possible effort to be sure what I say is correct, you should not consider any of this to be authoritative tax advice. Rely on your regular tax person for that. If you (or your tax person) find any errors in this article, feel free to reach out to me directly.

Income tax is quite a bit more complex than it may appear from this article; but even though I am intentionally over-simplifying it a bit, you should come away from reading this with a good understanding of how income taxes work—and, more importantly, you should be in a better position to determine what, if any, benefit there is for you in the new tax law. Be patient as we work through the basics.

How taxes work

In order to understand what benefits you may receive from the new tax bill, you should know how our progressive tax system works. “Progressive” means that each portion of your income is taxed at a progressively higher rate. I’ll use a filing status of “married filing jointly” throughout, for simplicity.

The tax on the first $19,050 of income is taxed at 10%. From $19,051 to $77,400, it’s taxed at 15%, and so on. The percentage is called the “marginal tax rate.” It is not your overall tax rate—the percentage of your income that you actually pay.

The table is arranged to simplify your calculation. Here is an example:

Your taxable income is $100,000. That means you are in the 25% bracket—you are above $77,401 but below $156,151. You’ll pay base tax of $10,658 plus 25% of the income above $77,400. That’s $22,600. 25% of that amount is $5,650. Your total tax is $16,308, which is an overall rate of 16.3%.

Deductions, exemptions and credits

You are allowed to reduce your gross income by certain deductions and exemptions to minimize the income tax you owe. Here is where they come into play.

An “exemption” is what used to be called a “dependent.” Each exemption is worth $4,150 (2018 schedule before the tax bill). For a married couple, you’ll get two exemptions, for $8,300, plus one for each dependent child.

“Deductions” are other items you will use to lower your taxable income. If you own a home, you may choose to deduct the mortgage interest you paid, along with property taxes and state income taxes. There is also a “standard deduction” you will use if it’s more than the total of the things you can itemize. It’s $13,000 for a married couple filing their return jointly.

Subtracting exemptions and deductions from your Adjusted Gross Income (AGI) give you taxable income—the number used to calculate how much income tax you owe.

Finally, you may receive tax credits. These reduce your tax liability on a dollar-for-dollar basis. One popular tax credit is the child credit, where families are able to deduct $1,000 for each child in the household 17 years of age or younger. Another is the Mortgage Credit Certificate (MCC), which allows a qualifying first-time buyer to claim a percentage of their mortgage interest (currently 20% in California) as a tax credit.

One simple scenario: A married couple with one child, filing jointly. They earn $100,000 annually and do not have enough deductions to itemize, so they’ll use the standard deduction. Their income tax numbers will look like this:

One more scenario before we look at the changes. Our young family just bought a home, so they have some interest and property tax to deduct. Let’s say they also paid $2,000 in state income taxes. If the total of these items is more than $13,000, they’ll itemize their deductions on Schedule A of their tax return.

They bought their home last year for $530,000. It’s their second home, so they were able to put 20% down. They paid $18,000 mortgage interest and $6,500 property tax. They’ll itemize these, along with the $2,000 state income tax. Their situation will look like this:

Because they own a home and have enough individual deductions to justify itemizing, they reduce the taxes they owe by $2,025, or about $170 per month. This is the tax advantage of owning their home: the difference between what they would pay as a renter (standard deduction) and what they’ll pay as a homeowner (itemized deductions).

Ch…ch…ch…changes

On January 1, 2018, the new tax code will presumably take effect. While it is a massive bill (1,097 pages), written by a bunch of lawyers, here are the main changes as they will affect you. We’ll also list some items that will not change even though either the House or Senate version may have originally made a change. These items are from the text of the Tax Reform and Jobs Act itself.

Old System

New System

Mortgage interest

You can deduct interest on the first $1 million of loan.

You can deduct interest on the first $750,000 of loan
Equity lines

You can deduct interest on up to $100,000 of loan placed on the property after its purchase, such as a HELOC

You can no longer deduct interest on a HELOC
Property and state income tax

You can deduct the amount of property tax and state income tax you paid

You can deduct up to $10,000 for the total of property tax and state income tax
Capital gains on selling your home

You can exclude up to $500,000 in gain ($250,000 for a single person) as long as you have occupied the home for 2 out of the previous 5 years

No change. There was a proposal to change the requirement to 5 of the previous 8 years, but it was removed from the final bill
Mortgage Credit Certificates (MCC)

These allow first-time buyers of low and moderate income to claim a tax credit for 20% of the interest they pay for as long as they occupy the home as their personal residence

No change. The House version eliminated MCC, but that provision was removed in the final bill

Non-Real Estate Provisions

Personal exemption

$4,150 per person

Repealed—no more personal exemption at all
Standard Deduction

$13,000 (married filing jointly)

$6,500 (single)

$24,000 (married filing jointly)

$12,000 (single)

Alimony

Deductible, but recipient claims it as income

No longer deductible. Recipient no longer claims it as income.
Estate Tax

Tax applied to estates valued above $5.49 million ($11 million for married decedents)

Exclusion raised to $11.2 million for single decedent
Pass-through Income (corporations and LLCs)

No provision for any adjustments

20% reduction of pass-through income claimed, but with some limitations and conditions. Essentially, someone who owns a corporation whose income is reported on their personal tax return, that income will be treated at a lower rate than ordinary income. High earners, such as high-producing real estate agents and other professionals, will save a great deal of money with this provision
ACA insurance mandate

Those who do not have health insurance will pay a fine, which was deemed by the Supreme Court to be a form of tax

The ACA mandate is repealed effective 2019
Tax brackets

Seven brackets, ranging from 10%-39.6%.

A taxpayer reaches the top bracket with taxable income of $480,051

Seven brackets, ranging from 10% to 37%.

A taxpayer reaches the top 37% bracket with $600,000 taxable income. Someone earning $480,051 would see their tax bracket drop to 35% compared to the existing law

For those seeking a more detailed summary, visit “Tax Buzz” or the National Association of Realtors summary. This page is focused on how the law affects homeowners and real estate agents.

How the changes affect you:

The three-person household we have used for our example would see their taxes change like this:

   

If they don’t itemize their deductions, they’ll see their taxes go down because of the lower marginal tax bracket and the doubled child credit. The credit is temporary: it expires in 2025.

If the family can itemize their deductions the picture looks like this:

   

The total deductions the family can itemize under the new system amount to $2,500 more than the standard deduction. We have listed that as “additional” on the grid. They will reduce their tax liability by $766, compared to the $2,491 they would save if they were unable to itemize their deductions.

Where to go from here

If you want to examine different scenarios for yourself, do this:

  1. Print out the old and new tax tables from this page
  2. Write down your gross income for “old” and “new” scenarios
  3. Calculate your “old” taxes using either itemized deductions or the standard deduction as appropriate
  4. Calculate the “new” taxes in the same way
  5. Compare

If you are handy with a spreadsheet, you’ll save a great deal of time, at least with the simple math part.

I’ll reiterate: I am not a CPA, tax preparer or tax attorney. I do my best to be accurate, but you should not consider any of what you have just read to be tax advice. You should get that from a licensed professional, not Some Guy on the Internet (me).

You are welcome to reach out to me, however. My direct line is 925-383-2846. If I am unable to pick up, please leave a message.

Joe Parsons

 

 

 

brexit graphicYou have probably heard about the important vote in the United Kingdom: Britain will leave the European Union. What you may not know is the effect an event in Europe could have on you here in California.

How “Brexit” affects you

The results of Thursday’s election in the UK has roiled financial markets all over the globe. The U.S. stock market reacted with heavy selling: the Dow Jones Industrial Average was down more than 500 points at times. This volatility causes “flight-to-safety” buying—investors sell stocks, but move their cash into safer investments, such as U.S. Treasury bonds, which are viewed as having nearly zero risk.

They also pour money into Mortgage Backed Securities, which are also very safe, but with a much higher yield than Treasuries.

All this buying of bonds means that their prices are moving higher. This is welcome news for anyone in search of a new mortgage to buy or refinance a home in the San Francisco Bay Area.

Mortgage lenders sell most of their loans to investors. Fannie Mae and Freddie Mac top the list of these investors. These two mortgage giants pool the loans they have bought into a type of bond called Mortgage Backed Securities (MBS). When the demand for MBS is higher, their price increases. This higher price means that the lenders can sell their loans for a higher price, so they lower the interest rates on the mortgages they offer.

The news of Britain’s exit from the European Union (“Brexit”) has sparked furious activity in the financial markets worldwide. This morning’s chart for the MBS looks like this:

MBS Chart

The mortgage market at the open on Friday 6/23/16

Each green bar means that the price of the MBS increased from the day before. A long bar means a large change in price. The MBS market normally moves 10-25 points from one day to the next. Today, however, the market opened with a 75-point gain from yesterday’s close. This is an unusually large increase.

What this means for you

Lenders look at the MBS market each day as they prepare their rate sheets. Because of today’s sharp gain, rates are lower—nearly .25% lower than yesterday’s pricing.

What you should do now

If you are thinking about buying soon anywhere in the San Francisco Bay Area, now is a good time to act; today’s lower rates mean a lower payment for the home you want—or more home for the payment you can afford. If you are considering a refinance, you should lock a rate as soon as possible; your potential savings are higher today than ever before. Keep in mind that it is highly unlikely that rates will move any lower than they are today—but very likely that they will “bounce” higher in the very near future.

Be careful!

Any time the market makes big moves like this one, there is increased volatility—prices make wide swings in both directions. Holding out for further improvement could lead to disaster: you could miss the boat entirely.

We are here to help you take advantage of this opportunity. You can call us anytime at 925-383-2846.

house with plans

It’s not that hard to get a mortgage

The Narrative

If you pay attention to print and broadcast media, you’ve seen stories—lots of them—about how hard getting a mortgage is today. Banks have been upping their standards, they say, cherry picking only the very best applicants with flawless credit scores, lots of money in the bank for large down payments and long tenure at the same job.

Are banks being super picky?

The Chief Economist for Realtor.com, Jonathan Smoke, says that banks are being so picky because today’s low interest rates, combined with suffocating regulations, mean that they don’t make enough money on each loan to justify accepting anyone other than near-perfect borrowers. Some researchers point to very high average credit scores (754 last year) as evidence that the banks have raised their standards high enough to exclude many or most applicants.

This narrative is utterly false.

What’s the REAL story?

The truth is this: the vast majority of people with a credit score of 620 or higher and an ability to document their income and assets will be able to get a conventional mortgage for as much as 97% of the property’s purchase price. If a borrower’s low score is the result of current collection accounts or judgments, they’ll have to deal with them in some way; but their loan will be approved. Borrowers with scores as low as 580 can get an FHA loan with as little as 3.5% down.

Most loan applications today are processed using an Automated Underwriting System, or AUS. Mortgage giants Fannie Mae and Freddie Mac provide the two most commonly used. If an applicant’s loan is approved through the AUS and the loan officer has correctly input the borrower’s income and assets, most lenders will approve the loan.

Do lenders drag their feet?

Some journalists have claimed in widely circulated articles that lenders are reluctant to make loans to less-than-perfect borrowers because with today’s low rates, they don’t make enough money. Those who make these claims clearly do not understand how lenders originate and fund mortgages.

How mortgage lending really works

The lender, a mortgage bank, takes a loan application. Once they have approved the loan, they give the borrower the money. These funds come from a specialized line of credit called a “warehouse line.” After close of escrow, the bank sells the loan to an investor. The investor (e.g. Fannie Mae or Freddie Mac) pays a premium for the loan—in other words, they pay more than the face amount of the loan. The bank uses part of the proceeds to pay off the warehouse line to free it up for funding another loan. The rest goes to pay salaries and overhead and make a small profit.

Do low rates put a lid on lending?

The bank does not care what the mortgage rates are—not one bit. The bank sets its rates based on the prices the investor (Fannie Mae or Freddie Mac) pays for the loan. The margin—the “markup” on each loan they sell—remains essentially constant regardless of the rates in the marketplace.

How about the high credit standards?

The claim that mortgage credit standards are very tight is based on information from researchers: that the average credit score for conventional mortgages is currently 754. This is a very high score; a perfect score is 850. They conclude from this that lenders require such high scores.

That conclusion is false. The minimum permissible credit score for conventional loans has been 620 for several years, so it is far more likely that potential applicants with lower scores do not apply because they fear being rejected. This leaves more borrowers with higher credit scores, who skew the statistics.

This is why this prevailing narrative is so damaging. Borrowers with imperfect credit histories and less than a 20% down payment simply do not apply. After all: who wants to get rejected? This is a classic case of “self-fulfilling prophesy.”

Other myths

There are other incorrect assumptions in circulation. This has to do with how much loan a borrower can qualify for. A borrower qualifies for a loan based on his or her debt-to-income ratio (DTI). The lender adds up the housing expense (including taxes, insurance and mortgage insurance, if any) and all monthly debt payments. Dividing this number by the borrower’s gross monthly income gives a percentage, the DTI. If the housing expense is $2,000 and other debt is $475, the total debt is $2,475. If the borrower’s income is $5,500, the DTI is 45%. Some articles have claimed, that reducing the DTI as far as possible by paying off more debt will get a “better deal,” but this, too, is incorrect. Reducing consumer debt is a very good idea, but it will not improve the terms of a borrower’s loan.

What should you do now?

Many aspiring homebuyers sitting on the sidelines watching home prices increase. They know their situation is not perfect, and their hopes fade with the rising prices. If you are in this group, you should act—now. Here’s do today, while this is fresh in your mind:

  1. Know your credit status. You can get a free credit report by going to a site like freecreditreport.com or creditkarma.com. If there are collections or liens on your credit report, deal with them now. If there are errors on your credit report, get them corrected as soon as possible. You can do this on line, by going to the credit bureaus’ websites.
  2. Gather your financial documents: two years’ tax returns, a current month’s pay stubs and a bank statement showing where you’ll get your cash to buy.
  3. Make an appointment with a loan officer to discuss your plans and situation. You will learn what kind of loan you can get and, if you need to work on negative items on your credit report, what steps you should take.

The truth is that getting a mortgage today is more difficult today than it was before 2008. But that difficulty is not in qualifying for the loan. It is because there is a heavier burden of documentation (including a great many redundant disclosures) to move a loan application through the system.

You can do this

Getting a mortgage is not as easy as it once was—but it is NOT impossible. If home ownership is one of your dreams—especially if you are a first time home buyer—you should waste no more time on the sidelines. Rates are low, and prices are still reasonable. A good place to start is to contact us and start the conversation.

You CAN prove the journalists and pundits wrong. You CAN make home ownership a reality.

Just take the first step.

Real Estate Purchase Strategy

First time buyers are still important!

Since I’ve been involved in mortgage and real estate for nearly four decades, the media reaches out to me often for facts about our industry. This time. reporter Amy Fontinelle called me for information about first time home buyers. This is a subject near and dear to my hear, and she definitely got it right with this story. Amy leads off with.

Buying your first house can be exciting, but it can also be intimidating because of all the financial steps and real estate procedures you need to prepare for. Here’s what you need to know.

Check out the rest of Amy’s well-written article: https://www.massmutual.com/individuals/educational-articles/buying-your-first-home

You can see other articles where reporters have used my experience here.

 

falling mortgage ratesIf you own a home today, you are almost certainly being subjected to an avalanche of direct mail urging you to refinance your mortgage. Ads on the radio and TV are in your face constantly, making the same pitch.

If you’re like most people, you tune them out.

Now may be the time to act. Here’s why: First, you should understand how lenders determine the rates they offer. Almost all loans are sold on the secondary market; Fannie Mae and Freddie Mac are the two largest investors in these loans. They pool those millions of home mortgages into a type of bond called a Mortgage Backed Security (“MBS” for short), which is then traded on Wall Street like any other bond.

When there is high demand for the MBS, the price goes up. When that happens, rates drop–because the banks issuing the mortgages can now sell them to the investor for a higher price. The banks pass that improvement on to you, the consumer.

The chart below shows what the MBS have been up to since December 30 of last year. The green bars represent those days when the MBS price increased, the red ones, when it declined.

Do you notice a trend?

MBS rally

To put this into perspective, because of the long rally in bonds, we have seen mortgage rates drop  significantly. What’s significant? Here’s an example: On December 29 of last year, you could have locked a 30 year fixed rate mortgage at around 4.25% without paying any discount points. Today, the same loan will be 3.625%–that’s a 5/8% lower rate. That’s the lowest point in 12 months. To find a lower rate, you’d have to go back three years or more.

Is it worth refinancing now? Possibly. For a loan of $400,000, for example, with a rate of 4.125%, dropping your rate to 3.625% will cut your monthly payment by close to $150 a month. You’d save over $6,000 in the first five years–after recovering the cost of doing the refinance.

You should be aware that when rates have a prolonged rally as they have done this year, there is a very good chance that they’ll turn around and go back up with no warning. At a minimum, you should look at the numbers for your own situation to determine whether you can benefit.

If you’d like to start the process now, click on the “Get Started”  button below.

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Please note: none of the foregoing should be interpreted as a rate quote. The interest rate you can get will be determined by a detailed analysis of your financial profile.

Rocket

Since when is a mortgage like a rocket?

Anyone watching the Superbowl on Sunday couldn’t miss the ad series for Quicken Mortgage’s “Rocket Mortgage.” If you bought into their pitch, you’d think that you’d download their app, hit a couple of buttons on your phone and get your mortgage in minutes—like magic.

The government agency charged with protecting consumers, aptly named the Consumer Financial Protection Bureau, took notice, sending out this tweet:cfpb rocket mortgage tweet

Setting aside the possibility of returning to the too-easy lending standards that led up to the meltdown of 2008, the real problem with this ad is how much it disregards the real process of getting a mortgage today.

It doesn’t mention that a borrower will still have to supply income and asset documentation. They’ll still have to get an appraisal—and they won’t be able to order the appraisal until they’ve received all the disclosures required by law.

The ads don’t say that an underwriter will have to paper trail any “large” deposits showing up in the applicant’s bank statement. “Large” could be as little as $500.

They don’t tell you that you’ll have to write letters of explanation for every derogatory entry, or every inconsistency in the past addresses listed on your credit report.

If you believed Quicken’s pitch, you’d think they were the only geniuses who figured out automated underwriting. The fact is that almost ALL loan originators use one of two automated underwriting systems (AUS): Desktop Underwriter (Fannie Mae) or Loan Prospector (Freddie Mac). Any loan originator can get your information, run your credit and give you a preliminary loan decision in minutes.

Oh, and one other thing? We small, local lenders actually return phone calls.

News ReporterAre subprime mortgages coming back?

I speak to a lot of journalists; between the circulation of “The Mortgage Insider” and the fact that I’ve been around as long as I have, they look to me as an authority for their stories.

The latest was in the influential trade magazine, “Scotsman’s Guide.” Reporter Victor Whitman reached out to me last week to get thoughts on subprime mortgages, and whether they are making a comeback. I had an opportunity to get back on my favorite soapbox–that there is a false narrative about how hard it supposedly is to get a mortgage. I’ve been writing on that topic for years–most notably in this article.

You can find the Scotsman article HERE.

All about appraisals

application button

Whether you are buying or refinancing, getting a mortgage means getting an appraisal. Although a licensed appraiser does use some judgment in coming up with an opinion of value, the process is not as arbitrary or subjective as you might think. This movie explains how it all works.

Transcript:

One important part of your mortgage process is the appraisal. The lender will require this report to be sure there is adequate security for the loan they are about to give you. They want to have a good idea of the property’s value as part of the underwriting process.

Here’s how an appraisal is done. The appraiser, who is licensed by the State, will visit your property. He or she will measure it, take pictures and, for some loan programs, do a quick inspection to make sure there are no health or safety problems. The appraiser will describe the property, called the Subject Property, in a standardized way: square footage, room count, amenities, lot size, condition…things like that.

Then the appraiser will find at least three other properties (”comparable sales” or “comps”) similar to the subject and in close proximity that have have sold within the previous six months. They will describe each one of these in the same standardized way as they did the subject.

Having done that, the appraiser makes dollar adjustments to the comps to make them the equivalent of the subject. A comp with 200 square feet more living space than the subject would carry a negative adjustment of around $10,000. After adjusting the comps, the appraiser calculates a weighted average to arrive at an opinion of value. The lender will use this value to calculate its maximum loan. If your transaction is a purchase, the lender will use the lower of the appraised value or the agreed purchase price.

What is an escrow, anyway?

There’s all this talk about “escrow;” it opens, we’re in escrow, it closes. What is “it,” anyway? What happens there? Who does what? This movie explains all.

Transcript:

If you’ve never bought a house before, you may be wondering about this mysterious thing called “Escrow.” It opens, it closes, we’re in it…what is “it,” anyway?

The escrow is just a neutral third party whose job it is to make sure everyone gets what they agreed to. The escrow officer, usually someone who works for a title company, coordinates all the many documents that make up your transaction.

After all the parts of the transaction have been brought together, the escrow officer will prepare the “instructions.” This document has all the numbers and terms that you and the seller have agreed on—and they have to match perfectly, or else the transaction can’t go forward. When you sign the buyer’s instructions and all the other paperwork, you’re saying that those are the terms you agreed to.

After you’ve signed your name a whole lot of times, the escrow officer puts everything into a “funding package” and sends it off to the lender. A day or two later, the money is wired into the escrow. This is called “funding.” Documents are then recorded at the County and you own the house. This is the Close of Escrow. Most of it happens behind the scenes, but we think it is good for you to know what that whole process is.

For many first time home buyers, finding out that they’ll have to come up with closing costs along with their down payment can come as a rude surprise. For mortgages requiring a low down payment, like FHA, VA and 97% conventional loans, the closing costs can be more than the down payment. This movie explores what closing costs are, and suggests some strategies for handling them when you’re short on cash.

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