House-Hacking Rental Property


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House-hacking refers to buying a multifamily property on an owner-occupied mortgage, living in one unit and renting the others. If you’re thinking about becoming a rental mogul, starting early is an advantage. Not only will you have longer to accumulate a larger portfolio, you can increase the leverage on the first acquisitions if they are owner-occupied.

Leverage is the use of other people’s money to finance an investment. The higher the loan-to-value, the greater the leverage which can increase the yield.

A $200,000 rental property with an 80% LTV at 4.5% for 30 years producing a 16.88% before-tax rate of return would increase to a 23% return on investment by increasing the mortgage to 90%. A typical down payment on an investor property in today’s market is 20-25% but, in some cases, a higher loan-to-value is possible.

Owner-occupied, multi-unit properties, two to four units, allow a borrower to occupy one of the units and rent the others out. The cash flows from the rental units subsidize the cost of housing for the unit occupied by the owner. VA will guarantee 100% of the mortgage for eligible veterans, while FHA will loan up to 96.5% for qualifying borrowers.

Consider a four-unit property was purchased as owner-occupied and the other three units were rented for $800 each. If an FHA loan was obtained, the owner could live for roughly $355 a month after collecting the rent and paying the expenses. Assume the owner lived in it for two years and then, rented out the fourth unit for the same $800 per month. The cash flow would rise to $4,800 a year with a before-tax rate of return of 30% based on a 2% appreciation.

Occupy 1 unit Rent all 4 units
Gross Scheduled Income @ $800 monthly each $2,400 $3,200
Cash Flow Before Tax $4,59 $4,861
Before Tax Rate of Return 20.77% 30.56%

Rental properties offer the investor to borrow large loan-to-value mortgages at fixed interest rates for up to 30 years on appreciating assets with tax advantages and reasonable control that many other investments don’t enjoy.

Some people consider rental properties the IDEAL investment with each letter in the acronym standing for a benefit it provides. It provides income from the rent which many investments do not have. Depreciation is a non-cash deduction from income that increases cash flow. Equity buildup occurs as each payment is made by reducing the principal owed. Appreciation happens over time as the value of the property increases. L stands for leverage that was explained earlier in this article.

You may be able to buy another four unit as an owner-occupant before you need to start using a normal investor’s down payment. In the meantime, you could have eight units that are increasing in value while the mortgage balance is decreasing with every payment made. If there is sufficient equity in the properties by the time, you’re ready to buy more, you may be able to take cash out of the existing ones to use for the down payments.

This can be a great way to turbocharge your net worth by becoming an owner and a real estate investor at the same time. To learn more about rental properties, download the Rental Income Properties guide and/or contact me at (503) 289-4970 to schedule an appointment to meet to discuss the possibilities.

Who Earns the Commission?


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What do you think the motivating reason would be for the 5% of all homebuyers who chose not to work with an agent but instead conducted their own home search, contacted the seller, negotiated the contract, located their financing, arranged their inspections and all of the other services provided by REALTORS®? Most people would probably guess the buyers were wanting to do the work themselves and earn the commission in the form a lower purchase price.

Looking at it from the seller’s perspective, what would be the reason for the 8% of all home sellers who chose not to work with an agent but instead did their own research to determine the value of their home, coordinated all of the marketing efforts necessary to have sufficient exposure to the market, negotiate directly with the buyer, and investigate all of the other steps necessary to close the sale? Is it possible and even probable, that they too were trying to earn the commission and net more proceeds from the sale?

If the home sold for fair market value, it would be reasonable to assume that the seller won out over the buyer. If it sold for less than market value, it seems that the seller didn’t realize his full equity in the home. In either case, both buyer and seller engaged in activities that they were less experienced and capable than the real estate professional.

The Profile of Home Buyers and Sellers (Exhibit 8-1) reports that 14% of sales were For-Sale-by-Owners in 2004 compared to just 8% in 2019. The trend shows that agent-assisted sales rose to 89% in 2019 from 82% in 2004.

The three most difficult tasks identified by for-sale-by-owners is getting the price right, preparing or fixing up the home for sale, and selling within the length of time planned.

The time on the market for sale by owners experienced was less than that of agent assisted homes; two weeks compared to three weeks. This could indicate that the home didn’t maximize its potential sales price. According to the previous mentioned survey, for sale by owners typically sell for less than the selling price of other homes.

The reality is that both parties cannot earn the commission. It is earned by providing specific services that are essential to the transaction. The capital asset of a home represents the largest investment most people make. An investment of that importance certainly deserves the consideration of a professional trained and experienced to handle the complexities involved. There is value to having a third-party advocate helping each party to the transaction.

The tasks involved in buying and selling a home exist and must be done. Since nine out of ten transactions involve an agent and therefore, a commission. It comes down to deciding which is more important: time or money. If a buyer or seller values their time more than the commission, they’ll usually work with an agent. If money is more valuable to a buyer or seller, they may try purchasing or selling without an agent. One thing is for sure: there are two parties to the transaction and only one commission.

Take the Standard Deduction & the Home


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Now that the standard deduction is increased to $12,200 for single taxpayers and $24,400 for married ones, many homeowners are better off with the standard deduction than itemizing their deductions to write off their mortgage interest and property taxes. There was some speculation that without the tax advantages, homeownership is not the investment it once was.

By looking at the other benefits, you can see that homeownership is still one of the best investments people can make.

A $275,000 home financed with a 4.5%, 30-year FHA loan would have an approximate total payment of $2,075. The difference in the value of the home and the amount owed on the mortgage is called equity. Two things cause equity to increase: the home appreciating in value and the principal loan balance being reduced with each payment made on an amortizing loan.

In this example, if the home were appreciating at 2% annually, the value would increase by $5,500 the first year which would be $458.33 per month. At the same time, with each payment made, an increasing amount would reduce the unpaid balance which would average $363.00 a month in the first year.

The homeowner’s equity would increase over $800 a month. Instead of paying rent, the homeowner is building equity in their home. It becomes a forced savings and lowers their net cost of housing. In seven years, the homeowner in this example would have $80,901 in equity instead of seven years of rent receipts.

This example doesn’t consider tax advantages at all. If the homeowner would benefit from itemizing their deductions, it would lower their cost of housing even more.

The IRS recommends each year to compare the standard and itemized deductions to see which would benefit you more. Items such as substantial charitable donations, mortgage interest, property taxes and large out-of-pocket medical expenses could increase the likelihood of itemizing deductions.

You can see the benefits using your own numbers without tax advantages by using the Rent vs. Own.

Understanding Reverse Mortgages


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Reverse mortgage loans are like traditional mortgages that permits homeowners to borrow money using their home as collateral while retaining title to the property. Reverse mortgage loans don’t require monthly payments.

The loan is due and payable when the borrower no longer lives in the home or dies, whichever comes first. Since no payments are made, interest and fees earned are added to the loan balance each month causing an increasing unpaid balance. Homeowners are required to pay property taxes, insurance and maintain the home, as their principal residence, in good condition.

Reverse mortgages provide older Americans including Baby Boomers access to their home’s equity. Borrowers can use their equity to renovate their homes, eliminate personal debt, pay medical expenses or supplement their income with reverse mortgage funds.

Homeowners are required to be 62 years and older and meet the following requirements:

  • Own the home free and clear or owe very little on the current mortgage that can be paid off with the proceeds
  • Live in the home as their primary residence
  • Be current on all taxes, insurance, and association dues and all federal debt
  • Prove they can keep up with the home’s maintenance and repairs

Payouts are based on the age of the youngest spouse. The younger the age, the less money can be borrowed. Reverse mortgages offer two terms … a fixed rate or variable rate. Fixed rate HECMs have one interest rate and one lump sum payment. Variable rate loans offer multiple payout options:

  • Equal monthly payouts
  • A line of credit with access until the funds are gone
  • Combined line of credit and fixed monthly payments for a specified term
  • Combined line of credit and fixed monthly payments for the life of the loan

Traditional reverse mortgages, also called Home Equity Conversion Mortgage, HECM, are insured by FHA. There are no income limitations or requirements and the loan funds may be used for any purpose. The borrower must attend a counseling session about the HECM, its risk, benefits, and how much can be borrowed. The final loan amount is based on borrower’s age and home value. FHA HECMs require upfront and annual mortgage insurance premiums but can be wrapped into the loan.

Proprietary HECM loans are not federally insured. Lenders create their own terms, including allowing loan amounts higher than the FHA maximum. Proprietary HECMs don’t require mortgage insurance (upfront or monthly), which may result in more funds available. Proprietary reverse mortgages typically have higher interest rates than FHA HECMs.

Advantages

  • Create a steady stream of income during retirement
  • The proceeds aren’t taxed or risk borrower’s Social Security payments
  • Title and rights to the home are retained by the homeowner
  • Monthly payments are not required

Disadvantages

  • The loan balance increases over time rather than decreases as with an amortizing loan
  • The loan balance may exceed the property value eliminating inheritance
  • The fees may be higher than traditional mortgage loans
  • Any absence of the home for longer than 6 months for non-medical or 12 months for medical reasons makes the loan due and payable

More information is available about reverse mortgages from the Consumer Financial Protection Bureau or Federal Trade Commission or HUD.gov.

Downsizing in 2020


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Approximately 52 million or 16% of Americans are age 65 and over. It is easy to understand that some of them are thinking of downsizing their home because they don’t need the same space they did in the past.

It can be liberating to divest yourself of “things” that have been accumulated over the years but are no longer needed. Moving to a less expensive home, could provide savings for unanticipated expenditures or cash that could be invested for additional income.

Savings can be realized in the lower premiums for insurance and lower property taxes, as well as, the lower utility costs associated with a smaller home.

Typically, owners downsize to a home to 2/3 to 50% of their current home’s size. In some situations, it is not only economically beneficial, but their interests may have changed so that a different style of home, area or city might fit their lifestyle better.

The sale of a home with a lot of profit will not necessarily trigger a tax liability. Homeowners are eligible for an exclusion of $250,000 of gain for single taxpayers and up to $500,000 for married taxpayers who have owned and used their home two out of the last five years and haven’t taken the exclusion in the previous 24 months.

Homeowners should consult their tax professionals to see how this may apply to their individual situation. For more information, you can download the Homeowners Tax Guide.

Call me at (503) 289-4970 to find out what your home is worth and what it would take to make the move to another home.

Another Source for a Down Payment


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Borrowing from a 401k, 403b or the cash value of life insurance policy is a common financial strategy. While taxpayers are not allowed borrow from either a traditional or Roth IRA, they can withdraw funds before age 59 ½ for specific purposes like a first home purchase, qualified higher education expenses or permanent disability without incurring a 10% penalty.

First-time home buyers can make a penalty-free withdrawal of up to $10,000 if they haven’t owned a home in the previous two years. This would allow a married couple who each have an IRA to withdraw a lifetime maximum of $10,000 each, penalty-free for a home purchase.

In many cases, the money would be used for a down payment or closing costs. However, some buyers might consider this source to increase their down payment so they could qualify for a loan without mortgage insurance.

There is another condition where a taxpayer can withdraw money from their IRA without triggering the tax or penalty if it is returned to the IRA within 60 days. This can only be done once in a 12-month period. Unless you’re certain you can redeposit the money in the strict time frame, the potential tax and penalties makes this a risky and expensive way to arrange temporary funds.

If the taxpayer qualifies for the penalty-free withdrawal, there may still be taxes due. Contributions to traditional IRAs are made with before-tax dollars and the tax is paid when the funds are withdrawn. Since Roth IRAs are made with after-tax dollars, there is no tax due when the funds are withdrawn.

Another interesting fact about this provision is that the taxpayer making the withdrawal can help a qualified relative which includes children, grandchildren, parents and grandparents.

Before withdrawing money from an IRA, taxpayers should get advice from their tax professional concerning their individual situation.

Anticipating the Cost of a Home


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The largest expenditure a buyer has when purchasing a home is the down payment which can range from zero for veterans or 3.5%, 5%, 10% and 20%. With mortgages come closing costs which can be another 2-4% and must be paid at settlement in cash.

Most mortgages require an escrow account to pay the property taxes and insurance when they are due. Generally, the lender will require one to three months of taxes and one month of insurance so they can be paid before the actual due date.

First-time buyers should be aware that they’ll need this amount of funds available to purchase a home. Unlike tenants who are not responsible for repairs, homeowners are, and it is necessary to be able to pay for them when they’re needed.

Newer homes will need less repairs and older homes probably, more. At some point, components like the furnace, air-conditioner and appliances will need to be replaced which could crush a homeowner’s budget if they are not expecting them.

Homeowners should expect between one and four percent of the value of the home in annual repairs. The age and condition of the home and whether some of the items have been replaced will help assess the anticipated expenditures.

Components Estimated Life
Dishwasher 9-10 years
Refrigerator 13 years
Furnace 15-25 years
Air-conditioner 8-15 years
Stove top 13-15 years
Oven 15 years
Compactors 6 years
Water heater 8-12 years
Faucets 15-20 years

A $175,000 home with 2% estimated repair expenditures would be $3,500 a year or about $300 per month. Some years, it may not run that much and other years, it might be more. By anticipating the maintenance expenses, a homeowner is more likely to handle things when they arise.

Another way to handle the risk of unexpected repair expenses would be to purchase a home warranty. For $500 -700 a year, repairs and sometimes, replacements will be handled by the protection plan.

Call me at (503) 289-4970 for a list of trusted protection plans available in our area.