LifeFocus.com T. Young info@lifefocus.com www.LifeFocus.com
Buying a Home
March 28, 2010
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Table of Contents Homeownership ................................................................................................................................................ 12 What is it? ................................................................................................................................................ 12 Isn't it always smarter to buy rather than rent? ........................................................................................ 12 What are the benefits of homeownership? ...............................................................................................13 What should you think about when choosing a home? ............................................................................14 How do you find and buy a home? ...........................................................................................................14 How are vacation homes different? ..........................................................................................................15 What about selling a home? .....................................................................................................................15 Buying a Home ................................................................................................................................................. 16 What is it? ................................................................................................................................................ 16 Using an agent or buyer's broker ............................................................................................................. 16 Buying from the owner ............................................................................................................................. 17 Buying at an auction or foreclosure sale .................................................................................................. 17 What to do once you find the right house .................................................................................................18 Be sure you're getting clear title to the house .......................................................................................... 18 Be sure the house is in good condition .................................................................................................... 19 When does the house actually become yours? ....................................................................................... 19 Finding the Right Home .................................................................................................................................... 20 Introduction .............................................................................................................................................. 20 Before the search .....................................................................................................................................20 Consider your needs ................................................................................................................................ 20 Community living arrangements ...............................................................................................................20 Building a home ....................................................................................................................................... 22 Choosing a neighborhood ........................................................................................................................ 22 Make a list ................................................................................................................................................ 23 How Much Can You Afford? ..............................................................................................................................25 Introduction .............................................................................................................................................. 25
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Getting to the bottom line ......................................................................................................................... 25 Other housing expenses to factor in ........................................................................................................ 25 Lenders use qualifying ratios ................................................................................................................... 25 Mortgage prequalification and preapproval ..............................................................................................26 Make sure you really can afford it ............................................................................................................ 26 The Purchase Process ......................................................................................................................................27 What is the purchase process? ................................................................................................................27 What's the difference between making an offer and completing a purchase and sale agreement (P&S)? ..................................................................................................................................................... 27 How do you make an offer? ..................................................................................................................... 27 How much should you offer? ....................................................................................................................27 What terms should the P&S contain? ...................................................................................................... 28 Why should you schedule a home inspection? ........................................................................................ 29 What does a home inspection cover? ...................................................................................................... 30 What if the inspector finds problems? ...................................................................................................... 30 How do you find a reliable home inspector? ............................................................................................ 30 How much does an inspection cost? ........................................................................................................31 What's next? ............................................................................................................................................ 31 The Down Payment .......................................................................................................................................... 32 How much do you need for a down payment? .........................................................................................32 Can you get a low down payment mortgage? ..........................................................................................32 What about larger down payments? ........................................................................................................ 33 What about mortgages that don't require a down payment? ................................................................... 33 Investing money for a down payment ...................................................................................................... 33 Alternative Ways to Fund Your Down Payment ................................................................................................ 34 How much money will you need for a down payment? ............................................................................ 34 Funding alternatives .................................................................................................................................34 How Should You Own Your Home? ..................................................................................................................36 Introduction .............................................................................................................................................. 36 What are the most common forms of property ownership? ..................................................................... 36
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A note on community property ................................................................................................................. 37 The Closing Process ......................................................................................................................................... 38 What is the closing? ................................................................................................................................. 38 Before the closing .................................................................................................................................... 38 The closing ...............................................................................................................................................38 Using Title Insurance to Protect Your Interest in Your Home ........................................................................... 41 What is a title examination? ..................................................................................................................... 41 What are some common title problems? ..................................................................................................41 What is title insurance? ............................................................................................................................ 41 What about lender's title insurance? ........................................................................................................ 42 Mortgage Basics ............................................................................................................................................... 43 What is it? ................................................................................................................................................ 43 Prequalification vs. preapproval ............................................................................................................... 43 Applying for a mortgage ........................................................................................................................... 43 Mortgage brokers ..................................................................................................................................... 44 Private mortgage insurance ..................................................................................................................... 44 Escrow account ........................................................................................................................................45 Closing costs ............................................................................................................................................45 Buydowns ................................................................................................................................................ 45 Mortgage life/disability insurance ............................................................................................................. 46 Private Mortgage Insurance (PMI) .................................................................................................................... 47 What is private mortgage insurance (PMI) and why do you need it? .......................................................47 How much does PMI cost? ...................................................................................................................... 47 Can PMI ever be removed? ..................................................................................................................... 47 Are there any alternatives to paying PMI? ............................................................................................... 47 Choosing a Mortgage ........................................................................................................................................49 Introduction .............................................................................................................................................. 49 Fixed rate mortgages ............................................................................................................................... 49 Adjustable rate mortgages (ARMs) .......................................................................................................... 49
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Government mortgage programs ............................................................................................................. 51 Other types of mortgages .........................................................................................................................52 Mortgages from nontraditional lenders .....................................................................................................54 Mortgage Clauses ............................................................................................................................................. 56 What are mortgage clauses? ................................................................................................................... 56 Why are mortgage clauses important? .................................................................................................... 56 What is an acceleration clause? .............................................................................................................. 56 What is an assumption clause? ............................................................................................................... 56 What is a conversion clause? .................................................................................................................. 57 What is a due-on-sale clause? .................................................................................................................57 What is an escrow covenant? .................................................................................................................. 57 What is an insurance covenant? .............................................................................................................. 57 What is a prepayment clause? .................................................................................................................57 Prepayment and Biweekly Mortgage Payments ............................................................................................... 58 Introduction .............................................................................................................................................. 58 How prepayment affects a mortgage ....................................................................................................... 58 Biweekly payment schedules ................................................................................................................... 59 Income Tax Considerations for Homeowners ................................................................................................... 61 Introduction .............................................................................................................................................. 61 First-time homebuyer tax credit ................................................................................................................61 Additional standard deduction for non-itemizers ...................................................................................... 62 Can you deduct your mortgage payments? ............................................................................................. 62 How are points and closing costs treated for tax purposes? ....................................................................63 What is the tax treatment of home improvements and repairs? ...............................................................64 Property Taxes ..................................................................................................................................................66 What are property taxes? .........................................................................................................................66 How property taxes are determined ......................................................................................................... 66 Property taxes vary, depending on location ............................................................................................. 67 Paying property taxes .............................................................................................................................. 67
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Deducting property taxes on your income tax return ............................................................................... 67 Special Considerations for Second/Vacation Homes ........................................................................................69 Introduction .............................................................................................................................................. 69 Should you buy a vacation home? ........................................................................................................... 69 How much will it cost to own a vacation home? .......................................................................................69 What to look for in a vacation home .........................................................................................................70 How do you insure a vacation home? ...................................................................................................... 71 What about renting your home to others? ................................................................................................71 What are the income tax consequences of owning a second or vacation home? ................................... 71 Timeshares ....................................................................................................................................................... 73 What are timeshares? .............................................................................................................................. 73 Types of timeshare ownership ................................................................................................................. 73 Other types of timeshare programs ..........................................................................................................73 How much does it cost? ........................................................................................................................... 74 Tax consequences of owning a timeshare ...............................................................................................74 Purchasing a timeshare ........................................................................................................................... 74 Is a timeshare right for you? .....................................................................................................................75 Homeowners Insurance .................................................................................................................................... 76 What is homeowners insurance? ............................................................................................................. 76 Who is covered? ...................................................................................................................................... 76 What is covered? ..................................................................................................................................... 77 What is not covered? ............................................................................................................................... 78 Questions & Answers ...............................................................................................................................79 Flood Insurance ................................................................................................................................................ 80 What is flood insurance? ..........................................................................................................................80 Do you need flood insurance? ................................................................................................................. 80 How can you purchase flood insurance? ................................................................................................. 80 How much flood coverage can you obtain? ............................................................................................. 80 How much does flood insurance cost? .................................................................................................... 80
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What else should you know about flood insurance? ................................................................................ 81 Vacation Home Tax Considerations ..................................................................................................................82 What are vacation home tax considerations? .......................................................................................... 82 Vacation home tax treatment ................................................................................................................... 82 Second home tax treatment ..................................................................................................................... 84 Deductibility of Points and Other Closing Costs ................................................................................................85 What is the deductibility of points and other closing costs? ..................................................................... 85 What are points? ...................................................................................................................................... 85 Are points deductible and when? ............................................................................................................. 85 What if the points are withheld by the lender from the loan proceeds? ................................................... 85 Can you deduct points paid by the seller? ............................................................................................... 86 Can you deduct points charged on a mortgage secured by a second home? ......................................... 86 If you are amortizing the deduction of points on a loan over the term of that loan and the loan ends early, how do you treat the points you have not yet deducted? ............................................................... 86 How are points paid on a refinanced loan treated? ..................................................................................86 Can other closing costs be deducted? ..................................................................................................... 86 First-Time Homebuyer Tax Credit .....................................................................................................................87 Introduction .............................................................................................................................................. 87 Home purchases made April 9, 2008 through December 31, 2008 ......................................................... 87 Home purchases made on or after January 1, 2009 and before November 7, 2009 ............................... 87 Home purchases on or after November 7, 2009 and before July 1, 2010 ............................................... 88 Special rules apply to members of the uniformed services ......................................................................89 Electing to treat purchase as if made in prior year ...................................................................................90 Allocating the credit between individuals who aren't married ...................................................................90 Summary of general rules (table) .............................................................................................................90 Popular Types of Mortgages ............................................................................................................................. 92 Less Common Mortgage Options ..................................................................................................................... 93 Personal Liability Umbrella Insurance ...............................................................................................................94 Buying a Home ................................................................................................................................................. 95 How much can you afford? ...................................................................................................................... 95
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Mortgage prequalification vs. preapproval ............................................................................................... 95 Should you use a real estate agent or broker? ........................................................................................ 95 Choosing the right home .......................................................................................................................... 96 Making the offer ....................................................................................................................................... 96 Other details .............................................................................................................................................96 The closing ...............................................................................................................................................96 Applying for a Mortgage .................................................................................................................................... 98 Before you apply ...................................................................................................................................... 98 What you'll need when you apply .............................................................................................................98 Prequalification and preapproval ..............................................................................................................98 Finalizing the application ..........................................................................................................................99 Refinancing Your Mortgage .............................................................................................................................. 100 When to do it ............................................................................................................................................ 100 The cost of refinancing .............................................................................................................................100 No cash-out versus cash-out refinancing .................................................................................................101 The Housing and Economic Recovery Act of 2008 ..................................................................................101 The Making Home Affordable Plan .......................................................................................................... 102 Tax Benefits of Home Ownership ..................................................................................................................... 103 First-time homebuyer tax credit ................................................................................................................103 Temporary additional standard deduction for non-itemizers .................................................................... 104 Deducting mortgage interest .................................................................................................................... 104 Tax treatment of real estate taxes ............................................................................................................104 Tax treatment of home improvements and repairs .................................................................................. 104 Deducting points and closing costs ..........................................................................................................105 Exclusion of capital gain when your house is sold ................................................................................... 105 Opening the Door to Homeowners Insurance ...................................................................................................107 Why you need it ....................................................................................................................................... 107 Property coverage ....................................................................................................................................107 Liability coverage ..................................................................................................................................... 108
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Purchasing homeowners insurance ......................................................................................................... 108 Insuring a New Home During Construction .......................................................................................................109 You can insure your new home during construction with a homeowners policy ...................................... 109 Liability and theft coverage are provided ................................................................................................. 109 A dwelling and fire policy is another option .............................................................................................. 109 Workers' compensation coverage ............................................................................................................109 What if you're the boss? ...........................................................................................................................110 Re-evaluate your coverage when construction is complete .....................................................................110 Insuring a Condo or Co-Op ............................................................................................................................... 111 The master policy .....................................................................................................................................111 Additional coverage for improvements .....................................................................................................111 What your personal policy will and will not cover ..................................................................................... 111 The dwelling policy alternative ................................................................................................................. 111 Loss assessment ..................................................................................................................................... 112 Loss settlement ........................................................................................................................................ 112 Read your policy before making a claim .................................................................................................. 112 Coordination of benefits under the master policy and personal policy .....................................................112 Insuring Your Vacation Home ........................................................................................................................... 113 What is covered under your primary residence's homeowners insurance? .............................................113 What is a dwelling fire policy? .................................................................................................................. 113 What about liability insurance? ................................................................................................................ 113 How much does it cost? ........................................................................................................................... 113 Which mortgage is better--fixed rate or adjustable? ......................................................................................... 114 What's private mortgage insurance (PMI), and can my mortgage lender require me to have it? ..................... 115 I'm a first-time homebuyer, without a lot of cash to put down. What type of mortgage would be best? ............116 What's the Homestead Act? ..............................................................................................................................117 What's involved in getting a VA mortgage? ...................................................................................................... 118 How much money do I have to put down to buy a house? ............................................................................... 119 Can I buy a house with no money down? ......................................................................................................... 120
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What are the advantages of making biweekly mortgage payments? ................................................................121 What is involved in buying a house that's for sale by owner? ...........................................................................122 Should I choose a mortgage with no points and pay a higher interest rate? .................................................... 123 My mortgage includes an early-payoff penalty statement. What does that mean? ...........................................124 Should I buy a home or continue renting? ........................................................................................................ 125 Can I use a piggyback mortgage as an alternative to private mortgage insurance (PMI)? ...............................126 Can my mortgage lender require me to have an escrow account? ...................................................................127 Does homeowners insurance cover losses that occur outside my home? ....................................................... 128 I'm building a new home. Do I need to insure it while it's under construction? ................................................. 129 How can I reduce the cost of my homeowners insurance? ...............................................................................130 I need to file a claim on my homeowners insurance. How do I do this? ........................................................... 131 Will I have trouble getting homeowners insurance if my dog has bitten someone in the past? ........................ 132 How can I insure my possessions during a move? ........................................................................................... 133 I'm placing some items into self-storage. Will they be covered under my homeowners insurance? ................ 134 Why do I have to purchase homeowners insurance in order to obtain a mortgage? ........................................ 135 What is a hurricane deductible? ........................................................................................................................136 Should my partner and I buy a house together even though we're not married? ............................................. 137 We just bought our first home. What can we deduct from the settlement statement? ...................................... 138 Does my homeowners insurance cover what's in my yard? ............................................................................. 139 What are points, and do they affect my insurance rates? ................................................................................. 140 Will my condo association's master policy cover my property? ........................................................................ 141 Do I need title insurance if I'm buying a condominium? ....................................................................................142 Can I save money on my homeowners insurance premium if I install a home security system? ..................... 143 My property is close to a river. Do I need flood insurance? .............................................................................. 144 How do I insure my historic home? ................................................................................................................... 145 I'm planning to add an in-law apartment to my home. How will this affect my homeowners insurance? .......... 146 Do I need flood insurance if I buy a third-floor condo on the beach? ................................................................147 Is landscaping covered under my homeowners insurance? ............................................................................. 148 Are hunting rifles covered under my homeowners insurance? ......................................................................... 149
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If my home is destroyed, will my homeowners insurance cover my living expenses until I rebuild? ................ 150 Are manufactured homes safer these days? .................................................................................................... 151
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Homeownership What is it? If you're like most consumers, homeownership involves the largest financial transaction you'll participate in during your lifetime. As such, it's no wonder that the process of buying or selling a home can be so stressful, frustrating, and, at times, totally confusing. If you want to ensure that you make sound financial decisions and survive the process with your sanity intact, you should first educate yourself about real estate transactions and then engage in careful planning. Your first step should be to ask yourself: "Do I really want to own a home?"
Isn't it always smarter to buy rather than rent? Many people feel that renting is like throwing your money away, and that you should buy a house as soon as you can. However, this isn't necessarily true. Although there can be many benefits to homeownership, many people find renting more advantageous than buying. Which is better for you? To find out, you'll need to evaluate many nonfinancial and financial factors. Nonfinancial advantages of renting The nonfinancial advantages of renting include: • Moving is easier: Simply find a new home to rent, give the required notice, pack up, and move (although there may be some complications if you break a lease). This is particularly attractive to individuals who are often relocated by their employers. • You don't need to hire someone to do repairs: Is your faucet leaking, air conditioner blowing hot air, heater blowing cold air? No worries--just call the landlord. • You don't need to maintain the property: Need the driveway shoveled, the grass mown, or the leaves raked? Don't get up--most landlords include these services in the lease. Financial considerations Is renting really a better financial option than buying? Certainly you'll save some costs associated only with buying, such as a down payment (though if you rent you generally must pay two months up front plus a security deposit), closing costs, and property taxes. You may even save on other expenses of owning, like purchasing new furniture/appliances, landscaping, or remodeling. And, you can generally rent an apartment, house, or condo for less than the monthly cost of buying the same space. The answer seems easy, doesn't it? But this is deceiving. Rent payments are not deductible on your federal income tax return (although some of it may be deductible on your state return), but mortgage interest and property taxes are if you itemize. As a result, the effective cost of owning a home may be lower than it appears compared to renting. To get an accurate comparison, you need to calculate after-tax costs. Further, there are other financial benefits of buying (e.g., equity) that you must consider. For more information on the financial benefits of homeownership, see below. Tip: The rent vs. buy calculation is complicated and many factors come into play, such as the price of the home, the amount of your down payment, current interest rates, the current property tax rate, your income tax bracket, how long you intend to live in the home, and the amount of rent you're currently paying. You may want to seek the help of a financial advisor to determine whether renting or buying makes better sense for you.
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What are the benefits of homeownership? For many, owning a home represents the American dream--a back yard, privacy, a place to call your own. If you're committed to fulfilling that dream, you'll never be happy renting regardless of any advantages doing so may hold. Other advantages of homeownership include: Stability and flexibility Owning your own home can provide a certain sense of security. You won't be faced with the prospect of finding yourself without a place to live if your landlord dies suddenly or decides to sell the building, and you won't have to deal with increases in rent. Caution: The price of this stability is a certain amount of risk. If you become delinquent in your house payments, your mortgagor may foreclose and pursue a forced sale of your home--and you may lose money on the sale. Renters are not faced with this possibility because they do not own the property in which they live. As a homeowner, you'll also have almost unlimited flexibility to personalize your home. From painting and wallpapering to landscaping to putting in a skylight or even adding a room, the possibilities are endless. Renters typically don't have this freedom. Financial benefits Income tax deductions: As you're probably aware, federal tax laws strongly favor homeowners. Mortgage interest and property taxes are tax deductible, provided you itemize your deductions. If your total itemized deductions exceed the standard deduction ($11,400 for married taxpayers filing jointly in 2010), this can provide the potential for an enormous tax benefit, especially in the early years of homeownership. For more information, see our separate topic discussion, Income Tax Considerations for Homeowners. Tip: For 2007 through 2010 only, premiums paid or accrued for qualified mortgage insurance is treated as deductible mortgage interest. Qualified mortgage insurance means mortgage insurance provided by the VA, FHA, and Rural Housing Authority as well as private mortgage insurance (PMI). The amount of the deduction is phased out if your AGI exceeds $100,000 ($50,000 if married filing separately). This provision does not apply with respect to any mortgage contract issued before January 1, 2007 or after December 31, 2010. Tip: A federal income tax credit equal to 10 percent of the purchase price of a home, up to $8,000 ($4,000 if married filing a separate return), may be available to individuals who qualify as first-time homebuyers. The first-time homebuyer tax credit is available only for homes purchased prior to May 1, 2010 (July 1, 2010, if a written binding contract for the sale is entered into prior to May 1, 2010). Several requirements and limitations apply. Tip: Under the Housing and Economic Recovery Act of 2008, homeowners can take an additional standard deduction of $500 ($1,000 if married filing jointly) for property taxes if the taxpayer does not itemize deductions. This deduction is available for taxable years beginning in 2008 and 2009 only. Gain on sale exclusion: If you sell your home and qualify, you may exclude up to $250,000 of your capital gain from tax. For married couples, the exclusion is $500,000. Equity: As a homeowner, you can borrow against the equity in your home, using either a second mortgage or a home equity line of credit. The interest on a home equity loan of up to $100,000 is also tax deductible, regardless of how you use the money. Many homeowners use home equity loans to consolidate other high-interest loans, make repairs and improvements, and even fund a child's education. Lenders will generally allow you to borrow up to 80 to 90 percent of the value of your home. Asset appreciation: You may buy a home with a little of your own money (your down payment) and a lot of
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someone else's (your mortgage). However, if the value of your home increases, the profit is all yours when you sell it. You benefit from the increased value of the entire property, even though originally you used only a small portion of your own money to finance it.
What should you think about when choosing a home? When choosing a home, focus on determining what you need and how much you can afford. Your lifestyle and the size of your family will certainly influence your choice. So will the size of your income. What you need What you need in a home is, to a large extent, a personal matter. You may decide that you need that 16-room colonial, or you may find you can get what you need from a condominium, a co-op, or some other residential arrangement. Or, you might decide to build the home of your dreams. Whatever you decide, you must be able to afford it. What you can afford How much do you have for a down payment, and what size mortgage will fit your budget? Determining what you can afford is always a matter of running the numbers. When doing so, be sure to consider tax issues, such as the home mortgage interest deduction and real estate taxes. You should also include other considerations, such as the price of homeowners insurance. For more information, see our separate topic discussions, Alternative Ways to Fund Your Down Payment, Mortgage Basics, and Choosing a Mortgage . Once you've determined that the home you need is attainable at a price you can afford, you're ready to take the next step.
How do you find and buy a home? Finding a home Brokers and real estate agents can help you find a home. Since the seller of the property typically pays the broker, you may want to hire a buyer's broker to work for you. Sometimes you'll find a home that is listed as "for sale by owner." While such arrangements can eliminate brokers and broker's fees from the transaction, be wary. If you don't have a broker to help you navigate through the home-buying process, hiring an attorney to protect your interests is especially important. An attorney should make sure that your deal is properly documented and that you are obtaining a good and clear title to the property. Occasionally, a home is auctioned or foreclosed by a mortgage holder. You can get a good deal at such a public sale, but you can also buy yourself a big headache. Be cautious: The condition of the house, outstanding real estate taxes, and undisclosed liens can all turn your good deal into a bad one. For more information, see our separate topic discussion, Buying a Home. Buying a home Once a buyer and seller come together, the buyer typically submits a written offer to purchase the property. If the seller accepts the offer, additional terms of the sale are hammered out in a purchase and sale agreement and a closing is scheduled. Prior to the closing, a home inspection is advisable to determine whether there are any problems with the home that may not have been detected by a normal examination. At the closing, money and title instruments are transferred, and mortgage documents, title insurance documents, and other instruments required by the various parties are signed. For more information, see our separate topic discussions, The Purchase Process and The Closing Process. Forms of ownership There are many ways to own a home. The way that you own real estate is specified in the deed of title and determines what rights and protections you may or may not have with respect to the property. See our separate
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topic discussion, How Should You Own Your Home? for more information.
How are vacation homes different? In addition to the above issues, you'll have a few special considerations when thinking about buying a second/vacation home. For starters, vacation homes are typically considered a luxury. Accordingly, they receive different tax treatment, especially if you rent yours out to others during the time that you own it. Many buyers choose timeshare arrangements as an alternative to purchasing a traditional vacation home. A timeshare is a special type of real estate ownership for vacation homes.
What about selling a home? First, consider all of your alternatives, such as making home improvements and/or converting your residence to rental property. If you decide to sell, the most important considerations will involve preparation, timing, and pricing. You need to decide whether to use a real estate broker and whether you are willing to extend a private mortgage to a potential buyer. If you need the proceeds from the sale of your old home to fund the purchase of a new home and the sale is delayed, you might need to think about a bridge loan to cover your shortfall until your old home is sold. Finally, you also must consider the tax consequences of selling your principal residence. The most important of these involves your ability to exclude certain capital gains from your income in the year that you sell the home. There are also special capital gains rules to consider when selling second/vacation homes. See our separate topic discussions, Selling a Home and How Home Sales Are Taxed for more information.
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Buying a Home What is it? Finding the right home to buy can be a challenging prospect, but knowing what to expect can make the process easier. You can (1) buy through agents representing the seller and/or use a buyer's broker, (2) buy directly from an owner, or (3) shop the auctions and foreclosure sales. Once you find the house you want, you must make an offer, check for clear title to the property, and arrange for a home inspection. And after the closing, you can finally move into your new home.
Using an agent or buyer's broker What a real estate agent can do Real estate agents, real estate brokers, and Realtors? can guide you through the home-buying process and may be able to help with some or all of the following: • Determining your housing needs • Showing you properties and neighborhoods • Suggesting sources and techniques for financing • Acting as intermediary in negotiations • Recommending professionals whose services you may need (e.g., an attorney, inspectors, appraisers) • Providing insight regarding market activity in the area you're considering • Disclosing positive and negative aspects of various properties that might otherwise have escaped your attention Who the agent works for The real estate agent generally works for (and is paid by) the seller. The agent must generally give his or her client (the seller) any information that could affect the seller's position. However, there are many types of buyer-seller-agent arrangements, such as: • The traditional seller's agency arrangement, whereby a seller employs an agent to list a property and solicit buyers. The seller pays the agent's commission when the house is sold. • Single-agency brokers, who list properties and solicit buyers for a seller; they also find homes and negotiate prices and terms on a buyer's behalf. To avoid a conflict of interest, the same firm does not represent both parties in a single transaction. • Dual-agency brokerage arrangements, whereby a single agent may represent both the buyer and the seller in the same transaction. The agent agrees not to disclose confidential information that could benefit one party at the expense of the other. Finding a good real estate agent If you want to work with a real estate agent, be sure to select an agent with a good reputation and expertise in the neighborhood(s) you are considering. Here are some steps you can take to find a good real estate agent:
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• Find out the names of the brokers and agents who work in the area where you want to buy (check the yellow pages). • Contact the local real estate board and the state real estate commission to determine if any complaints have been registered against agents or brokers with whom you may want to work. • Call some of the most promising brokers. Tell each one what kind of buyer you are (e.g., a first-time homebuyer, a veteran house hunter) and what you are looking for in a home. Ask the broker to put you in touch with an experienced agent who can meet your needs. • Interview each prospective agent. Find out what he or she knows about the community, and evaluate how well you might work together. You may decide to work with more than one agent. Unlike a seller, a buyer generally does not enter into an agreement with one agent. So, if you're dissatisfied with the one you're working with, you're free to choose another. Using a buyer's broker Unlike a seller's broker, a buyer's broker works on your behalf. Buyer's brokers don't list properties; instead, they help you find the kind of home you want within your price range. Buyer's brokers may offer several compensation arrangements, including commission splitting with a seller's broker or an hourly fee. In an hourly fee arrangement, the buyer's broker's fee is not necessarily tied to the selling price, so the broker has no reason to focus his or her search on more expensive homes. Buyer's brokers can also help you purchase homes that aren't listed with real estate agents, such as "for sale by owner" homes (see below). However, using a buyer's broker can have disadvantages. They can be expensive, especially if you choose to compensate them on an hourly basis. And some seller's brokers are reluctant to split their commission with buyer's brokers, which may result in your buyer's broker limiting the properties you are shown if you choose a commission-splitting compensation arrangement.
Buying from the owner In a "for sale by owner" (FSBO, pronounced "fizzbo") situation, the owner offers the home for sale without the involvement of an agent, and thus avoids paying brokerage fees and commissions. You deal with the seller directly, rather than through the seller's agent. You should be even more thorough when inspecting the property in the case of a FSBO. That is because a seller generally has no requirement to volunteer information about the condition of the property, whereas a broker must generally disclose all material information that he or she possesses. Without the involvement of real estate brokers, the parties typically require assistance to complete the necessary paperwork to finalize the transaction. Before you make an offer to purchase FSBO property, seek the advice of your attorney. A written offer to purchase real estate becomes binding when it is accepted by the seller, so you should make sure you have adequately protected yourself against problems that may subsequently arise. At a minimum, your offer to purchase should be contingent upon satisfactory inspections (e.g., structure, termites) and the ability to obtain financing. If a purchase and sale agreement (also known as a P&S) is to be executed, your attorney should review that as well.
Buying at an auction or foreclosure sale Property secured by a loan on which the debtor has defaulted is known as distressed property, and is often subject to foreclosure proceedings. You may be able to purchase a home at below-market prices during any of the following three phases of these proceedings: • If the owner of the home is in default but foreclosure proceedings haven't yet been initiated, you can still buy the property directly from the owner. However, you may have difficulty getting clear title to the
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property (see below). In addition to buying the property from the owner, you may have to pay off various other lienholders. • Properties that have been foreclosed upon are offered at auction or foreclosure sale. If you are the highest bidder, you may purchase a home at a price covering the remaining defaulted mortgage balance and attendant costs. Some junior liens are eliminated before the foreclosure sale, thus clearing the title, but you will still be responsible for paying any outstanding property taxes. • Properties that were offered at auction but did not sell revert to the lender, and you may then purchase such property directly from the lender. You may get a bargain on a home this way, and you should get clear title, but you will still be responsible for paying any back property taxes. Buying property at an auction may require a substantial cash outlay. Find out before the auction how much of a cash deposit you will need, whether the deposit is refundable, and whether financing will be available, or even accepted. In contrast, when you buy directly from a lender, you generally get good financing terms as well as a reasonable purchase price. Because of the possibility of physical damage to distressed property or creditor liens against its title, there is a great amount of risk involved with purchasing it, so you'll want to do some thorough research before you do so. Start out by: • Enlisting the aid of a professional home inspector to inspect the property thoroughly. Add the cost of any necessary repairs to the price of the house to get a better idea of what it will actually cost to buy the house. If you can't inspect the property in advance of the sale, make your offer to purchase contingent on a satisfactory home inspection. • Investigating the property's title for any junior liens or other title defects. Factor into the total cost of purchasing the house the money you'll spend to find and correct title problems. Your attorney should include a guarantee-of-clear-title clause in your offer to purchase. • Having the property appraised. It's important to know how much a home is actually worth before you can determine if the selling price is reasonable.
What to do once you find the right house Once you find the house you want, it's time to make an offer. Have your attorney review your offer to purchase before you submit it to the seller. If accepted, it becomes a binding agreement between you and the seller. It's important to make sure that everything you want included in the deal is contained in the initial contract, because once it is signed by all parties, it may be too late to add or change anything. Tip: In some states, the contract simply contains an accepted offer to purchase a particular property at a specified price. Once the purchase price has been accepted, other contract terms are negotiated in the purchase and sale agreement. Your offer may not be accepted. If the seller wants to negotiate, a counteroffer is made. If the counteroffer is not acceptable, you can allow it to expire or make another offer. Negotiation can go on for weeks, although an agreement is typically reached by the second or third try.
Be sure you're getting clear title to the house Before closing, an attorney or a title specialist should conduct a title examination. The purpose of the title examination is to discover any problems (such as outstanding liens or judgments against the property, unpaid taxes, ownership disputes, etc.) that might prevent you from getting clear title to the home. Generally, title problems can be cleared up before the closing or immediately after by applying some of the sale proceeds to clear encumbrances. But in some cases, severe title problems can delay the closing or may even cause you to consider voiding your contract with the seller. In order to preserve your option to void the contract, make sure a guarantee-of-clear-title clause is included in the purchase and sale agreement.
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You should also consider purchasing an owner's title insurance policy. Before a title insurance policy is issued, a title report is prepared based on a search of public records. This report gives a description of the property, along with any title defects, liens, or encumbrances discovered in the course of the title search. After reviewing the report, the title insurance company issues an owner's title insurance policy, which protects you against additional title defects that were not discovered in the title search (e.g., forged signatures). The cost of this insurance can vary significantly from state to state and among insurance companies, and you will generally pay a one-time premium. Tip: Owner's title insurance coverage should not be confused with lender's title insurance, which is required by most mortgage lenders. Lender's title insurance simply protects the lender's lien against the property, making the mortgage more attractive on the secondary market. Lender's title insurance does not protect your investment in the property. Thus, you should purchase owner's title insurance in addition to the required lender's title insurance.
Be sure the house is in good condition Since a house is such a major investment, you should learn as much as possible about the condition of a house before you buy it. A professional home inspection will uncover both positive and negative aspects of the home. After conducting the inspection, the inspector will create a report explaining his or her findings. If the inspector's report indicates that the house needs minor or moderate repairs, such as a new roof or water heater, the seller may lower the price of the home to cover the cost of making the repairs. The seller may also agree to make the repairs before you buy the house. If major flaws are uncovered in the course of the inspection, you may choose not to buy the home. As long as your purchase offer is contingent upon a satisfactory inspection and you act within the time period specified, you should have no trouble walking away from the house and receiving a full refund of your deposit if the inspection uncovers any major problems.
When does the house actually become yours? The house becomes yours after the closing (also called settlement, title closing, or closing of escrow). The purpose of the closing is to transfer ownership of the property from the previous owner to you. At the closing, you will fill out the required paperwork, which is necessary to make the transfer of ownership official. Closing can be an arduous process, but once it's over, you'll be the proud new owner of a home!
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Finding the Right Home Introduction If you don't really know what you're looking for in a home, how do you find the right one? Careful planning and consideration of your options can help ensure that you will be happy with the one you select. You may decide that buying a traditional, single-family home is not your best bet. A condominium or a cooperative may better serve your needs. Or, you may decide that building a new home may be the only way to get what you want. Whatever type of home you end up looking for, your selection should be based on an educated decision.
Before the search Before you begin the search for a home, you should make sure your financial house is in order. Get a copy of your credit report and verify that the information it contains about you is correct. If not, correct any errors as soon as possible. If you have any outstanding bad debts, you should clear them up before you apply for a mortgage or else risk paying a higher interest rate or being denied altogether. Once you know your credit history is in good shape, search for a mortgage lender and get preapproved for your mortgage. Having a mortgage preapproval letter will give you credibility and possibly extra leverage as a buyer when it comes time to make an offer to purchase a home. If you don't know anything about home construction, you may want to learn some basics. Become familiar with both positive and negative things to look for in a home. Doing so will help you spot both features of value (the dovetailed joints in the kitchen cabinets) and signs of poor workmanship or damage (the water stain on the sunroom ceiling). This can be particularly important if you're looking at older homes. When you start looking, always be prepared to make an offer on a home. You never know when you'll come across the one you want. Once you do, you may find you need to act quickly to keep it from falling into the hands of another interested buyer. At the same time, learn to be patient. Don't jump at the first house you see because you're afraid you won't find anything better. Wait until you find what you're looking for, because you may have to live with it for some time to come. You want to be happy with the home you select.
Consider your needs When deciding what you need in a house, move from general to specific considerations. Begin by picking a price range and a general location. Next, think about what sort of living arrangement (e.g., a single-family home, condominium, or cooperative) best suits your needs. Once that's done, you can focus on more of the details, such as a particular neighborhood, the age of the home, and the type of home you want. When you get down to even more specific details (e.g., the number of rooms, a fireplace), you may want to make a list of wants and needs, keeping in mind what you can afford. This may help you keep matters in perspective once you begin shopping.
Community living arrangements Many people prefer some sort of community living arrangement, and condominiums and cooperatives are two widely recognized variations of such arrangements. The terms "condominium" and "cooperative" (or "condo" and "co-op") do not refer to specific types of buildings or communities; rather, they reflect legal forms of ownership. While the two are somewhat similar, there are important differences between them.
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Condos As a condo owner, you typically don't own the building or the land. Generally speaking, you own everything within your unit, but not the physical structure itself. You also own an undivided proportional interest in the rest of the development. Part of your monthly condominium fee is used to operate and maintain these common areas. A board of directors governs a condominium community. Elected by the condominium association, which is made up of all the owners in the community, the board is responsible for managing the property and protecting the interests of the owners. In most areas, getting a mortgage to buy a condo is no more difficult than financing a single-family home purchase. Mortgage interest and property taxes are generally tax deductible if you itemize, just as they are on a single-family home. Tip: Homeowners can take an additional standard deduction of $500 ($1,000 if married filing jointly) for property taxes if they do not itemize deductions. This deduction is available for taxable years beginning in 2008 and 2009 only. Co-ops When you buy a unit in a co-op community, you're actually buying shares in the corporation that owns the entire complex. This corporation generally holds the mortgage on the cooperative property. By purchasing shares in a co-op, you obtain the right to use your unit and an interest in the common areas. Monthly co-op fees cover not only shared maintenance and insurance costs, but also utilities, property taxes, and principal and interest payments on the property's mortgage. Like condos, co-ops are governed by a board of directors. In addition to all the responsibilities of a condo board, co-op boards are responsible for making monthly mortgage payments on the property, as well as approving or rejecting prospective buyers. Because you aren't actually buying real property, you would take out a share loan instead of a mortgage to purchase a co-op unit. The interest on a share loan isn't deductible, because the stock securing the loan is considered personal property. However, if the co-op unit is your primary or secondary residence, the portion of your monthly co-op fee used to pay mortgage interest and property taxes would be tax deductible. Tip: Homeowners can take an additional standard deduction of $500 ($1,000 if married filing jointly) for property taxes if they do not itemize deductions. This deduction is available for taxable years beginning in 2008 and 2009 only. Some important distinctions Condo boards tend to be somewhat less restrictive than co-op boards. Both set and enforce rules regarding occupancy, pets, and alterations or improvements to individual units. However, unlike condo boards, co-op boards tend to scrutinize prospective members personally, professionally, and financially. The co-op board might reject someone for any number of reasons. Because of this, it can also be difficult to sell your co-op unit, since the board of directors must approve the buyer. In contrast, condo boards cannot prevent you from selling your unit to whomever you choose. Moreover, if you decide to rent out your unit, the condo board can't dictate your lease terms unless the condo rules and regulations restrict or prohibit leasing. Advantages and drawbacks of community living Community living arrangements can be an attractive alternative to traditional single-family dwellings. Since condos and co-ops are often less expensive than single-family homes, first-time homebuyers may find them an easier way to take advantage of the benefits of homeownership. Many condo and co-op communities include health clubs, tennis courts, pools, playgrounds, and other amenities. Shared ownership can also help build a sense of pride and community spirit. There are drawbacks, however. You may have significantly less privacy in a condo or co-op community than you
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would in a single-family home. Your condo or co-op board may not approve renovations you want to make. And as the common facilities age, costly repairs may result in increased monthly condo or co-op fees.
Building a home Sometimes, building a home may be the only way to get what you really want. Building has its tradeoffs, however. Often, you must choose from a group of standard floor plans rather than design your own. Delays and shoddy workmanship are always a risk. However, if you have thought it through and still want to build your dream house, you have a few planning steps to take. You must choose a lot. You must choose a builder. You may need to shop for a construction loan. You should hire an attorney to handle the purchase and sale process. Careful planning is required to help minimize the risk of buying something that hasn't yet been built.
Choosing a neighborhood Your home's value will be influenced by the value of the properties surrounding it. Common wisdom suggests that you should not purchase the most expensive home in the neighborhood. There are numerous factors to consider when choosing a neighborhood; some may be more important to you than others. Among them are: • Schools: The quality of the schools in the area is of extreme importance, especially if you have children. Even if you don't, the reputation of the school system may be an important factor if you later decide to sell your home. • Crime levels: Is the crime rate increasing or decreasing? Find out the frequency of break-ins and other crimes against homeowners in the area. Public records at the town hall and newspaper archives at the local library may be good sources of information. • Utilities: What's the average cost of utilities in the area? How does the tap water taste, and is it fluoridated? How promptly does the phone company respond to maintenance calls? Is cable television available? • Hospitals: Find out how close the nearest hospitals are. Inquire about the reputations of emergency and other services, and determine if they accept your medical insurance. • Property taxes: What is the residential property tax rate, and how often does it increase? How is the property appraised? • Municipal services: Determine what services (e.g., garbage removal, recycling, or water and sewage) might be provided by the community, and what services (if any) you'll have to pay a private contractor to provide. • Accessibility: If you choose a suburban location, will you have a lengthy commute to work? Test your commute to work in off-peak hours and during prime drive time. • Business considerations: If you operate a business from your home, you'll need to know whether this is permitted in the neighborhood you are considering. Will on-street and/or off-street parking be available? • Recreation: Will you be near golf courses, public gyms, tennis courts, swimming pools, or parks? Will you need to pay to use these facilities? • Transportation: Convenient access to commuter rail lines, buses, subways, and highways is generally advantageous, although noise, traffic, and pollution can be concerns if these facilities are too close to your home. • Traffic: While an increase in traffic generally signals growth in the area, excessive traffic can cause
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unhealthy levels of noise and air pollution. Get a clear impression of the traffic situation both during the week and on the weekends. • Shopping: Are you close to grocery and convenience stores, pharmacies, gas stations, dry cleaners, and banks? Are you so close that traffic will be a problem? • Neighbors: Can you determine if your neighbors might share your interests? Look for ski racks or bike racks on their cars, or barbecue grills in back yards. If you have children, are there signs of other children of similar ages in the neighborhood? • Terrain: Find out if flooding has been a problem in the recent past, or if the area is part of an identifiable floodplain. • Future improvements: Check with the zoning department at the local town hall to see if any zoning changes, airport expansions, road improvements, etc. may impact the area you're considering.
Make a list To help you refine what you're looking for in a home, consider making a list of your wants and needs (bearing in mind the difference between the two). You might also compile a list of objectionable features, or "don't wants," to get a complete picture of your ideal home. While evaluating your wants and needs, don't forget about your resources (or lack thereof). Always keep in mind what you can afford. The following is a sample wants/needs list containing some of the aspects you may want to consider: Item
Need
Want
Commuting Time: Less than one hour
___________ ___________
Less than one-half hour
___________ ___________
Setting: Urban
___________ ___________
Suburban
___________ ___________
Country
___________ ___________
Particular neighborhood:________________________ ___________ ___________ Particular school district:________________________ ___________ ___________ Particular architectural style:_____________________ ___________ ___________ Lot size
___________ ___________
Home: Number of bedrooms
___________ ___________
Number of bathrooms
___________ ___________
Bath in master bedroom
___________ ___________
Eat-in kitchen
___________ ___________
Separate dining room
___________ ___________
Basement
___________ ___________
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Home business permitted in neighborhood
___________ ___________
Separate entrance for business
___________ ___________
Expansion potential
___________ ___________
Fireplace
___________ ___________
Garage (1 car, 2 car, etc.)
___________ ___________
Other
___________ ___________
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How Much Can You Afford? Introduction An old rule of thumb said that you could afford to buy a house that cost between one and a half and two and a half times your annual salary. In reality, there's a lot more to take into consideration. You'll want to know not only how much of a mortgage you qualify for, but also how much you can afford to spend on a home. In order to know how much you can truly afford, you need to take an honest look at your lifestyle and your standard of living, as well as your income and what you choose to spend it on.
Getting to the bottom line If you have unlimited resources, you can afford to buy whatever home your heart desires. For most of us, though, that's not the case. Unless you can afford to buy a house outright, you'll probably need to get a mortgage to help you pay for it. So, determining how much house you can afford is often a case of determining how much of a mortgage you can afford. Start with some simple math: Take your monthly income and subtract all of your non-housing-related expenses. What you're left with is the amount per month that you have available to allocate toward housing.
Other housing expenses to factor in In determining what you can afford to spend on a home, you should also take into account other housing-related expenses. The total amount of expenses may depend in part on what type of home you buy and where it's located. Such expenses include: • Maintenance costs--everything from weekly rubbish removal to a new roof • Utility costs--electricity, heating and/or air-conditioning, gas, water and/or sewer • Homeowner association fees or condominium assessment fees Deduct the monthly portion of these expenses from what you estimated your monthly housing allowance to be, and you're getting close to determining how much of a monthly mortgage payment you can afford. Of course, mortgage lenders have a slightly more sophisticated way of determining how much they think you can afford.
Lenders use qualifying ratios Lenders use formulas called qualifying ratios to calculate how much of a mortgage you qualify for. These ratios are based on your gross monthly income, your housing expenses, and your long-term debt. The first qualifying ratio a lender scrutinizes is your housing expenses to income ratio. According to the Government National Mortgage Association (Ginnie Mae), in order to qualify for a conventional mortgage (one not insured or guaranteed by the federal government), your housing expenses generally should not exceed 28 percent of your gross monthly income. Your monthly housing expenses include mortgage principal, interest, taxes, and insurance; consequently, this ratio is often abbreviated as PITI. The ratio is also known as the front ratio. The second ratio that a lender looks at (known as the back ratio) is one that takes into account your expenses that extend 11 months or more into the future (e.g., a car or student loan). These expenses are considered long-term debt. Your monthly housing expenses, plus your other long-term debt, determine what's known as your
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debt ratio, or PITIO. To qualify for a conventional mortgage, Ginnie Mae indicates that these expenses generally should not exceed 36 percent of your gross monthly income. Example(s): If your gross annual income is $30,000, your gross monthly income is $2,500. Your front ratio (PITI) should not exceed more than 28 percent of this, or $700. Your back ratio (PITIO) should not exceed $900 (36 percent of $2,500). Mortgages that are insured or guaranteed by the federal government may allow more liberal qualifying ratios. Federal Housing Administration (FHA) loans may allow front ratios as high as 29 percent and back ratios of 41 percent, while Department of Veterans Affairs (VA) loans may allow up to 41 percent for both ratios. Remember that the figures provided are estimates. Qualifying ratios may vary from lender to lender, and each mortgage application is considered individually. Lenders generally use both ratios, since the two provide information about different aspects of your total financial picture.
Mortgage prequalification and preapproval Consider shopping for your mortgage before you start shopping for your house. Compare the mortgage rates and terms offered by various lenders, and then get preapproved or prequalified with the lender of your choice. That way, you'll know how much you can spend on a house before you fall in love with one that's just out of your reach. Make sure you understand the difference between prequalification and preapproval. Prequalification is simply the process of estimating how much money you'll be able to borrow based on the qualifying ratios appropriate for the type of mortgage you're considering. Preapproval, on the other hand, means the lender has verified your income and checked your credit references. Once you're preapproved, you'll get a letter stating that the lender will give you a mortgage up to a certain amount, provided that certain conditions are met (e.g., the property is appraised for an amount sufficient to cover the mortgage). Preapproval lets you know exactly how large a mortgage you can get. It also gives you more credibility as a buyer, since the preapproval letter lets the seller know that you'll qualify, financially, for a mortgage if your purchase offer is accepted.
Make sure you really can afford it Remember that mortgage lenders can only tell you how much of a mortgage you qualify for, not how much you can afford. If homeowners insurance and property taxes are escrowed with your lender, these expenses will increase your monthly mortgage payment. The payment amount will be even more if you're required to carry specialty policies such as flood or earthquake insurance in addition to homeowners insurance. And if property taxes are especially high, you may find that you're unable to afford the home. Tip: Keep in mind that your actual mortgage payment will also depend on your interest rate and the term of the loan. Generally speaking, lower rates of interest and longer terms equal lower monthly mortgage payments. Now might be the time to think about revising your budget. Perhaps you can think of ways to reduce your non-housing-related expenses; doing so will free up money that you can apply toward your housing costs. Also keep in mind any future plans that may affect your budget. Perhaps you'll need to buy a new car in a few years. If you haven't already done so, perhaps you'll be starting a family soon. If you have children, as soon as they're in kindergarten you'll need to think about saving for their college expenses. No matter how much of a mortgage a lender tells you that you qualify for, you must always be sure your mortgage payment is not beyond your means. After all, it's the roof over your head.
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The Purchase Process What is the purchase process? Buying a home involves several steps, some of which may vary according to state law or local custom. In general, though, the preliminary steps include making an offer on the home, completing a purchase and sale agreement (also known as a P&S), and scheduling a home inspection.
What's the difference between making an offer and completing a purchase and sale agreement (P&S)? In some states, the offer to purchase and the P&S are separate documents. In these states, a typical offer to purchase is a short form in which the buyer offers to purchase a specified piece of property from the seller for a specified price on a specified date. This document is a quick, formal way to establish a commitment between the buyer and seller. Usually, the signing of the offer is accompanied by a down payment (also known as earnest money). The offer recites that if the offer is accepted by the seller, the parties will execute a P&S by a particular date. It's important to note that an accepted offer is a binding contract. For this reason, making or accepting an offer should be done with care. If you intend to seek legal advice, an attorney should be retained to review the offer as well as the P&S. The P&S will supercede the accepted offer. It contains the finalized terms and conditions (and any remaining details) of the transaction. Once it is signed by both parties, the P&S becomes the final agreement between the parties. In other states, only one document is used. There's no preliminary offer to purchase form; the actual offer is made directly on a standard P&S form (which might be called a purchase offer contract). This detailed contract contains all of the terms of the sale.
How do you make an offer? In most home sales, offers and counteroffers are made through a real estate agent or other intermediary, such as an attorney. If agents and attorneys aren't involved, the buyer and seller can deal with each other directly. The offer must be made in writing, either on a preliminary offer to purchase form, or on the actual P&S. (Oral contracts for the sale of land are not enforceable.) Normally, the buyer submits an earnest money deposit with the offer. This deposit is applied toward the down payment on the house if the offer is accepted and the deal closes, or returned to the buyer if the offer is rejected. Once the offer has been accepted, it's possible for a buyer to lose his or her deposit if certain conditions are not met. For that reason, it's essential that the offer and/or P&S be drafted properly. It may be wise to hire an attorney for this purpose. Caution: Before making an offer, make sure you can afford the real estate taxes and monthly insurance premiums.
How much should you offer? That depends on several factors, including your financial situation, how much you want the house, general market conditions, a comparative market analysis and/or appraisal of the home, and the length of time the house has been on the market.
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The seller's asking price should be considered a guideline. Offers may be made at, below, or above this price. The seller's flexibility depends on current market conditions and on how anxious he or she is to sell the house. Although an old rule of thumb states that any bid within 5 or 10 percent of the asking price is reasonable, market conditions may dictate otherwise. In a seller's market, when the demand for homes is high and the supply of homes is low, a seller may have several offers on the table (some of which may even be above the asking price). In a buyer's market, however, it may be wise to bid at least 5 percent below the asking price. Before negotiations begin, you should decide the maximum amount you're willing to pay for the house. You'll want to keep that amount "close to the vest," particularly from an agent or broker who represents the seller. Your first offer may be somewhat below this final price, leaving you room to increase your bid if necessary. If you've found your dream house, how can you ensure that your offer will be accepted? Unfortunately, there's no guarantee that you won't be edged out by another buyer with a better offer. However, you can do the following to make your offer more attractive: • Make an offer at (or very close to) the asking price. • Make your offer free of contingencies, such as selling a previous home or passing inspections. But keep in mind that eliminating these safeguards can be risky. • Offer a large earnest money deposit to demonstrate that you're a serious buyer. • Offer to pay the seller's closing costs. • Get preapproved for a mortgage. You may be a more attractive buyer if the seller knows you can obtain financing. Even if you're very interested in the home, you should keep the following points in mind: • Maintain your perspective (there are lots of other houses out there). • Stay objective and weigh your decisions carefully. • Be prepared to hit a few snags when negotiating. • Walk away from the deal if you have to.
What terms should the P&S contain? The P&S is a legal contract containing all of the terms and conditions of the sale, including the duties of each party and the remedies if a default occurs. Once the parties sign this contract, the provisions can't be changed (unless both parties agree to an amendment). That's why it's a good idea for both sides to retain attorneys before signing a P&S. Normally, a standard form is used (although this form may vary from state to state, or even from one real estate office to another). If you retain an attorney, he or she will probably strike out certain words or sentences in the P&S and add others to protect your interests. If you've decided to forgo an attorney and are presented with a standard form, use the form as a guideline; it's not sacrosanct. It may be wise, though, to consult with an attorney before making changes to it. The contract will contain many provisions, including the following: • Names of the parties: All parties to the transaction should be named in the contract. If more than one person owns the property (e.g., a husband and wife own the home jointly), it is especially important that each signs the contract. • Property description: The property should be identified by both street address and legal description
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(such as the book and page where the seller's deed is recorded). • Quality of title: The type of deed to be conveyed and the condition of the title should be stated in the contract. Because legal terminology is often used, an attorney might prove valuable in this area. • Personal property: Any personal property included in the transaction should be listed. Personal property refers to items that are not permanently attached to the land or building. Examples include refrigerators, stoves, washers and dryers, and mini-blinds. • Purchase price: The purchase price of the property and the terms of payment should be clearly spelled out in the contract. All dollar amounts, payment methods, and payment dates should be included. • Deposit: The earnest money deposit is the money you submit to the seller when you make the offer on the house. If your offer is accepted and you fail to follow through on your commitment, the seller may be entitled to keep this money. The amount of the deposit should be stated in the contract, along with the circumstances under which the seller may keep this deposit. • Property condition: Generally, the seller is required to deliver the property to the buyer in the same condition it was in when the contract was signed. The P&S should specify that any damage occurring between the contract signing and the closing date must be repaired at the seller's expense. • Inspection contingency: The buyer should add a contingency or rider to the contract (if there isn't one already), allowing a home inspection by a certain date. An unfavorable inspection of the home by a professional may allow you to avoid the sale if you want. Or, the seller may agree to repair the property (up to a certain dollar amount) or lower the purchase price so that you can make the necessary repairs later. • Mortgage contingency: The mortgage contingency clause seeks to make the sale dependent on the buyer's ability to obtain a mortgage commitment. Typically, this provision recites the amount of the mortgage and the date by which the buyer must submit a complete mortgage application form. The maximum interest rate acceptable to the buyer might also be recited. • Closing and possession dates: The contract should set forth the closing date and the date the buyer will take possession of the home. (These dates are usually the same.) This provision should also state that the property will be delivered free of all tenants and occupants. While it's important to protect your interests by using contingencies in the contract, it's equally important to make sure that you meet all of the obligations required to exercise a contingency. Buyers must be aware of the dates by which an inspection must occur, mortgage financing must be secured, and so on. If you don't exercise your rights under the contract by the required dates, you may severely compromise the protections in the contract.
Why should you schedule a home inspection? Buying a home is a major investment. Naturally, you should know as much as possible about the condition of the home before you agree to buy it. For that reason, you should insist on an inspection contingency clause in your offer to purchase and/or P&S. You'll want to hire a professional home inspector to look for structural and mechanical defects in the property. You might also want to conduct a termite (or other pest) inspection and test for environmental hazards, such as radon, lead paint (if the house was built before 1978), and mold. The home inspection should reveal both positive and negative aspects of the home and help you decide whether to make the purchase. Caution: Even brand-new homes should be inspected. Although the home might look fine to the untrained eye, an inspector may be able to uncover shoddy workmanship, potential drainage problems, and the presence of unsafe radon levels.
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What does a home inspection cover? A standard home inspection will generally cover the following areas: • The structure of the house, including the foundation, walls, ceilings, stairs, and attic • The exterior, including the roof, chimney, caulking and weather stripping, grading, drainage, driveways, and patio • The interior, including visible insulation and ventilation, leaking, steps, counters, railings, cabinetry, and sinks • The interior plumbing, such as fixtures, faucets, drains, toilets, and water heater • The electrical system, including wiring, fixtures, and overload protection • The heating and air-conditioning systems, including type, capacity, condition, distribution of sources of heating and cooling, controls, humidifiers, and fire safety • The basement or crawl space, including construction, structural ability, settlement, and water penetration There are limits to the inspection. Normally, the inspector will not move furniture or boxes that block access to parts of the house. He or she should also do nothing to damage the property (for example, by dismantling walls or systems). Tip: You may want special features inspected, such as the septic system, swimming pool, or tennis court. If you want to test for the presence of pests or environmental hazards, you may need to hire a specialist.
What if the inspector finds problems? Look to your P&S to determine the rights and duties of the parties. Generally speaking, though, the procedure is as follows. After inspecting the property, the inspector issues a report, noting any problem areas. If the report indicates that the house requires repairs (e.g., a new water heater or a new roof), the buyer typically has a few options: • Request that the seller have the problem repaired by a certain date. • Request that the seller lower the purchase price of the property to cover the cost of making the repairs. • Request that the seller split the cost of the repairs with the buyer in some fashion. • Last recourse? Inform the seller that the deal is off and ask for an immediate refund of any deposits.
How do you find a reliable home inspector? In many states, home inspectors don't have to be licensed to do business. Therefore, finding a reputable home inspector will require some homework. It might be best to obtain a referral from a relative, friend, coworker, or attorney. Caution: Be somewhat wary of referrals from a real estate agent. Although a home inspector should be independent and unbiased, a referral from an agent may encourage a more favorable inspection report. That's because the agent wants the sale to go through, and the inspector might appreciate the business.
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You might want to look for an inspector who's a member of a trade association, such as the American Society of Home Inspectors (ASHI). This organization requires applicants to pass standardized tests and conduct numerous supervised inspections before being admitted as members. ASHI members also agree to abide by a written code of ethics and prescribed standards of practice designed to protect the homebuyer. Once you've found a likely candidate, ask the inspector how many inspections he or she has conducted. Get some information on the inspector's background, too. Former home builders or structural engineers may make especially good inspectors. A real estate agent who performs inspections on the side, however, probably isn't your best bet. Finally, make sure the inspector is bonded or carries liability insurance. If you buy the home and the inspector failed to detect a serious flaw, you may be able to obtain some compensation.
How much does an inspection cost? The price range for a home inspection varies according to geographical area. It can also depend on the age, size, and construction of the home. In addition, specialized inspections (e.g., septic inspection, pest inspection, and radon inspection) may involve extra charges. In general, you should expect to pay a minimum of $140 for a basic inspection. The price could amount to $500 or more, though.
What's next? After your P&S has been signed, your mortgage application submitted, and the inspections completed, things should be fairly quiet for a while. You'll continue to submit any required paperwork to your mortgage professional, and an appraisal of the home will be scheduled for mortgage purposes. Eventually, you'll have to obtain an insurance binder. If all goes well, you can look forward to the closing process.
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The Down Payment How much do you need for a down payment? In the past, lenders usually required a down payment of at least 20 percent of the purchase price of a home. Nowadays that's no longer the case. Instead, the amount of your down payment will depend on a variety of factors, such as the amount of money you have saved for your home purchase, your current financial situation, and your feelings toward other investment options.
Can you get a low down payment mortgage? Today, many lenders are approving loans with lower down payments. In addition, certain private and government entities have low down payment programs. FHA mortgages You may be able to get a Federal Housing Administration (FHA) mortgage with a down payment of as little as 3.5 percent. Qualification standards are relatively lenient for FHA mortgages, and the terms of these mortgages are generally very attractive, making them ideal for first-time homebuyers. Keep in mind, however, that FHA loans require borrowers to pay mortgage insurance premiums. VA mortgages Department of Veterans Affairs (VA) mortgages are another low down payment option. VA mortgages are available to qualified veterans and their surviving spouses. VA mortgage terms are also generally very attractive, and in many cases, little or no down payment is required. Conventional mortgages You may be able to obtain a conventional mortgage with a down payment of less than 20 percent with the help of private mortgage insurance (PMI). Low down payment mortgages are somewhat risky for lenders, because they believe you are more likely to default on a loan in which you have very little invested. For this reason, lenders generally require PMI if you are borrowing more than 80 percent of the value of the home you are purchasing (i.e., your down payment is less than 20 percent). If you are concerned about taking on PMI payments, keep in mind that you may not have to pay PMI forever. For loans originated after July 29, 1999, your lender is obligated to cancel your PMI once you have reached 22 percent equity in your home, provided you have a good payment history. Or, you can petition your lender to remove the PMI if you have a good payment history and reach 20 percent equity in your home. Tip: In addition to requiring PMI, lenders sometimes have stricter qualification standards and offer lower loan limits and higher interest rates if your down payment is less than 20 percent. If you don't have at least 20 percent for a down payment, consider asking if your lender would be willing to increase your mortgage interest rate a quarter of a point rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly insurance premium. However, mortgage interest is generally tax deductible; PMI payments are not. Tip: There is a limited exception to the general rule that PMI payments are not deductible. For amounts paid or accrued in 2007 through 2010, qualified mortgage insurance payments can be deducted in the same manner as qualified mortgage interest, but only for mortgage insurance contracts issued on or after January 1, 2007 and before January 1, 2011. In addition, the deduction is phased out for taxpayers with adjusted gross income exceeding $100,000 ($50,000 for married individuals filing a separate return).
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Tip: If you opt to pay a higher interest rate instead of taking on PMI, remember that you may be able to cancel your PMI sometime in the future, whereas you'll have to pay the higher interest rate until the mortgage is paid off or you refinance. Another alternative to PMI is to obtain 80-10-10 financing, where a lender provides a traditional 80 percent first mortgage, and you then obtain a 10 percent second mortgage and make a 10 percent down payment.
What about larger down payments? If you have more than 20 percent to put down, you may still want to take the time to weigh your down payment options. With a larger down payment, you will reduce the amount of your mortgage and thus the amount of interest you will pay. And since a larger down payment usually means less risk, lenders often offer lower interest rates and are more lenient toward borrowers who provide larger down payments. Also, a larger down payment gives you instant equity in your home, which can be accessed through a home equity loan or home equity line of credit. Keep in mind, however, that there may be situations where you might not want to make a large down payment. For example, you may want to keep the money in your emergency cash reserve. Or, you may want to put the money toward other investment opportunities.
What about mortgages that don't require a down payment? Some lenders offer "no down payment" or "100 percent financing" mortgage programs. However, these programs typically have high interest rates and closing costs, along with additional qualification requirements.
Investing money for a down payment If you're saving for a down payment, you may be wondering where you should invest your money. The answer depends on how soon you'll need the money, since the more time you have, the more risk you may be willing to accept in considering investments. If you're going to need the down payment within the next few years, you'll probably want to minimize risk. For many, this means a bank savings account. However, you'll also want to consider money market accounts as well. Money market accounts are low-risk, and generally pay slightly higher interest rates than bank savings accounts.
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Alternative Ways to Fund Your Down Payment How much money will you need for a down payment? It used to be that most lenders would require a down payment equal to at least 20 percent of a home's purchase price. Today, however, there's good news for homebuyers who have little money saved for a down payment. Many lenders have relaxed their requirements and are approving loans with lower down payments. In addition, there are numerous private and government-sponsored low down payment mortgage programs, such as those offered by Fannie Mae, Freddie Mac, the Federal Housing Administration, and the Department of Veterans Affairs. However, if you've done all you can to save for a down payment and it's still not enough, don't worry--you have other options. The following are some alternative methods you can use to help fund your down payment. Caution: Keep in mind that if your down payment is less than 20 percent, you may have to pay private mortgage insurance (PMI), which can equal.5 to 1.25 percent of your total loan amount at closing.
Funding alternatives Rent with option to buy A rent with option to buy (also known as a lease with option to purchase, lease purchase, or lease option) allows you to rent a home for a certain period of time (e.g., three years) while a portion of your rental payments accumulate and are credited toward your down payment. At the end of the lease term, you have the option to purchase the home for a specified price. If you choose not to exercise the purchase option, it usually expires. These arrangements often require you to pay a nonrefundable fee (referred to as an option fee), which can be as much as 2 to 3 percent of the purchase price. Shared equity financing A shared equity arrangement can be structured in many ways. However, it typically involves an investor who supplies all or a portion of the down payment on the home. The investor may also take a partial ownership interest in the house and make part of each monthly mortgage payment. Meanwhile, you live in the home, make the payments on the mortgage, and pay fair market rent to the investor for the portion of the home that he or she owns. At a point in time that is specified in the equity-sharing agreement (e.g., after the home is sold or after a certain time period), the investor is entitled to receive the money for the down payment back, plus a share of any appreciation that has occurred. Borrow from the cash value of a life insurance policy If you have accumulated a substantial cash value in your life insurance policy, you may be able to borrow from it in order to raise funds for a down payment. You may be able to borrow up to 90 percent of your policy's cash value, and the interest rate is usually substantially lower than rates for bank loans and credit cards. However, any outstanding loan balance will be subtracted from your death benefit when you die, reducing the amount your beneficiaries will receive upon your death. Borrow against your assets/convert assets to cash Another option is to borrow against your assets (e.g., personal property, fixed-income investments) to raise money for a down payment. When you borrow against an asset, the asset becomes collateral for a loan. You still own the asset, but the lender takes a security interest in it. If you fail to repay the loan as promised, the lender has the right to take legal action to acquire the asset and sell it to repay your outstanding debt.
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You may also want to sell, redeem, or otherwise liquidate an asset in order to come up with a source of funds for a down payment. While you can easily determine the value of certain assets, such as fixed-income investments, placing a value on other types of assets (e.g., personal property) requires some additional research. So, you may want to enlist the services of a qualified appraiser to help you estimate the asset's value. Caution: Liquidating assets can have tax ramifications. Gifts Most mortgage lenders allow gifts to be used for part of the down payment on a home. However, lenders often require borrowers to contribute some of their own money toward a down payment in addition to any gifts. You'll also need to submit a letter to your lender that proves that the money is a gift rather than a loan, and that you are not expected to repay the funds. You may also have to submit documentation, such as bank statements, showing the funds withdrawn from your benefactor's account and deposited into your account. Borrow from an employer-sponsored retirement plan If you participate in an employer-sponsored retirement plan, one way to come up with money for a down payment is to borrow the money from your plan. Many employer-sponsored retirement plans (e.g., 401(k) plan) allow you to borrow against the funds in your account. Depending on the rules established by your employer, you may be able to borrow against your own contributions and the earnings on this money. You may also be able to borrow against contributions made by your employer if you are vested in those dollars. Interest rates on these types of loans are generally only one or two points above the prime rate. Although loans from retirement plans generally must be paid back within five years, the repayment period can be longer if funds are used to purchase a primary residence. Many plans carry restrictions, so consult your plan administrator for more details. Caution: If you leave your employer before you repay a loan from an employer-sponsored retirement plan, the balance of your plan loan will typically be due immediately. If it's not repaid on time, the loan balance will be deemed a distribution for tax purposes, and you may be subject to the 10 percent penalty tax. Withdraw from a traditional IRA You can withdraw funds from your traditional IRA and use them for a down payment. However, all or part of a distribution from a traditional IRA must be included in taxable income in the year received. While funds distributed prior to age 59½ are generally subject to a premature distribution penalty, an exception applies when the distribution is used within 120 days to pay the costs of acquiring, constructing, or reconstructing the principal residence of a first-time homebuyer. There is a $10,000 lifetime limit on distributions covered by the first-time homebuyer exception, however. Withdraw from an employer-sponsored retirement plan If your plan allows, you may be able to take a distribution from your employer-sponsored retirement plan and use the funds for a down payment. You'll want to consult your plan administrator to find out what options, if any, are available to you. Before you withdraw from an employer-sponsored plan, however, keep in mind that distributions from an employer-sponsored plan generally must be included in taxable income in the year received. In addition, a 10 percent federal penalty tax may be assessed on distributions made before age 59½. Caution: Taking money out of your retirement plan to apply to the purchase of a home should be done only after careful consideration--it is generally not recommended.
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How Should You Own Your Home? Introduction You can legally own real estate in one of many different ways. The way you own property is important because it affects what you can do with it while you own it, how you can dispose of it during life, who receives it at your death, and how taxes are apportioned.
What are the most common forms of property ownership? Sole ownership Sole ownership (or outright ownership) occurs whenever you fully own the home by yourself. You alone enjoy full use of the property. You alone are responsible for any of the costs associated with the property. In general, you are the only one who can decide how to dispose of the home. Joint tenancy A joint tenancy (also called joint tenancy with rights of survivorship, or JTWROS) is one of the ways two or more people can own something together. If you are the co-owner of a home owned as a joint tenancy (a joint tenant), that home passes automatically at your death to the remaining joint tenants without the expense and delay of probate. A joint tenant may sell his or her interest in the home. If this happens, the remaining cotenants' rights of survivorship in that interest end. The joint tenancy continues among the remaining cotenants, but the purchaser becomes a tenant in common. Caution: Joint tenancy can exist without rights of survivorship in some states. If this is the case in your state, be sure to be very clear about what type of joint ownership (with or without rights of survivorship) is being created. Tenancy in common A tenancy in common is an ownership interest shared by two or more persons in real property. Each owner (called a tenant in common) has a right to use and possess the entire property even though he or she may actually own an unequal share. Shares are proportionate to contributions or determined by agreement. At death, an owner's share passes to his or her beneficiaries and generally must pass through probate. Tenants in common do not have survivorship rights. This lack of survivorship rights distinguishes a tenancy in common from other joint ownership arrangements. None of the tenants have exclusive rights to any part of the property. Tenants in common are free to transfer their portion of the property without first obtaining the consent of the other tenants. Tenancy by the entirety A tenancy by the entirety can only exist between spouses. If you are the co-owner of a home owned as a tenancy by the entirety (a tenant by the entirety), that property passes automatically at your death to your spouse without the expense and delay of probate. Neither spouse can encumber or dispose of the property without the consent of the other. This form of ownership can be used as an asset protection tool. Creditors of one spouse generally cannot reach property that is owned as a tenancy by the entirety until the nondebtor spouse dies or the tenancy by the entirety is terminated by divorce or transfer to another form of ownership. Caution: A tenancy by the entirety is not recognized in all states.
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Timeshares A timeshare is a special type of ownership for vacation homes. For the most part, there are two types of timeshare ownership: a deeded plan and a nondeeded plan. In a deeded timeshare plan, you purchase a fractional ownership interest in a specific unit. You can rent, sell, donate, or bequeath your ownership interest just as you would any other real estate that you own. In a nondeeded timeshare plan (also known as right-to-use ownership), ownership remains with the original property owner/developer. You purchase a lease, license, or club membership that gives you the right to use the property for a specific time each year for a limited number of years. Once the lease expires, the right to use reverts to the property owner/developer. Qualified personal residence trust (QPRT) A qualified personal residence trust (QPRT; pronounced "Q-Pert") is an irrevocable trust that is often used as an estate-tax-saving device. The home is owned by the trust, but you retain the right to use the property for a term of years. The beneficiaries of the trust are often your children or grandchildren. At the end of the term of years you select, your beneficiaries will inherit the home. Putting the title of the home in the trust's name is considered a taxable gift. However, you may discount the value of the gift depending on the length of the term of years you select and the applicable government interest rates. If you outlive the term of years, the value of the residence will not be included in your gross estate. However, if you die before the term ends, the full value of the residence at the time of your death is included in your estate.
A note on community property To date, community property laws have been enacted in Puerto Rico and 10 states: Alaska (which has an optional system), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Community property laws establish a set pattern of property ownership for married couples. Although the laws vary among these states, some general characteristics are shared by all. In general, community property states deem that each spouse owns a one-half interest in the home if it was purchased during marriage. At the death of one spouse, the surviving spouse is entitled to one-half.
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The Closing Process What is the closing? The purpose of the closing (also called the settlement, title closing, or closing of escrow) is to transfer ownership of property from the seller to the buyer and transfer funds from the buyer to the seller. The closing process varies, depending on location. In general, though, by the time of the closing, an offer has been made and accepted, financing has been arranged, inspections have been completed, and all contingencies have been satisfied. Usually, what remains is a stack of paperwork that needs to be signed.
Before the closing Review the good faith estimate of closing costs Your lender will provide you with a good faith estimate of the closing costs shortly after you submit your loan application. This is an itemized estimate of what your closing costs will be. Be sure to review it carefully to help you prepare for the closing. Keep in mind, however, that this document is just an estimate and may not include all costs due at closing. So, ask the closing agent (a representative of the title company or mortgage lender, a real estate broker, or an attorney who conducts the closing meeting) to send you a final list of the actual costs a few days before the closing. Purchase title insurance Sometime before the actual closing date, an attorney or title company (normally hired by your mortgage lender) will usually conduct a title examination. The purpose of this title examination is to discover any problems that might prevent you from getting clear title to the home. Title problems are generally cleared up before the closing, but in some cases, they can delay the closing. In extreme cases, a title problem may be so serious that you decide not to purchase the home. A title problem could also cause a lender to refuse to finance a purchase. To protect yourself from title defects that were not discovered in the course of the title examination and that may not appear until after you've taken ownership of the property, you may want to purchase title insurance. You generally pay a one-time fee for title insurance, the price of which varies depending on the location of the home, its purchase price, and the type of title insurance coverage you select. Most mortgage lenders will require you to take out lender's title insurance, which protects the lender's interest in the property. However, a lender's title insurance policy does not protect your full interest in the property. So, you may want to purchase a separate owner's policy to protect your interest in case of title defects. Obtain homeowners insurance Most lenders require you to obtain homeowners insurance coverage before the closing for the property you are buying. Typically, you'll need to provide the lender with proof of insurance coverage at the closing. Do a final walk-through A final walk-through allows the buyer to do one last inspection of the property before closing to make sure that the seller has made all repairs and satisfied any obligations specified in the purchase and sale contract. The final walk-through usually occurs within 24 hours of the closing.
The closing Who needs to be present? Although the players vary depending on local custom, some or all of the following individuals will be present at the closing:
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• The closing agent • The buyer and/or buyer's attorney • The real estate agent(s) involved in the sale • The seller and/or the seller's attorney • A notary to witness signatures of the parties What type of paperwork will there be? The following is a list of some of the paperwork you may find at closing. This list is not exhaustive and will vary from state to state. Make sure you read and understand all of the documents you are asked to sign. • Grant Deed: This document states that the title of the property is being transferred from one party to another. • Change of Ownership Report: Required by the taxing authority in your jurisdiction, this form gives notice of the transfer of ownership. Depending on the selling price of the home, your property tax assessment may be adjusted upon receipt of this document. • Fixed (or Adjustable) Rate Note: This note simply states your interest rate if you have a fixed rate mortgage. If your mortgage is an adjustable rate mortgage, the Adjustable Rate Note explains how your interest rate is calculated, your lifetime interest rate cap, etc. • Promissory Note: This note spells out the amount and repayment terms of your mortgage loan. Your signature on the promissory note is your pledge to repay the loan. • Mortgage: This contract gives the lender a lien against the property. If you fail to repay your mortgage as promised, the lender has the right to foreclose. • Deed of Trust: In some states, this document is used instead of a mortgage. Title is conveyed to a trustee rather than the borrower. • Truth in Lending Disclosure: Among other things, the Truth in Lending Disclosure tells you exactly how much you will pay over the life of your mortgage, including the total amount of interest you will pay. • HUD-1 Settlement Statement: This statement details the cash flows among the buyer, seller, lender, and other parties to the transaction. It also lists the amounts of all closing costs and who is responsible for paying these. • Occupancy Affidavit and Financial Status: In this document, you state that the property is owner-occupied or will be within a certain period after closing. You promise to make the home your principal residence for at least a year and further promise that there has been no significant change in your financial status since you applied for the mortgage. • Signature Affidavit: This is a notarized copy of your signature. • Flood Insurance Authorization: Whether or not your property is located in a flood zone, this document states that you will get appropriate flood insurance coverage if this ever becomes necessary. • Name Affidavit (AKA): This document must be filled out by people who have had name changes, such as those recently married, divorced, or widowed, and borrowers with AKAs on their credit reports. • Compliance Agreement: On this form, you promise to cooperate with your lender in adjusting clerical errors and other mistakes that may put your loan documents out of compliance. • Borrower's Certification and Authorization Letter: This document authorizes your lender to take steps
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to verify statements you have made and certifies that you have not misrepresented your financial status. • Notice to Applicant of Right to Receive Copy of Appraisal Reports: As the name implies, this form notifies you of your right to receive a copy of any appraisal reports. • Quality Control Announcement and Authorization: This is notification that your loan documentation may be included in a random quality control audit. • IRS Form 4506: This form gives your lender the right to request a copy of your tax returns from the IRS. Make sure you indicate, on the form, the tax period(s) you authorize your lender to review. This should generally be no more than the past two years' tax returns. • Servicing Disclosure Statement: This statement explains that servicing of your loan may be transferred to another entity. It informs you of your consumer rights regarding the servicing of your loan. • Smoke Detector Certificate: This document certifies that smoke detectors are in place and working properly. • Termite Inspection Certificate: This document certifies that the building has been inspected for the presence of termites and termite damage. Tip: You may be required to bring a photo ID, along with certain documentation (e.g., proof of insurance coverage) to the closing. You should receive a copy of all of the paperwork at closing or within a few days to keep for your records. What funds will be due? Once all of the paperwork has been signed by the appropriate parties, you will be required to submit a certified or cashier's check to pay for the closing costs and any other funds that are due (e.g., down payment). Typical closing costs include the appraisal fee, points, credit report fee, loan origination and processing fees, recording fee, title search fee, and other expenses. Closing costs can total between 3 and 7 percent of your mortgage amount. Tip: The lender may establish an escrow account for the buyer at this time to pay for items such as property taxes, homeowners insurance, and private mortgage insurance. Payment of these items into an escrow account, plus the prepayment of interest owed on the mortgage through the end of the current payment period, can add significantly to the buyer's closing costs. What if the seller hasn't met his or her obligations? If the seller hasn't met certain agreed upon obligations (e.g., repairs), be prepared to demonstrate exactly where the contract requires the seller to take action and how he or she has failed to fulfill this requirement. Also, have a reasonable remedy in mind. For example, if the cracks in the front porch weren't repaired as promised, you might suggest that the seller place additional money in escrow to cover the cost of this repair. Ideally, all such disagreements should be resolved prior to the closing. How does it all end? At the end of the closing, you'll be given the keys to your new home. The closing agent will then officially record the mortgage and deed at the local property record office and disburse any funds to the appropriate parties (e.g., seller, lender, real estate agents).
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Using Title Insurance to Protect Your Interest in Your Home What is a title examination? Title is the right to own, possess, use, control, and dispose of property. When you buy a home, you are actually buying the seller's title to the home. Before the closing, an attorney or title company (normally hired by your mortgage lender) will usually conduct a title examination by searching public records. The purpose of a title examination is to discover any problems that might prevent you from getting clear title to the home. The title examiner will then issue a report that describes the property, along with any title defects, liens, or encumbrances discovered in the course of the title examination.
What are some common title problems? Most run-of-the-mill title problems can be cleared up before the closing. But in some cases, certain title problems can delay the closing. If a title problem is severe enough, you may decide not to purchase the home. A title problem can even result in your mortgage lender refusing to finance the purchase. Many different situations can affect a property's title. For example: • A home's seller claims to be single, but a title search reveals that the seller is married and owns the house with his or her spouse. • A title search reveals that the property is titled in a deceased individual's name, but there is no will on file to indicate how he or she disposed of it. • A home's sellers took out a home improvement loan, which they have since repaid. However, the lien was never removed from the title. • A home's sellers had a dispute with a contractor over the workmanship on some home renovations, and the sellers withheld final payment on the contract. The contractor filed a mechanic's lien on the property, which was never removed. • You are buying a home and a property survey discovers that the family room that the sellers added on a few years ago is partially situated on a neighbor's property.
What is title insurance? Title insurance protects you against title defects that were not discovered in the course of the initial title examination and that may not appear until after you've taken ownership of the property. A title insurance policy protects you and your heirs against title defects for as long as you own the property. The policy represents the title insurance company's responsibility to compensate you for any covered loss caused by a defect in the title or any lien or encumbrance that was not discovered in the title examination. Title insurance companies usually offer two types of title insurance policies: standard and extended. Standard policies provide limited coverage, offering protection for certain off-record title problems (e.g., fraud), as well as those that could be uncovered during a search of public records (e.g., recorded mechanic's liens). Extended policies provide the same coverage as standard policies, as well as additional coverage for title problems that aren't found so easily, such as unrecorded liens and title defects that could only be uncovered during an inspection of the property. You usually pay a one-time fee for title insurance, the price of which varies depending on the location of the home, its purchase price, and the type of title insurance coverage you select.
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Tip: Most title insurance policies contain coverage exceptions, so it is important to understand exactly what is covered by the policy.
What about lender's title insurance? When you get a mortgage, most mortgage lenders require you to take out lender's title insurance, which protects the lender's interest in the property. Coverage on a lender's policy is limited to the amount of the loan and gradually decreases as the loan is paid off. Keep in mind that a lender's title insurance policy does not protect your full interest in the property. As a result, you should consider purchasing a separate owner's policy to protect your interest in case of title defects.
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Mortgage Basics What is it? So you're ready to buy a house. You're probably going to need help financing such a large purchase, which usually means getting a mortgage. A mortgage is an interest in property, created by a written document, that secures the repayment of a loan. When you take out a mortgage loan to buy a home, the home becomes the collateral for the loan. If you don't repay the loan as agreed, the lender may take your property and sell it to satisfy the debt.
Prequalification vs. preapproval When you prequalify for a mortgage, you get a mortgage lender's estimate of how much you can borrow. Prequalification does not guarantee that the lender will grant you a loan, but it does give you a rough idea of where you stand. Many lenders will prequalify you for a mortgage over the phone, usually at no cost. However, if you're really serious about buying a home, you may want to consider getting preapproved for a mortgage. Preapproval is when a lender, after verifying your income and checking your credit, gives you a letter of commitment stating that you'll be given a mortgage up to a certain amount (as long as certain conditions are met). Lenders usually charge a fee for mortgage preapproval. Tip: Keep in mind that the mortgage you qualify for or are approved for isn't necessarily how much you can afford. You'll first need to examine your budget and lifestyle to make sure that your mortgage payment will be within your means.
Applying for a mortgage Do your homework ahead of time Before you apply for a mortgage, do some homework. Know how large a mortgage payment your budget will allow, and research the various types of mortgages that are available. You'll also want to obtain a copy of your credit report to make sure that there are no errors on it. Shop around Shop around among various mortgage lenders. Start out by looking in the real estate section of the newspaper and surfing the Internet for information on different lenders. Also, be sure to ask friends, family, and real estate professionals (e.g., attorneys, real estate agents) for references. In addition to low costs and rates, you'll want to consider the types of loans each lender offers, whether the lender has a good reputation for loan servicing, and the type of loan approval process the lender uses. Tip: Typically, the better your overall financial picture, the better the loan terms you'll be offered. The application process Once you have decided on a particular lender, you'll meet with that lender and be asked to fill out an application. The application will give the lender information on areas such as your employment history, your income/expenses, and your assets/liabilities. You'll also be asked to provide the following documents: • Bank account numbers, the address of your bank, and account statements from the past three months • All investment statements from the last three months
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• Pay stubs, W-2 forms, or other proof of employment and income verification • Proof of payment history on revolving debt (e.g., credit card statements, canceled rent checks) • Information on other consumer debt (e.g., car loans, student loans) • Divorce settlement papers, if applicable Tip: Having all of your documentation in order ahead of time will speed up the application process. Tip: You may also have to pay an initial application fee. Once you have completed the application and supplied the necessary paperwork, your lender will submit the application for underwriting, which means that the information you supplied on the application will be verified and submitted to an underwriter for approval. It is usually at this time that the lender will order an appraisal and perform a credit check. If your loan application is approved, you will receive a letter from your lender that outlines the terms and amount of the loan. You'll then work with your lender and other individuals (e.g., closing agent) to schedule a date for the closing. If your application is rejected, your lender will usually try to work with you to fix any problems and resubmit the application for approval. If you are turned down for a loan, keep in mind that there are many lenders that deal in loans for people who have poor credit, people who make low down payments, etc. Chances are you'll be able to find another lender that will be able to meet your needs.
Mortgage brokers When you get a mortgage from a bank, credit union, or mortgage company, you deal directly with the lending institution. However, if you don't have the time to evaluate the various mortgage programs available, or if you think you may have trouble qualifying for a mortgage, you may want to consider working with a mortgage broker. A mortgage broker acts as a middleman and works with a number of banks, mortgage companies, and other lenders to find the best mortgage for you. Although using a mortgage broker will save you time, it will cost you money. Typically, broker's fees are as much as 2 percent of the mortgage loan (or more if you have poor credit). Before you go ahead and choose a mortgage broker, take some steps to make sure the company is reputable. Ask for referrals from friends and associates. You can even call your state's banking regulatory agency to check your broker's record.
Private mortgage insurance What is it? Most lenders feel that borrowers who make low down payments (and therefore have little equity in the property) are more likely to default on a mortgage loan. As a result, they generally require you to purchase private mortgage insurance (PMI) if you are borrowing more than 80 percent of the value of the home you are purchasing (i.e., your down payment is less than 20 percent). PMI guarantees that your lender will be paid if you default on your mortgage. Tip: Some mortgages (e.g., VA loans) do not require PMI. How much does it cost? PMI premiums vary depending on the insurance company, but they are usually based on factors such as the type of mortgage loan and the loan amount. Although PMI can be expensive, you may be unable to qualify for a mortgage without it.
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Can you cancel it? If you are concerned about taking on PMI payments, keep in mind that you may not have to pay PMI forever. If you have a good payment history and reach 20 percent equity in your home, you can petition your lender to remove the PMI. For loans that originated after July 29, 1999, your lender is obligated to remove PMI once you have reached 22 percent equity in your home, provided you have a good payment history. Are there any alternatives? If you're confident that you won't default on your loan, consider asking if your lender is willing to increase your mortgage interest rate rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly PMI premium. However, mortgage interest is generally tax deductible, whereas PMI payments are not. Caution: With this arrangement, you'll pay interest for the life of the loan. In contrast, you can generally remove PMI once you obtain a certain amount of equity in your home. Another alternative to PMI is to obtain 80-10-10 financing, where a lender provides a traditional 80 percent first mortgage, and you then obtain a 10 percent second mortgage and make a 10 percent down payment.
Escrow account An escrow account (also known as an impound account), is an account set up by a mortgage lender to hold money for escrow items that are due from a borrower, such as property taxes and homeowners insurance. If your lender has set up an escrow account for you, you will pay your lender for your escrow items in addition to your mortgage principal and interest. Your lender will then pay the appropriate parties for any escrow items on your behalf. Tip: Since the amount due for certain escrow items (e.g., taxes, insurance) can change, the amounts due in your escrow account can also change. This can cause your monthly payment to your lender to either increase or decrease.
Closing costs What are they? Closing costs, also called settlement costs, are the fees and other charges you pay to your lender at the closing or settlement. Closing costs generally include the appraisal fee, points, credit report fee, loan application/processing fee, recording fee, title search fee, and other expenses. Your lender is required by law to give you an itemized estimate of what your closing costs will be (known as the good faith estimate of closing costs) shortly after you submit a mortgage application. How much are closing costs? On average, closing costs amount to approximately 3 to 7 percent of a home's selling price. Keep in mind that while some lenders advertise "no closing costs" loans, these loans often roll the costs into your overall loan balance or charge a higher interest rate. Tip: Your lender may allow you to either pay your closing costs up front or finance them.
Buydowns A buydown is when a lender is paid points (interest that is paid up front) in exchange for a lower interest rate on a mortgage. Buydowns can either permanently or temporarily reduce the interest rate. Some even work on a graduated basis. If you are considering a permanent buydown option, it is important to first determine whether or
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not it would be worthwhile. You can calculate your break-even point by determining how many months it would take for the money you'd save with a buydown to exceed the cost of the points you paid.
Mortgage life/disability insurance Mortgage life insurance pays off your mortgage if you die, while mortgage disability insurance covers your mortgage payments if you become disabled. Mortgage life/disability insurance may be appropriate if you want to make sure that your family would be able to continue to make mortgage payments if you were to die or become disabled. It is important to note, however, that there may be other, more affordable ways to provide this type of protection (e.g., individual life and/or disability insurance policies). Consult an insurance professional for more information.
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Private Mortgage Insurance (PMI) What is private mortgage insurance (PMI) and why do you need it? Most lenders feel that borrowers who make low down payments (and therefore have little equity in the property) are more likely to default on mortgage loans. When a default does occur, a lender must foreclose on the home and sell it to satisfy the debt. The lender pays the foreclosure costs out of the sale proceeds before applying any money to the outstanding loan balance, often losing money on the transaction. As a result, lenders generally require you to purchase private mortgage insurance (PMI) if you are borrowing more than 80 percent of the value of the home you are purchasing (i.e., your down payment is less than 20 percent). PMI guarantees that your lender will be paid if you default on your mortgage. Caution: PMI protects the lender's financial interest in your home. PMI does not protect you against losing your house in the event of a default on your mortgage. In fact, the private mortgage insurance company may seek recourse against you for any amount it pays to your mortgage lender if you default on your mortgage. Government loan programs that offer low down payment mortgages may not require PMI. For example, VA loans don't require PMI because the federal government guarantees a portion of the total mortgage. FHA loans don't require PMI because they are insured by the federal government. However, the insurance cost is passed on to the borrower through an initial mortgage insurance premium (MIP) that often is financed as part of the loan amount, and through annual MIP charges that become part of the monthly mortgage payments. Tip: For 2007 through 2010 only, premiums paid or accrued for qualified mortgage insurance is treated as deductible mortgage interest. Qualified mortgage insurance means mortgage insurance provided by the VA, FHA, and Rural Housing Authority as well as private mortgage insurance (PMI). The amount of the deduction is phased out if your AGI exceeds $100,000 ($50,000 if married filing separately). This provision does not apply with respect to any mortgage contract issued before January 1, 2007 or after December 31, 2010.
How much does PMI cost? PMI premiums vary depending on the insurance company, but they are usually based on factors such as the type of mortgage loan and the loan amount. PMI premiums are often paid to your loan servicer along with your monthly housing payment (principal, interest, taxes, and insurance). Although PMI can be expensive, you may be unable to qualify for a mortgage without it.
Can PMI ever be removed? The good news is that you won't have to pay PMI forever. If you have a good payment history and reach 20 percent equity in your home, you can petition your lender to remove the PMI. For loans that originated after July 29, 1999, your lender is obligated to remove PMI once you have reached 22 percent equity in your home, provided you have a good payment history. However, you may be required to obtain a home appraisal from an appraiser approved by the lender; the appraisal fee will be an expense you'll have to pay.
Are there any alternatives to paying PMI? If you don't have at least 20 percent for a down payment, there are a couple of alternatives to paying PMI. Consider asking if your lender is willing to increase your mortgage interest rate rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly insurance premium. However, mortgage interest is generally tax deductible, whereas PMI payments are not. Moreover, if you're able to make prepayments against your mortgage principal, you'll save on the total interest charge you'll pay over the term of
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your mortgage. Caution: With this arrangement, you'll pay the interest for the life of the loan. In contrast, you can generally remove PMI once you obtain a certain amount of equity in your home. Another alternative to paying PMI is 80-10-10 financing (also known as piggyback financing). With this type of financing, a lender provides a traditional 80 percent first mortgage. You then obtain a 10 percent second mortgage and make a 10 percent down payment. Keep in mind that 80-10-10 financing can be altered to accommodate the size of your down payment (e.g., you could put 8 percent down and obtain 80-12-8 financing). However, the lower your down payment, the higher the loan fees and interest rate may be. Caution: Although the mortgage interest you pay is generally tax deductible, the initial and ongoing costs of these arrangements may be higher than your PMI payments would be, particularly if you put less than 10 percent down.
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Choosing a Mortgage Introduction Like homes, home mortgages come in all shapes and sizes: short-term, long-term, fixed, adjustable, jumbo, balloon--these are all terms that will soon be familiar to you, if they're not already. There's a mortgage out there that's right for you. To figure out which one, though, you'll want to take into consideration such factors as your risk tolerance, the length of time you plan on staying in your home, whether you're looking for a mortgage with low up-front costs, and the size of the mortgage you need.
Fixed rate mortgages As the name implies, the interest rate on a fixed rate mortgage remains the same throughout the life of the loan. Your monthly payment (consisting of principal and interest) generally remains the same as well. The entire mortgage is repaid in equal monthly installments over the term (length) of the loan. Length does make a difference In the mortgage market, long-term loans are generally considered to be 30 or more years in length; short-term loans are those under 30 years in duration. While they may vary between 10 and 40 years (depending in part on the size of the loan), the usual terms for fixed rate mortgages are 15 and 30 years. Although the monthly payment for a 15-year mortgage will be higher than the monthly payment for a 30-year mortgage, it won't be twice as high, and the shorter term of the loan will save you a substantial amount in total interest charges. Example(s): If you borrow $100,000 at 8 percent for 30 years, your monthly principal and interest payment will be $733. Over the 30-year term, you'll pay a total of $164,155 in interest. If you borrowed the same amount at the same interest rate for 15 years, your monthly payment would be $955 (about 30 percent higher than the payment for the 30-year mortgage), and the total interest you'd pay over the 15-year term would be $72,017--a savings of $92,138. Because the lender would lose money on a long-term fixed rate loan if interest rates were to rise, the lender may adjust the rate accordingly, in effect charging you a premium to offset this possibility. As a result, a 30-year mortgage may have a higher fixed interest rate than a 15-year loan, and both will carry higher interest rates than those initially charged on an adjustable rate mortgage (ARM). The good news is, you're locked in; the bad news is, you're locked in Locking in a fixed interest rate on your mortgage has its good and bad points. If interest rates rise, yours won't; as a result, your monthly mortgage payment will always remain the same. This can be reassuring to homeowners on tight budgets or with fixed incomes. For this reason, fixed rate mortgages often appeal to individuals with a low tolerance for the risk associated with fluctuating monthly payments. But if interest rates go down, yours won't, and your (now high) mortgage payment will remain the same. While you might be able to refinance your home, paying off the higher-rate mortgage with one that carries a lower interest rate, this isn't always possible. In addition, the interest rate might need to drop significantly to offset the expenses associated with refinancing, and you'd need to remain in your home long enough to allow the monthly savings associated with the lower rate to recoup those expenses.
Adjustable rate mortgages (ARMs) In general With an ARM, also called a variable rate mortgage, your interest rate is adjusted periodically, rising or falling to keep pace with changes in market interest rate fluctuations. Since the term of your mortgage remains constant,
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the amount necessary to pay off your loan by the end of the term changes as your loan's interest rate changes. Thus, your monthly payment amount is recalculated with each rate adjustment. Example(s): You have a $100,000 ARM with an initial interest rate of 6.5 percent and a 30-year term. Your monthly mortgage payment (in whole dollars) is $632. The interest rate is adjusted annually. At the end of the first year, the interest rate increases to 8.5 percent. To reflect this increase and to repay the outstanding principal balance over the remaining 29 years in the term, your payment will increase to $766 per month. If at the end of the second year the interest rate increases to 10.5 percent, your payment will increase to $906 per month. Depending on what's specified in the mortgage contract, an ARM can be adjusted semi-annually, quarterly, or even monthly, but most are adjusted annually. The adjustments are made on the basis of a formula specified in the mortgage contract. To adjust the rate, the lender uses an index that reflects general interest rate trends, such as the one-year Treasury securities index, and adds to it a margin reflecting the lender's profit (or markup) on the money loaned to you. Thus, if the index is 5.75 percent and the markup is 2.25 percent, the ARM interest rate would be 8 percent. What's to keep the interest rate from going through the roof--or, for that matter, from plunging through the floor? Most ARMs specify interest rate caps. The periodic adjustment cap may limit the amount of rate change, up or down, allowed at any single adjustment period. A lifetime cap may indicate that the interest rate may not go any higher--or lower--than a specified percentage over--or under--the initial interest rate. Example(s): Your ARM has an initial rate of 9 percent and is adjusted annually. The periodic adjustment cap is 1.75 percent per year, and the lifetime cap is 5 percent. This means that at your first adjustment, your interest rate can't exceed 10.75 percent or go below 7.25 percent. Over the life of your loan, your interest rate can't exceed 14 percent or fall below 4 percent. Caution: Some ARMs cap the payment amount that you are required to make, but not the interest adjustment. With these loans, it's important to note that payment caps can result in negative amortization during periods of rising interest rates. If your monthly payment would be less than the interest accrued that month, the unpaid interest would be added to your principal, and your outstanding balance would actually increase, even though you continued to make your required monthly payments. The initial interest rates (referred to as teaser rates) on ARMs are generally lower than the rates on fixed rate mortgages. If you can tolerate uncertainty in your mortgage interest rate and fluctuations in your monthly mortgage payment amount, believe that interest rates will stay low or go lower in the future, or plan to live in your home for only a short period of time, then you may want to consider an ARM. Hybrid ARMs Hybrid ARMs are mortgage loans that offer a fixed interest rate for a certain time period (3, 5, 7, or 10 years), and then convert to a 1-year ARM. Example(s): Your mortgage offers a fixed rate of 7 percent for 5 years. At that point, the mortgage converts to a 1-year ARM with a periodic adjustment cap of 1 percent and a lifetime cap of 4 percent. For the first 5 years, you pay 7 percent interest. In the sixth year, when the mortgage converts to a 1-year ARM and your first annual rate adjustment is made, your interest rate can't go above 8 percent or below 6 percent. Over the life of the loan, the interest rate can't go over 11 percent or below 3 percent. The initial fixed interest rate on a hybrid ARM is often considerably lower than the rate on either a 15-year or 30-year fixed rate mortgage. The longer the initial fixed-rate term, however, the higher the interest rate for that term will be. Generally speaking, even the lowest of these fixed rates is higher than the initial (teaser) rate of a conventional 1-year ARM. Hybrid ARMs are ideal for individuals who plan to stay in their homes for a short period of time (3 to 10 years), since they can take advantage of the low initial fixed interest rate without worrying about how the loan will change when it converts to an ARM. If you think your plans may change or you are planning on staying put for a while,
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look for a hybrid ARM with a conversion option. This option will allow you to convert your loan to a fixed rate loan before it turns into an ARM.
Government mortgage programs Generally, government mortgage programs offer mortgages insured and/or guaranteed by agencies of the federal government. These programs are often attractive to buyers (particularly first-time homebuyers) because they: • Offer fixed interest rates that are lower than those offered by conventional loans • Require little or no down payment • Use more liberal qualifying guidelines than conventional loans • Allow the buyer to work with a third party to pay part or all of the mortgage closing costs, or allow the buyer to finance the closing costs as part of the mortgage balance • Carry no prepayment penalties FHA loans Federal Housing Administration (FHA) mortgages are similar to conventional fixed rate mortgages, except that they are insured by the federal government. The borrower pays mortgage insurance premiums (MIPs). The initial premium is based in part on the term of the loan and the size of the down payment, and can equal as much as 2.25 percent of the amount borrowed. This initial premium can be financed into the loan. Depending on the same factors, the annual MIP varies from.25 to.5 percent of the amount financed; it is collected as a part of the monthly mortgage payments. In part because of the security this insurance offers, lenders sometimes set their FHA mortgage rates below the current interest rates on conventional mortgages. And depending on the amount you borrow, an FHA loan may allow a down payment of as little as 3.5 percent of the purchase price of your home. Tip: FHA mortgage amounts are limited, and the maximum loan amount varies among geographic regions. Caution: If you're buying a newly constructed home (less than 12 months old) and are applying for an FHA mortgage, you may need to convince the builder to sign a warranty as part of your loan package. If the home isn't new, FHA loans require that the home be in good repair. Tip: The Housing and Economic Recovery Act of 2008 includes the HOPE for Homeowners Act of 2008, which created a temporary program within the FHA to back FHA-insured mortgages to distressed borrowers. These mortgages refinance distressed loans at a significant discount. VA loans If you are a veteran, you may qualify for a Department of Veterans Affairs (VA) mortgage, which is similar to a conventional fixed rate mortgage. The VA guarantees to the lender that a certain portion of the mortgage will be repaid by the federal government if the borrower defaults on the loan. Based on the size of the loan, the VA guarantees: • 50 percent of a loan up to $45,000 • Up to $22,500 for loans over $45,000 and not more than $56,250 • 40 percent of loans over $56,250 and not more than $144,000 • 25 percent of loans over $144,000, up to a maximum of 25 percent of the FHA conforming loan limit for a single unit dwelling (currently, $104,250)
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Generally, a lender will offer a VA loan equal to four times the VA guaranty amount to a qualified borrower--with no down payment required. As a result, a qualified veteran with an available guaranty of $104,250 could receive a mortgage of up to $417,000, or up to $625,500 in the most expensive parts of the country.. Some lenders may allow servicemembers and veterans to borrow more than this amount if they're able to make an additional cash down payment. In part because of the security this guaranty offers, lenders usually set their rates on VA mortgages lower than those for conventional mortgages. Bond-backed mortgages A bond-backed mortgage is a mortgage loan issued by a city, state, or county government. The government entity sells bonds to investors, and uses the proceeds from the bond sales to fund the mortgage loans. The interest rates on these mortgages are often lower than rates available from conventional lenders. Mortgage terms and standards of eligibility are set by the individual government entity, and will vary among different communities.
Other types of mortgages Balloon mortgages A balloon mortgage is a short-term mortgage with a large principal payment due at the end of the loan's term. With this type of mortgage, you make fixed monthly payments for a certain period of time (3, 5, 7, or 10 years, with 5- and 7-year terms being the most prevalent). However, these monthly payments are based on the same repayment schedule (called an amortization schedule) as those for a 30-year fixed mortgage. For this reason, the fixed payments during this period are relatively low. At the end of this period the loan matures, and the remaining principal balance is due as one large final payment (called the balloon payment). Example(s): Your $150,000 balloon mortgage has an interest rate of 6.5 percent for 5 years, after which time the remaining principal comes due. Based on a 30-year amortization schedule, your monthly mortgage payment against principal and interest will be $948. At the end of the 5-year term, you'll owe a remaining principal balance of $140,422. This is your balloon payment. The short term and relatively low monthly payments make balloon mortgages attractive, particularly for buyers who do not intend to remain in the property beyond the term. However, this type of mortgage is best suited for individuals who are certain they'll be able to make the large payment due at the loan's maturity. If you want the option of converting the balloon payment to a different type of mortgage (perhaps you'll decide to stay in the house), look for a balloon mortgage with a reset feature. The reset feature allows you to convert the balloon payment to, for example, a fixed rate mortgage at the currently prevailing rate for the remainder of the original amortization schedule. Example(s): Your balloon mortgage described above has a reset feature that allows you to convert the remaining principal balance to a fixed rate mortgage with a 25-year term (the remaining term of the original amortization schedule). When the balloon payment of $140,422 comes due, the prevailing rate is 7.5 percent. Exercising the reset option, your new fixed payment becomes $1,048 per month. Graduated payment mortgages A graduated payment mortgage (GPM) begins with low monthly payments that gradually rise (usually over a 5- to 10-year period) and then level off for the remainder of the loan term. The interest rate on a GPM remains fixed throughout the life of the loan (usually 30 years). Example(s): You borrow money at 8 percent for 30 years. Each year for 5 years, your payments will increase by 7.5 percent. Thus, if your payment is $500 per month in the initial (0) year, it would be (in whole dollars) $538 per month after year 1, $579 per month after year 2, $621 per month after year 3, $668 per month after year 4, and $718 per month after year 5 and thereafter. The greater the annual increase rate and the longer the period of increases, the lower the initial monthly
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payments on a GPM will be. Caution: Because monthly payments on a GPM can start out quite low, negative amortization can occur in the early years of these loans. If the monthly interest charge according to the amortization schedule is greater than the monthly payment amount, the overage is added to the principal, and your loan balance will consequently increase until such time as your monthly payment amounts grow large enough to reverse this process. A GPM is best suited for a homeowner who enjoys predictable annual income increases (and so can afford the increasing payments), and who (in order to reverse the effects of negative amortization) will own the home for longer than the short term of the periodic increases in the monthly payments. Growing equity mortgages A growing equity mortgage (GEM), also referred to as a rapid-payoff mortgage, is actually a formalized method of prepaying your mortgage. The interest rate for a GEM is generally lower than that for a conventional fixed rate mortgage, and remains fixed throughout the life of the loan. However, the monthly payments generally begin at approximately the same level as those of a 30-year fixed rate mortgage. The payments gradually rise, usually over a period of 5 to 10 years, and then level off for the remainder of the loan term. The increases may be based on a predetermined schedule or on changes in an economic index specified in the mortgage contract. Example(s): For 10 years, the changes in your monthly GEM payment will be made annually, and your monthly payment will increase by 75 percent of the rate of increase in a U.S. Department of Commerce index that measures per-capita income growth. Thus, if the index increases by 6.8 percent, your payment would increase by 75 percent of that, or by 5.1 percent. If your monthly mortgage payment is $500 at the time of the adjustment, it will increase to $525.50 ($500 x 1.051). When your payment increases, the additional funds are applied each month directly to your loan's principal balance. This will accelerate the timetable for your mortgage payoff and reduce the total amount of interest you'll pay over the (shorter) life of the loan. As a result, while a GEM doesn't offer any long-term tax deduction advantages, it allows you to build equity in your home more rapidly. Shared appreciation mortgages A shared appreciation mortgage offers you a low fixed interest rate in exchange for your agreement to share with a lender a sizable share (usually 30 to 50 percent) of the appreciation in your home's value, either upon its sale or at a specified date. As part of the contract, the lender may also agree to make a portion of your monthly payments. Example(s): You want to buy a home with a sale price of $200,000. Normally, your lender charges 9 percent on conventional mortgages. If you put $40,000 down, your monthly mortgage payments on $160,000 for 30 years at 9 percent would be (in whole dollars) $1,287--more than you can afford at the time. Example(s): The property values in the neighborhood are appreciating, and both you and the lender feel that the home will be worth at least $250,000 in 5 years. The lender then offers to give you a 7 percent fixed rate mortgage for a 30-year term. Further, the lender agrees to make half the monthly mortgage payments for 5 years, if you'll agree to repay the lender those costs and 50 percent of the appreciated value of the property at that time (or upon the sale of the property, should that occur first). Example(s): At 7 percent for 30 years, the monthly mortgage payments would be $1,064. The lender will pay half this, or $532 per month, for 5 years (60 payments). At that point, your property is worth $250,000, and you pay the lender $31,920 in costs ($532 per month x 60 months) plus half the appreciated value ($25,000) for a total of $56,920. You then elect to stay in your home, and repay the remaining mortgage balance at 7 percent over the 25 years left of the original 30-year term. Over the previous 5 years, you've gotten regular salary increases, and you can now afford the monthly mortgage payments of $1,064.
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Example(s): On a $160,000 loan at 7 percent for 30 years, the total interest you pay is $223,214. Had you taken the same loan at 9 percent, your total interest payments over the full 30-year term would have been $303,462. Your savings equal ($303,462 - $223,214) - $25,000, or $55,218. Caution: Given that you are not paying all of the mortgage interest on a shared appreciation mortgage in a regularly scheduled manner, you should check with a tax advisor to determine its deductibility. A shared appreciation mortgage may limit or preclude your ability to borrow against the equity in your home. In addition, at the time you must meet your obligation to the lender, you may need to sell your home if you don't have an alternative means to meet that obligation. Moreover, if the value of your home has not increased as expected, the lender may require you to pay additional interest. Jumbo loans A jumbo loan (also known as a nonconforming loan) is any mortgage over $417,000, or over $625,5000 in the most expensive parts of the country, for a single-family home or condominium. This figure is set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), and is adjusted annually. Jumbo loans are called nonconforming loans because these organizations will not underwrite them, making them more risky to lenders. As a result, lenders often set their jumbo loan interest rates higher than conventional mortgage rates. This can make a significant difference over time. If you're just over the underwriting limit for conforming loans and are having to consider a jumbo loan, you might want to either look for a cheaper house or consider increasing your down payment in order to qualify for a conforming loan with a lower interest rate. Over the life of your mortgage, this could create significant savings. For ideas that may help you increase your down payment, see our separate topic discussion, Alternative Ways to Fund Your Down Payment.
Mortgages from nontraditional lenders Seller-financed mortgages With a seller-financed mortgage, also called a take-back or purchase-money mortgage, the seller of the home actually acts as the lender. You buy the home under an installment sale arrangement, which means that you take possession of the house and pay for it in periodic installments under the terms of a mortgage contract. You and the seller negotiate the terms of the contract, and you make your mortgage payments directly to the seller, rather than to a bank or mortgage company. Tip: Under such an arrangement, your property taxes and homeowners insurance are not included in your mortgage payment, as they often are with many traditional mortgages. Wraparound mortgages A wraparound mortgage is a type of mortgage in which the seller of the home you're purchasing also acts as your lender. You'll generally make your monthly payment on a wraparound mortgage directly to the seller. Each month, the seller uses a portion of your payment to make the payment on his or her original mortgage. The seller also finances an additional amount that covers the remaining purchase price of the home minus any down payment you tendered. These two parts--the seller's original mortgage and the additional balance the seller financed for you--combine to create the wraparound mortgage. The interest rate on a wraparound mortgage is somewhat higher than the rate on the seller's original mortgage, but it is often lower than interest rates available from conventional lenders. This can create a situation favorable to both you and the seller. Example(s): You're buying a home for $250,000, and have $25,000 for a down payment. The current rate for a 30-year fixed rate mortgage is 7.5 percent. For a $225,000 loan, this would mean
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a monthly mortgage payment of $1,835. The seller offers to finance the $225,000 for 30 years at 7 percent. This would make your payment $1,496 per month. At a savings of $339 per month ($1,835 - $1,496), you'll save $122,040 in total interest ($339 x 360 months) over the life of the loan. Example(s): When the seller receives your monthly mortgage payment of $1,496, a portion of it goes to the seller's own mortgage payment. The seller's mortgage is for $150,000 at 6.5 percent for 30 years; the monthly payment is $948. As a result, each month the seller pockets $548 ($1,496 $948). Over the life of your mortgage with the seller, the seller takes in $197,280 ($548 per month x 360 months), clearing a profit of $122,280 on the $75,000 ($225,000 - $150,000) he or she directly financed for you.
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Mortgage Clauses What are mortgage clauses? Mortgage clauses are provisions contained in a mortgage contract that outline special rights, powers, or remedies. Mortgage contracts also contain various covenants, which are promises or agreements between the lender and borrower. Because there are many different types of mortgage contracts (which may be subject to both state and federal law), mortgage contract provisions can vary widely.
Why are mortgage clauses important? As a homebuyer, you'll sign a mountain of paperwork at the closing or settlement meeting. If you required mortgage financing to purchase your property, one of the most important documents you'll sign is the mortgage contract. Few closing attorneys or settlement agents review each and every provision of the mortgage contract with a homebuyer. It's important, therefore, to understand the clauses or provisions contained in your mortgage. Although there are many different types of clauses and covenants, some of the more important ones are summarized here.
What is an acceleration clause? An acceleration clause in a mortgage contract allows the lender, in certain circumstances, to demand that the entire balance of the loan be repaid in a lump sum immediately. This clause may be triggered, for instance, if the borrower defaults on a regularly scheduled payment. Generally, the lender is required to give notice to the borrower before acceleration is invoked. Specifically, the buyer is notified of the default, the action required to cure the default, and the date by which the default must be cured. If the default is cured, the mortgage is reinstated. If it's not cured, the lender may invoke a statutory power of sale and begin foreclosure proceedings. (See due-on-sale clause below.)
What is an assumption clause? With an assumable mortgage, the assumption clause allows a buyer to take over the home seller's mortgage loan and monthly payment obligations, instead of obtaining a new mortgage. In many cases, the buyer may also be able to assume the seller's interest rate. By assuming a mortgage, a buyer can avoid settlement costs and loan application procedures. However, most conventional mortgages at present are not assumable (i.e., there is a "nonassumption" clause in the mortgage contract). Fully assumable mortgages With a fully assumable mortgage, the lender places no restrictions on who may assume the loan. Fully assumable mortgages were available in the 1980s, but many of these have either been paid off or ended through new refinancing terms. Those that still exist are generally not very attractive to homebuyers because they often have relatively high interest rates and the balance is usually quite low. The new borrower would then have to obtain other financing sources to cover the difference between the home's selling price and the mortgage balance being assumed. Qualified assumptions Modern assumable mortgages are usually qualified, which means that the loan can be assumed only if the lender approves the new borrower. Approval standards are often stringent, and the new borrower may have to pay various fees and charges before taking over the loan. The approval standards for assuming fixed rate mortgages are generally stricter than for assuming adjustable rate mortgages (ARMs).
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What is a conversion clause? Conversion clauses are often found in ARM contracts. This feature allows you to convert the ARM to a fixed rate mortgage at a designated time. The terms and conditions vary from lender to lender. Generally, though, you must give your lender 30 days' notice before converting. You must also pay a fee, usually $250 to $500. Some lenders specify when a conversion can be made, while others allow it any time during the first three to five years of the loan. The interest rate for a convertible ARM may be somewhat higher than for a nonconvertible ARM, and your up-front costs may be greater. When you convert, your new fixed interest rate is generally set at the current market rate for fixed rate mortgages. (Again, though, this can vary from lender to lender.)
What is a due-on-sale clause? A due-on-sale clause allows a lender to accelerate the loan if the borrower transfers a substantial beneficial interest in the property to another party. This may happen, for example, if the home is sold, the title to the property is changed, or the loan is refinanced.
What is an escrow covenant? In many cases, you're required to pay hazard insurance and property tax installments to the lender in advance. With an escrow covenant, the lender holds the funds in an escrow account until the payments are due to the insurer and property tax authority. Normally, either you'd submit the tax and insurance bills to your lender, or the lender would receive the property tax bill from a tax service and the insurance bill from your homeowners insurance carrier. The lender would then make payments to the proper party.
What is an insurance covenant? The insurance covenant requires the borrower to keep the property insured against loss by fire and certain other hazards (at least up to the amount of the mortgage). If the borrower fails to maintain adequate hazard insurance coverage, the lender may obtain this coverage at the borrower's expense. In the event of any loss, the borrower promises to give prompt notice to the insurance carrier and the lender.
What is a prepayment clause? Some mortgages charge a prepayment penalty if the borrower pays off the loan prior to maturity. A prepayment clause generally gives the borrower the right to pay off the loan prior to maturity without paying such a penalty.
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Prepayment and Biweekly Mortgage Payments Introduction Most homeowners make their regular mortgage payments every month for the duration of the loan term, and never think of doing otherwise. But prepaying your mortgage or making biweekly payments can reduce the amount of interest you'll pay over time.
How prepayment affects a mortgage By prepaying your mortgage, you reduce the amount of interest you'll pay over the life of the loan, regardless of the type of mortgage. However, prepayment affects fixed rate mortgages and adjustable rate mortgages in different ways. If you prepay a fixed rate mortgage, you'll pay your loan off early. By reducing the term of your mortgage, you'll pay less interest over the life of the loan, and you'll own your home free and clear in less time. If you prepay an adjustable rate mortgage, the term of your mortgage generally won't change. Your total loan balance will be reduced faster than scheduled, so you'll pay less interest over the life of the loan. Every time your interest rate is recalculated, your monthly payments may go down as well, since they'll be calculated against a smaller principal balance. If your interest rate goes up substantially, however, your monthly payments could increase, even though your principal balance has decreased. Should you prepay your mortgage? If you have extra cash, should you invest it or use it to prepay your mortgage? You'll need to consider many factors when making your decision. For instance, do you have an investment alternative that will give you a greater yield after taxes than prepaying your mortgage would offer in savings? Perhaps you'd be better off putting your money in a tax-deferred investment vehicle (particularly one where your contributions are matched, as in some employer-sponsored 401(k) plans). Remember, though, that the interest savings you'll obtain by prepaying your mortgage is a certainty; by comparison, the return on an alternative investment may not be a sure thing. Other factors may also influence your decision. The best time to consider making prepayments on your mortgage would be when: • You can afford to contribute money on a regular basis • You have no better investment alternatives of comparable certainty • You cannot refinance your mortgage to obtain a lower interest rate • You have no outstanding consumer debts that are charging you high interest that isn't deductible for income tax purposes (e.g., credit card balances) • You are in the early years of your mortgage, when, given the amortization schedule, the interest charges are highest • You have sufficient liquid savings (three to six months' worth of living expenses) to cover your needs in the event of an emergency • You won't need the funds you'll use for mortgage prepayment in the near future for some other purpose, such as paying for college or caring for an aging parent • You intend to remain in your home for at least the next few years
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Can you prepay your mortgage without penalty? You should find out whether your lender charges a penalty for mortgage prepayment. Any penalty charges would of course undercut your prepayment savings, and the penalties can sometimes be substantial. Some lenders don't charge any prepayment penalties on their mortgages, while others may penalize you only if your prepayment exceeds a certain amount or occurs within a certain time period. In these instances, you may still be able to make prepayments without incurring a penalty if you're careful. Example(s): Your mortgage contract charges a penalty of 3 percent of the prepaid amount if you prepay 20 percent of the principal balance within the first two years. You can, however, prepay 15 percent of the balance in two years, save considerably on the interest charges, and incur no penalty for doing so. Generally, Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) loans can be prepaid without penalty. Check your loan documents or contact your lender to find out if a prepayment penalty applies to your loan. Particularly against a fixed rate mortgage, regular contributions toward prepayment can dramatically shorten the life of the loan and result in substantial savings on the total interest you're charged. Example(s): If you pay off a $300,000 mortgage at 8 percent over 30 years, your normal payments against principal and interest will be $2,201 per month (rounded to whole dollars). You'll pay a total of about $492,466 in interest charges over the term of the loan. However, if you can pay an extra $200 every month, your mortgage will be paid off in just under 22½ years, and you'll save almost $146,000 in total interest charges. Tip: Prepaying part of your mortgage doesn't change your monthly obligation to your lender. Regardless of how much you prepay, you'll be in default if you fail to make your minimum monthly payments. So, before you consider prepayment, it's important to establish an adequate emergency fund to carry you through unforeseen financial difficulties.
Biweekly payment schedules A biweekly payment schedule is actually a formal method of mortgage prepayment. With a biweekly schedule, you make a payment on your mortgage every two weeks. Each payment is roughly equal to one-half of your normal monthly payment. If you maintain the schedule, you'll make an extra month's payment over the course of each year (26 half payments equal 13 full payments). You'll also pay less interest because your payments are applied to your principal balance more frequently. Example(s): Assume you have an 8 percent, 30-year mortgage of $300,000. Your normal monthly payment is $2,201 (rounded to whole dollars). Over the 30-year term, you'll pay about $492,466 in total interest. But if you arrange a biweekly payment schedule for this mortgage, with a biweekly payment amount of $1,100, you'd pay off the mortgage in approximately 23 years and save about $138,186 in total interest charges. If you want to make biweekly mortgage payments, talk to your lender. The best time to do this is when you take out the mortgage. Find out if you will be charged a fee for this service, and ask if there's a penalty for dropping out of the program prematurely. You may at some point discover that you can't afford the extra payment or can't stick to the biweekly schedule. Keep in mind that lender processing errors are more likely to occur with a biweekly payment schedule, since the lender receives twice as many payments on your mortgage. Moreover, given that the biweekly payment schedule may not always synchronize with your monthly mortgage due dates, your chances of making a late payment (and thus incurring a late fee and possibly blemishing your credit history) also increase with this alternative. Caution: Be cautious of biweekly payment plans set up by someone other than your lender (e.g.,
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third-party arrangements). It all adds up if you can do it on your own By making your regular monthly mortgage payments and adding extra funds to each payment, you may achieve the same result on your own as you can with a biweekly payment schedule. Here, the choice to prepay is yours each month. If you can contribute the extra amount on a regular basis, you'll reap the rewards. However, if you can't always pay the extra, you won't jeopardize your mortgage (and your credit report) as long as you can send in your regular monthly payment. This flexibility may be valuable if you encounter a period of financial difficulty.
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Income Tax Considerations for Homeowners Introduction Home ownership confers many benefits, including federal income tax advantages. In particular, you may be able to deduct your mortgage interest payments. In addition, special rules apply to the tax treatment of points, closing costs, home improvements, and repairs. For information about deducting your property taxes, see our separate topic discussion, Property Taxes. For information about home sales, see our separate topic discussion, How Home Sales Are Taxed. Tip: This discussion applies to your principal residence only. For tax rules surrounding second or vacation homes, see our separate topic discussion, Special Considerations for Second/Vacation Homes.
First-time homebuyer tax credit You may qualify for a federal income tax credit of up to 10 percent of the purchase price of a principal residence (subject to the dollar limitations described below) if you meet certain requirements: • The home must be purchased on or after January 1, 2009 and before May 1, 2010. If you enter into a written binding contract before May 1, 2010, you can still qualify if you close on the home before July 1, 2010. (The time period is extended for members of the uniformed services and others who receive government orders for qualified official extended duty.) • If you, and your spouse if you're married, haven't owned a principal residence in three years, you may qualify for a credit of up to $8,000 ($4,000 if you're married and file a separate return). • For home purchases after November 6, 2009, you may qualify for a credit of up to $6,500 ($3,250 if you're married and file a separate return) if you, and your spouse if you're married, have maintained the same principal residence for at least five consecutive years in the eight years preceding the purchase. • For home purchases after November 6, 2009, you can't claim the credit if the purchase price of the home exceeds $800,000. Generally, you won't have to pay back the credit (prior to January 1, 2009 the credit had to be paid back over 15 years in equal installments). There's one important exception, however: If the home ceases to be your principal residence in the 36 months following the purchase, you'll have to pay the credit back. If you're married at the time of purchase, the home must remain the principal residence of either you or your spouse for the 36-month period. The credit is reduced or eliminated for individuals with higher modified adjusted gross income ("MAGI"). The income levels that apply depend on your filing status and when the purchase is made: Qualifying home purchase: Filing status:
1/1/09 through 11/6/09
11/7/09 through 4/30/10
Married Filing joint Credit reduced if MAGI exceeds $150,000, eliminated when MAGI reaches $170,000
Credit reduced if MAGI exceeds $225,000, eliminated when MAGI reaches $245,000
All Others
Credit reduced if MAGI exceeds $125,000, eliminated when MAGI reaches $145,000
Credit reduced if MAGI exceeds $75,000, eliminated when MAGI reaches $95,000
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Additional restrictions apply as well. For example, you can't claim the credit if you're a nonresident alien. And, for purchases after November 6, 2009, you can't claim the credit if you're under age 18 at the time of the purchase (unless you're married and your spouse is at least 18), or if you can be claimed by someone else as a dependent. If you purchase a qualifying principal residence in 2009, you can elect to treat the purchase as if it occurred on December 31, 2008. Similarly, a qualifying purchase in 2010 can be treated as if it occurred on December 31, 2009, allowing you to claim the credit on your 2009 federal income tax return. Tip: For details on the current first-time homebuyer tax credit, as well as information regarding the rules that applied to home purchases on or after April 9, 2008 and before January 1, 2009, see our full discussion of the first-time homebuyer tax credit.
Additional standard deduction for non-itemizers Homeowners can claim an additional standard deduction for property tax if the taxpayer does not itemize. The additional amount that can be claimed is the lower of: • The amount of real estate property taxes paid during the year to state and local governments; or • $500 ($1,000 if married filing jointly) This additional standard deduction applies to tax years beginning in 2008 and 2009 only.
Can you deduct your mortgage payments? With most mortgages, part of each monthly payment is applied to the outstanding principal on your mortgage loan, and part is applied to the mortgage interest. If you itemize deductions on Schedule A of your federal income tax return, the part that is applied to mortgage interest may be deductible. Mortgage taken to buy, build, or improve your home You may be able to deduct qualified interest you paid on a mortgage to buy, build, or improve your principal home or second home, provided that the loan is secured by your home. More specifically, you may be able to deduct interest on up to $1 million of such mortgage debt ($500,000 if you're married and file separately). If your mortgage loan exceeds $1 million, some of the interest that you pay on the loan may not be deductible. Tip: Different rules apply if you incurred the debt before October 14, 1987. All loans taken on and secured by your primary residence and one second residence prior to October 14, 1987--no matter how the proceeds are used--are considered "grandfathered" debt. All interest paid on such grandfathered debt is deductible, even if the total debt exceeds $1 million. Tip: Special rules apply to the deduction of interest paid on a home construction loan. Tip: For 2007 through 2010 only, premiums paid or accrued for qualified mortgage insurance is treated as deductible mortgage interest. Qualified mortgage insurance means mortgage insurance provided by the VA, FHA, and Rural Housing Authority as well as private mortgage insurance (PMI). The amount of the deduction is phased out if your AGI exceeds $100,000 ($50,000 if married filing separately). This provision does not apply with respect to any mortgage contract issued before January 1, 2007 or after December 31, 2010. Home equity debt You may also be able to deduct the interest you pay on certain home equity loans. However, the rules are different. (Home equity debt involves a loan secured by your main or second home that exceeds the outstanding mortgages on the property.) The interest that you pay on a qualifying home equity loan is generally deductible regardless of how you use the loan proceeds (unless you use the proceeds to purchase tax-exempt vehicles). In other words, the loan doesn't have to be made to buy, build, or improve your residence.
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Deductible home equity debt is limited to the lesser of: • The fair market value of the home minus the total acquisition debt on that home, or • $100,000 (or $50,000 if your filing status is married filing separately) for main and second homes combined Example(s): You bought a home some years ago for $180,000, taking out a mortgage of $130,000 to do so. The $130,000 is considered home acquisition debt. The fair market value of the home has now increased to $195,000, and the principal balance on the loan has been paid down to $110,000. You decide to take out a home equity loan of $90,000. You may deduct interest paid on $85,000 of the $90,000 home equity loan. Why? Interest cannot be deducted on the home equity debt that exceeds the difference between the fair market value of the residence ($195,000) and the principal owed on the acquisition debt ($110,000) at the time the home equity loan is taken. If you refinanced your mortgage instead of taking out a home equity loan, see our separate topic discussion, Refinancing.
How are points and closing costs treated for tax purposes? When you buy a home or refinance an existing loan on your home, you'll incur settlement charges. These usually include both points and closing costs, such as attorney's fees, recording fees, title search fees, appraisal fees, and loan preparation fees. The income tax treatment of these settlement charges depends on the type of charge and (in some cases) the type of loan. Deducting points when you buy a home Points are costs that your lender may charge when you take out a loan secured by your home. One point equals 1 percent of the loan amount borrowed (e.g., 1.5 points on a $100,000 loan equals $1,500). If you itemize your deductions on Schedule A of your federal income tax return, and if your lender charges the points as up-front interest and in return gives you a lower interest rate on the loan, the points may be deductible. Tip: It doesn't matter whether your lender calls the charge points or a loan (or mortgage) origination fee. If this charge represents prepaid interest, it may be deductible. If you take out a mortgage to buy or improve your home and pay points, you can deduct the points in the year they're paid if you meet all of the following conditions: • Your loan is secured by your main home • Paying points is an established business practice in the area where the loan was made • The points paid were not more than the points generally charged in that area • You use the cash method of accounting (most individuals use this method) • The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes • The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged • You use your loan to buy or build your main home • The points were computed as a percentage of the principal amount of the mortgage • The amount is clearly shown on the settlement statement as points charged for the mortgage. The points may be shown as paid from either your funds or the sellers
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If you don't meet the above conditions, you must amortize your deduction of the points over the term of the loan. If the loan ends early (because, for example, you sell the home or refinance the mortgage), you may fully deduct the remaining points for the tax year the loan ends. For more information on deducting points, see IRS Publication 936. Tip: If the seller pays your points, they may also be deducted as an up-front interest charge. However, because they are also considered a reduction in the cost of the home, you must lower your cost basis in the home by an amount equal to the points paid by the seller. Tip: For information about deducting points charged on a mortgage secured by a second home, see our separate topic discussion, Special Considerations for Second/Vacation Homes. Deducting points when you refinance your mortgage Refinanced loans are treated differently. The points you pay on a refinanced loan generally must be amortized over the life of the loan. In other words, you can deduct a certain portion of the points each year. But there's one exception: If part of the loan is used to make improvements to your principal residence, you can generally deduct that portion of the points in the year the points are paid. Example(s): Suppose you take a cash-out refinance mortgage for $100,000 and pay two points ($2,000). You use $90,000 to pay off the principal debt owed on the old mortgage, $4,000 to pay off bills, and $6,000 to install new kitchen cabinets. Because 6 percent ($100,000 divided by $6,000) is used for home improvements, $120 worth of points (6 percent of $2,000) may be deducted in the year the loan is taken. The remaining $1,880 in points must be deducted ratably over the life of the loan. Tax treatment of closing costs Generally, you can't deduct closing costs on your tax return. Instead, you must adjust your tax basis (i.e., the cost, plus or minus certain factors) in your home. If you're buying a home, you'd increase your basis by the amount of certain closing costs that you've paid. Example(s): Your closing costs on a loan you take to purchase a $200,000 home total $3,000. Your closing costs would increase your cost basis in that home to $203,000. Caution: Escrow fees that you pay at closing to cover costs that you must pay later (e.g., hazard insurance premiums) are not added to the basis of your home.
What is the tax treatment of home improvements and repairs? Home improvements and repairs are generally nondeductible. However, a distinction is made between improvements and repairs, and they're treated differently for tax purposes. Home improvements Improvements can increase the tax basis of your home (which in turn can lower your tax bite when you sell your home). Improvements add value to your home, prolong its life, or adapt it to a new use. For example, the installation of a deck, a built-in swimming pool, or a second bathroom would be considered an improvement. Tip: You may be entitled to one or more tax credits for making certain energy-saving home improvements. Home repairs In contrast, a repair simply keeps your home in good operating condition. Regular repairs and maintenance (e.g., repainting your house and fixing your gutters) are not considered improvements and are not included in the tax basis of your home.
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Tip: However, if repairs are performed as part of an extensive remodeling of your home, the entire job may be considered an improvement.
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Property Taxes What are property taxes? The city, town, or county in which you live operates the school system, provides police and fire protection, repairs the streets--in short, it maintains the community infrastructure and provides services the residents enjoy. Doing this takes money, which the local governing authority raises (in part) through collecting real estate taxes, or property taxes.
How property taxes are determined Your property tax bill is based on two factors: the property tax rate and the assessed value of your home. The tax rate Put simply, a local governing authority's property tax rate will be the annual operating budget of the authority, divided by the assessed value of all the taxable real estate within its geographical boundaries. (Some property, such as that owned by churches, colleges, or the governing body itself, is not taxable.) This rate is expressed as a dollar amount per $1,000 of taxable assessed value. Example(s): A town with an annual budget of $3 million and a total taxable real estate assessment of $60 million would have a tax rate of $50 for each $1,000 of taxable assessed value ([$3,000,000/$60,000,000] x $1,000 = $50). In an effort to curb tax increases and to make local governing bodies more fiscally responsible, popular referendum ballots in many states have limited budget increases based on the collection of property taxes. For example, a budget may be limited to 1 percent of the market value of the property within the municipality. The assessed value of your home The other factor that determines your property tax bill is the governing body's assessment of your home value. This assessed value is usually a percentage of either your home's fair market value (FMV) or its replacement value (the cost of labor and materials to replace the home, less accrued depreciation). This percentage valuation may not be 100 percent of your home's FMV, however. As a result, your home's assessed value may differ from the price at which you bought it or could sell it. Whatever the percentage value used, it's generally applied uniformly within a particular class of property (commercial, industrial, or residential) to avoid inequitable assessments. Example(s): Your home's FMV is $180,000, and your town assesses real estate at 23 percent of FMV. Your home's assessed value, then, is $41,400. If the town's tax rate is $50 per $1,000, your annual property tax bill will be $2,070 ($50 x 41.4), or $172.50 per month. Caution: Many home assessments are based on outdated appraisals. In most cases, this means the property is assessed for far less than it is worth on the market. A home sale may trigger a reassessment for property tax purposes, and your tax bill may then increase. Appealing your assessment If you think your property tax assessment is incorrect, you may appeal it. There can be many reasons to do so: • A newly constructed high-rise across the street has deprived you of your view • The new commuter station has increased traffic in your neighborhood
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• Recent commercial development has increased noise, odors, and pollution • The house has developed structural flaws that may not be repairable • Pest control has become a problem Most property assessments are not based on individual inspections of the properties themselves. In many cases, these assessments may be based on large-scale appraisals done by third parties contracted to conduct them, and may have rolled over data from previous assessments. This process can perpetuate old valuations. As a result, getting your assessment changed may largely be a matter of doing a better job of appraising the property than the local assessment office did. Tip: If you do want to appeal your assessment, you must act promptly, since the filing period is often limited.
Property taxes vary, depending on location Property taxes can vary dramatically from one locale to another. Therefore, the local property tax rate should be one of the factors you consider when deciding to buy a home. Example(s): Assume Town A levies taxes at the rate of $14 per $1,000 of assessed value. Town B levies taxes at the rate of $30 per $1,000 of assessed value. If you buy a home in Town A that is assessed at $200,000, you'll pay $2,800 per year in taxes (or $233.33 per month). If you buy a home in Town B that is assessed at $200,000, you'll pay $6,000 per year in taxes (or $500 per month). Along with the tax rate, you'll want to consider the types of community services that are supported by the property taxes. In some cases, higher property taxes may mean more extensive services. The local property tax assessor's office can provide you with information about current property taxes in the area, as well as the allocation of property tax funds, the rate of property tax escalation, and the frequency of property tax increases.
Paying property taxes Property tax statements will be mailed to you from your local tax assessor's office. These statements generally contain a breakdown of your tax obligations, along with a description of how the tax was calculated, the assessed value of the property, a legal description of the property itself, the amount due, and the due date of the taxes you owe. Taxes are usually payable quarterly or twice a year. If your mortgage lender requires you to escrow taxes, though, you'll pay several months' worth of taxes to your lender up front when you buy your home. Thereafter, your mortgage payment will include one-twelfth of the annual taxes. Many lenders use a tax service that notifies them of property tax bills that are issued (you will generally pay a fee for this service when you finalize your mortgage loan). If your lender does not receive notice of your tax bills, mail any tax bills you receive to your lender, and your tax bill will be paid from your escrow account. Tip: A homebuyer is responsible for real estate taxes from the date of sale forward. At the closing, the buyer and the seller divide the real estate taxes, with the seller paying taxes up to (but not including) the date of closing. If the seller has already paid a tax bill for a period extending beyond the closing date, the buyer will reimburse the seller at closing for that extra portion.
Deducting property taxes on your income tax return If you itemize your deductions on Schedule A of your federal income tax return, you may be able to deduct the property taxes you paid during the year. To be deductible, the taxes must be based on the assessed value of the real property and be charged uniformly against all property under the jurisdiction of the taxing authority.
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Tip: Homeowners can claim an additional standard deduction for property tax if the taxpayer does not itemize. The additional amount that can be claimed is the lower of: (1) the amount of real estate property taxes paid during the year to state and local governments; or (2) $500 ($1,000 if married filing jointly). This additional standard deduction applies to tax years beginning in 2008 and 2009 only. This deduction is not available for any other tax year. Tip: Deductible real estate taxes generally don't include fees charged for local benefits and improvements ("betterments") that increase the value of the property, such as the installation of a town sewer line to the property. Tip: Payments you make to an escrow account generally aren't deductible until your lender actually pays the taxing authority. Caution: A real estate tax can only be deducted by the owner of the property upon which the tax is imposed. For example, if your mother holds title to a house and you pay the taxes for her, you won't be entitled to claim a deduction for the taxes paid.
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Special Considerations for Second/Vacation Homes Introduction A rustic cabin. a seaside cottage. buying a second/vacation home can be an alluring prospect. Before you decide to purchase one, though, you should consider a number of issues. These include the costs associated with owning a second/vacation home, the attributes of the home, its rental potential, and the income tax treatment.
Should you buy a vacation home? Before you buy a vacation home, first determine whether or not you can afford it. Even if you can rent it out or deduct part of the costs of ownership from your taxes, a vacation home is primarily a luxury, not an investment. You should buy one to add value to your life instead of to your net worth. Buying a vacation home may be right for you if: • Owning one has been your lifelong dream, and you can now afford it • You're almost ready to retire, and you plan to use the home as your primary residence in retirement (be sure to think about your future needs before you buy) • You'll save enough money on family vacations to offset the cost of the vacation home • You can recover most or all of the costs of owning the home by renting it out when you're not using it • You enjoy entertaining frequent guests (like it or not, there's a good chance that friends and family members will want to come visit) Buying a vacation home may not be right for you if: • You have to scrape the money together to afford it • You won't enjoy taking care of the property
How much will it cost to own a vacation home? Owning a vacation home may cost more than you think. Here are some of the things you can expect to pay for: Mortgage payment, taxes, and insurance Unless you pay cash for your vacation home, you'll have to pay a monthly mortgage payment. And, whether you pay cash or not, you'll have to pay property taxes and a premium for hazard and liability insurance on the home. Repairs, upkeep, and fees Whether you maintain the home yourself or hire someone else to do it, you'll have to spend money on repairing and keeping up the home. Maintenance costs can include cleaning, yard work, pool or spa maintenance, plowing, and both major and minor repairs. If you're buying a condominium, you won't have to maintain the exterior of your unit or do yard work, but you'll have to pay a monthly condominium fee instead. Or, if you decide to rent your home, you may want to hire a professional management company that will charge you a fee to rent out and maintain the home.
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Utilities The amount of money you pay for electricity, heat, sewage, water, phone, and other utilities will depend on how frequently you use the vacation home. These costs can really add up, especially if you have a large number of people staying in the home. Furnishings and supplies Unless your vacation home comes fully furnished, expect to spend quite a bit of money on furniture, bedding, and dishes to equip your new home. Cost of travel and entertainment Don't overlook the cost of traveling to and from your vacation home. You may also spend more money dining out than you would at home. Even groceries can cost more in a resort area. If you have guests, you may spend a lot on recreational activities and entrance fees to attractions, as well.
What to look for in a vacation home Personal tastes and the reason you're buying a vacation home will dictate the type of home you'll buy and its location. For instance, if you want to get away from it all, you might want a rustic cabin. On the other hand, if you plan on inviting family members to visit or are thinking about renting out the home, you might want to buy a spacious chalet in a resort area where there's lots to do. Here are some things to think about when you're choosing a vacation home. Location • Is the property within a three-hour drive of your home? This is important if you plan on traveling there frequently. • Are there recreational activities nearby that appeal to both you and potential renters? • Is the property in a scenic, desirable location such as near a lake, beach, or the mountains? • Is the area being heavily developed? This may be a plus if you're renting to others, a minus if you're looking for peace and quiet. • Will you enjoy coming back to the area year after year? Size • Is the home large enough to accommodate friends and family members who will want to visit? • Is the kitchen large enough to prepare meals comfortably? • Are the bedrooms and bathrooms adequate for the number of people who will be staying there? • Is there adequate parking? This is especially important if you have an RV or a large boat. • Is there room to store items that you want to leave at the home (e.g., extra clothing, equipment, or food)? Amenities (the added extras you may want) • Does the home have modern appliances, including a dishwasher and a washer/dryer? • Does the home have a fireplace for chilly evenings? This is especially important in ski country.
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• Does the home have a swimming pool? A hot tub? A sauna? • Does the home have a porch (screened or unscreened) where you and your guests can relax? Maintenance issues • Does the home have reliable plumbing, heating, and cooling systems? Making repairs while you're on vacation is no fun. • Will the grounds require a lot of maintenance? Unless you enjoy it, do you really want to spend your vacation working out in the yard? • Is the home currently in good repair, or will you have to renovate it in order to make it livable?
How do you insure a vacation home? You'll want to insure your vacation home against damage and loss. Your homeowners policy will provide liability coverage for you at your vacation home. However, most homeowners insurance policies provide only limited coverage for personal property at an additional residence. To insure the vacation home itself and to obtain additional personal property coverage, consider purchasing a dwelling and fire policy. There may also be insurance issues depending on how much of the year the property will be vacant. For more information, contact an insurance professional.
What about renting your home to others? If you want to rent your vacation home to others, keep the costs in mind. For instance, if you hire an experienced real estate rental broker who is familiar with rental homes and the rental market in which your vacation home is located, you'll have to pay a fee. If you go it alone, you'll have to pay for advertising, for travel to the property to show it to prospective tenants, and for an attorney to draw up leases. If you plan to rent your vacation home for several short periods during the peak rental season (e.g., weekly for a ski chalet), you'll want to budget for greater vacancy periods. And since short-term rentals tend to place greater wear and tear on a property, you'll need to budget for greater repair costs. On the plus side, renting your vacation home to other people when you're not using it can help defray the costs associated with owning the home and generate income for you.
What are the income tax consequences of owning a second or vacation home? The income tax treatment of your vacation home depends on how many days you rent it to others, and other factors. Property is for your personal use only, or is rented to others for less than 15 days per year If your second home is for your personal use only, or is rented to others for less than 15 days per year, the income tax treatment is straightforward. If you meet the requirements, you may deduct the following items: • Property taxes • Qualified residence interest • Casualty loss deductions Tip: Rental income received from such a home is not subject to tax.
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Caution: Because you don't report the rental income generated from this home, you can't deduct the expenses related to the rental. Unlike the sale of your principal residence, you aren't allowed a capital gain exclusion when you sell a vacation home or second home. However, a home that is currently a vacation home may qualify as your principal residence in as little as two years. For more information about the tax treatment, see our separate topic discussion, Sale of Vacation Home: Tax Considerations. Property is rented out for 15 days or more during the year When you rent out your home for more than 15 days during the year, things can get more complicated. The tax treatment of your vacation home now depends on how much time is allotted to personal use (as opposed to rental use). If you rent the home out for 15 days or more during the year, and your personal use of the home exceeds the greater of 14 days during the year or 10 percent of the days rented, then the property is considered a vacation home for tax purposes. The tax treatment is as follows: • Rental income: All rental income is reportable. • Rental expenses: Rental expenses must be divided between personal use and rental use of the property. Deductible expenses, such as insurance, repairs, utilities, and depreciation, are generally limited to the amount of income generated by the property. • Other deductions: You may deduct qualified residence interest, property taxes, and casualty losses. Caution: Mortgage interest is considered qualified residence interest if it is incurred with respect to your principal residence and one other residence. So, you won't be able deduct the mortgage interest on more than one secondary residence or vacation home. There are also limits on the amount of indebtedness that may be taken into account in determining the amount of qualified residence interest that is deductible each year. If you use your home less often for personal purposes (i.e., you don't meet the 14 day/10 percent rule), your vacation home is considered strictly rental or business property. The tax treatment is as follows: • Rental income: Gross rental income is taxable to the extent it exceeds the rental-related expenses. • Rental expenses: All expenses, including mortgage interest, property taxes, insurance, advertising, and so on, can be deducted against the rental income received on the property. You should report these expenses on Schedule E of your federal income tax return. • Losses: If the total rental expense exceeds the gross rental income, then the resulting loss may be deducted from your personal income (subject to relevant limitations, including the limitation on the deduction of passive losses). Caution: Unlike the sale of your principal residence, you aren't allowed a capital gain exclusion when you sell rental property or second/vacation homes. However, if you own and use the home as a principal residence for two out of the five years preceding the sale of the home, you may qualify for capital gain exclusion, even though the home was a rental property or vacation home for the balance of the five-year period. For more information about the tax treatment of rental property, see our separate topic discussion, Sale of a Principal Residence Converted to Rental Property. For more information about the tax treatment of vacation property, see our separate topic dicussion, Sale of Vacation Home: Tax Considerations.
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Timeshares What are timeshares? Timeshares are a special form of real estate ownership for vacation homes. If you've been on vacation lately, chances are you've been approached by someone trying to get you to participate in a sales presentation on timeshares. You may have even been offered a gift as an extra incentive. Although timeshares are certainly a popular vacation option, they can pose problems. So, it's important to understand how timeshares work before you purchase one.
Types of timeshare ownership For the most part, there are two types of timeshare ownership: a deeded plan and a nondeeded plan. Deeded plan In a deeded timeshare plan, you purchase a fractional ownership interest in a specific unit. You can rent, sell, donate, or bequeath your ownership interest just as you would any other real estate that you own. Ownership of a deeded timeshare can be structured in one of two ways: a fixed week or a floating week arrangement. In a fixed week arrangement, each owner receives a deed to the timeshare for a specific week(s). In a floating week arrangement, each owner receives a deed to use the timeshare for a week during a particular time period. However, the owner must then call the resort each year to make a reservation for the specific week that he or she wants to use the timeshare. Nondeeded plan In a nondeeded timeshare plan (also known as right-to-use ownership), ownership remains with the original property owner/developer. You purchase a lease, license, or club membership that gives you the right to use the property for a specific time each year for a limited number of years. Once the lease expires, the right to use reverts to the property owner/developer. Caution: As with any real estate purchase, you should seek legal advice before signing a timeshare contract.
Other types of timeshare programs Vacation exchange programs Many timeshare developments belong to timeshare exchange programs. These programs give you the ability to trade your timeshare week(s) with another timeshare owner. Most timeshare companies offer in-house exchange programs, as well as the ability to exchange your timeshare for another anywhere in the world at the same, one-time fixed price. Caution: Many exchange programs charge some type of fee to list your timeshare for exchange. The first year of membership is generally included in the purchase price. After that, there is an annual fee, as well as fees for each exchange. Point programs Some timeshare companies place a point value on each timeshare unit. Under the point system, you receive vacation credits that are redeemable for a varying number of accommodations, depending on the season, day of the week, size of the unit, and resort location. You may also be able to use your points toward the purchase of another timeshare.
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Vacation clubs Vacation clubs own multiple timeshare properties in different locations. After paying a fee and annual club dues, members can reserve timeshares at the various properties owned by the club.
How much does it cost? The cost of purchasing a traditional second or vacation home is out of reach for many consumers. Timeshares can give you the ability to have such a home, since you are only purchasing a fractional interest. Prices depend on many factors, such as the season and the timeshare's location. In addition to the cost of purchasing the timeshare, you must pay an annual maintenance/management fee. This fee must be paid every year, regardless of whether you use your timeshare, exchange it for another, or don't use it at all in a given year. Tip: Timeshare prices in the resale market tend to be lower than the price charged by developers for new units. You may benefit greatly by shopping in the resale market before you buy.
Tax consequences of owning a timeshare Generally, the interest that you pay on a deeded timeshare loan is tax deductible on your income tax return as interest on a second home. Your share of property taxes is also deductible. However, if you rent out your timeshare, you'll need to follow special tax rules for second/vacation homes. Tip: The interest that you pay on a nondeeded (or right-to-use) timeshare loan is not deductible. However, if you used a home equity loan to finance the purchase, the interest may be deductible.
Purchasing a timeshare You can usually find timeshare sales representatives in most vacation destinations with a high tourist population. Or, you may be contacted by a timeshare development through direct mail. After listening to a sales presentation and taking a tour of the facility, you'll be asked if you're interested in purchasing a timeshare. Most timeshare developers will finance the purchase of their timeshare units. However, these loans often have higher interest rates and shorter terms than conventional mortgages. Some lenders will also finance the purchase of a timeshare unit. Before you sign on the dotted line, consider the following: • Make sure that you have read all of the sale documents carefully and understand exactly what you're getting--deeded or nondeeded plan, fixed or floating week arrangement, etc. It's a good idea to take them to an attorney for review. • Is there a "cooling off" period during which you can cancel the contract and get your money back? • Is the timeshare development a member of any trade organization, such as the American Resort Development Association? • Is the resort managed properly? Are the facilities well maintained and kept up-to-date? • If you are primarily interested in the exchange benefit of a timeshare, make sure that you are purchasing a timeshare in a popular season (after all, not many people want to go to a ski resort in the middle of July). In addition, you'll want to make sure that the resort is affiliated with an exchange company. • Don't be forced into purchasing a timeshare as a result of high-pressure sales tactics. Just because
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you listened to a sales presentation and received a free gift doesn't mean that you are obligated to purchase something. • Remember that a timeshare should not be viewed as an investment. So, you shouldn't expect a return. Tip: If you need more information on purchasing a timeshare, contact the real estate commission or office of consumer protection in the state where the timeshare is located. Caution: Keep in mind that if you purchase a timeshare in a foreign country, U.S. federal or state property laws generally won't protect you.
Is a timeshare right for you? While timeshares may not be right for everyone, many people enjoy the convenience and affordability that owning a timeshare offers. Before you purchase a timeshare, ask yourself whether you'll want to vacation the same week in the same location each year, and whether you'll be physically and financially able to vacation at your timeshare every year. If not, you may be better off spending your money elsewhere.
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Homeowners Insurance What is homeowners insurance? Although some may not agree, you can't predict the future. You can, however, obtain homeowners insurance to protect yourself against unexpected financial loss related to your family, home, and possessions. As its name suggests, homeowners insurance can save you from severe financial loss if your home is damaged or destroyed. In addition, it covers your family's possessions and can provide you with compensation for liability claims, medical expenses, and other amounts that result from property damage and personal injury suffered by others. By paying insurance premiums and satisfying the other requirements of your insurance company, you can take control of the future. You still won't be able to predict when lightning will strike your house, but you will sleep better knowing homeowners insurance can save you from financial ruin if the worst happens. You spend years building up a solid financial foundation for yourself and your family. All that hard work can go down the drain in a matter of minutes unless you have a homeowners insurance policy or other risk transfer vehicle to protect you against the following scenarios: • A tornado shattering your home • A burglar breaking into your home • Your dog biting the neighborhood kid • Physical therapy costs for a guest injured by a fall in your home • A successful personal injury lawsuit brought by a neighbor Tip: Homeowners insurance is also a way for condominium and cooperative unit owners, mobile home owners, and renters to protect their possessions from damage or theft, and to obtain liability coverage for property damage and personal injury suffered by others.
Who is covered? Homeowners insurance protects more than just the owner of the house, condominium, or other property. Depending on your living situation, the following individuals are also covered under your homeowners policy. Named Insured The written contract between you and your insurance company is also referred to as your insurance policy. The policy's Declarations Page contains factual information concerning the insured persons, property, coverage amounts, and other terms of the coverage. One section of the Declarations Page identifies the Named Insured (meaning the individual who is primarily insured under the policy), usually the same person named on a deed or lease as the owner or tenant, respectively. You, as a Named Insured, receive the most extensive coverage under your homeowners policy, for you are covered by property insurance on your dwelling and other structures, in addition to personal property and liability insurance. Named Insured condominium owners and renters do not receive such extensive coverage because they do not, on an individual basis, own their dwelling or other structures. Spouses If your spouse resides in your dwelling, then he or she is covered by personal property and liability insurance, even if he/she isn't identified on the Declarations Page as a Named Insured.
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Residents Individuals who reside in your dwelling are covered by personal property and liability insurance if they are your relatives (e.g., your children) or if they are under 21 years of age and in the care of any member of your family. Employees Your household employees--such as housekeepers, au pairs, or gardeners--are covered by personal property insurance. Guests and other visitors Your guests and other invited visitors are covered by personal property insurance so long as you contact your insurance company to request coverage.
What is covered? The property insurance section of your homeowners policy protects more than just your actual home or dwelling. In most cases, your policy also covers your personal possessions, and protects you against liability claims. The following coverages are typically included in a standard homeowners insurance policy: Dwelling coverage Your policy covers your dwelling, any structures attached to the dwelling, and building materials and supplies that are stored near the dwelling and are used to construct, alter, or repair the dwelling or other structures on your property. Coverage for other structures The Declarations Page of your homeowners policy will usually identify your premises by its street address. Your policy also covers structures on your premises that are not attached to the dwelling, such as a toolshed or pool house. Personal property coverage Your homeowners policy also covers personal property, meaning articles you own other than land and buildings. Your personal property consists of the contents of your house, like furniture, clothing, and stereo equipment, as well as outdoor items like sporting equipment and gardening tools. Tip: Generally, the coverage limit for other structures and personal property coverage is a set percentage of the dwelling coverage amount. Other structures coverage is usually set at 10 percent of the dwelling coverage amount, while personal property coverage is often set at 50 percent of that amount. If you wish, you can increase a preset coverage amount by endorsement. If you own a condominium or cooperative unit, your homeowners insurance does not cover you for your entire dwelling space because you do not individually own the structure you live in. Instead, you are covered for your personal property and any portion of the unit you own under the terms of the condominium or cooperative documents. Loss of use If your dwelling is not fit to live in because of damage covered by the policy, you may receive reimbursement for living expenses while you wait to permanently relocate or wait for the dwelling to be repaired. A set coverage limit is applied to loss-of-use coverage, but it can be increased by endorsement.
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Liability coverage If you or another insured are found responsible for personal injury or property damage suffered by another person, your insurance company will cover the claim, up to the limit stated in the policy. This is true only if carelessness or negligence, rather than intentional misconduct, caused the injury or damage. Your policy will also cover the cost of your legal defense if a lawsuit is filed. Example(s): You may be found negligent if a meter reader was injured by falling off your tricky cellar stairs because the railing was broken (and you knew about the situation but failed to repair it). You may be found liable for intentional misconduct if you cut down a tree on your neighbor's property to improve your view. Medical payments to others If a nonresident requires medical assistance as a result of an injury suffered on or near your premises, your insurance will cover a portion of his or her medical expenses, up to the stated limit. Injuries that take place away from your premises are also covered, as long as you, another insured, a household employee, or your pet caused the injury.
What is not covered? A wide variety of damages, conditions, and costs are not covered by homeowners insurance. Your insurance policy describes a number of situations that are specifically excepted or excluded from coverage (called exclusions). Some policies contain more exclusions than others. Your policy also describes certain conditions you must meet and duties you must perform to be covered. Terms and limitations that were originally included in your policy can be changed by a document called an endorsement. For these reasons, you should carefully read your homeowners policy to learn the limitations and exclusions that apply to your specific situation. Here are just a few examples of situations when you are not covered by a homeowners insurance policy: • Land--Although the structures and possessions that lie upon a parcel of land are usually covered by a homeowners policy, the land itself is not. This means you're not covered by your policy if your neighbor's pool overflows and contaminates your untilled garden. • Coverage limitations--The Declarations Page of your policy recites maximum coverage amounts that limit what the insurance company must pay. Separate limits are set for the dwelling, other structures, personal property, loss of use, personal liability, and medical payments to others. • Flooding--Your homeowners policy will not cover you for damage that results from floods, waves, sewer overflows, or water seeping into your basement. • Business--If you're involved in a business activity, your homeowners policy will not cover you for liability or medical payments due other persons, even if the damage or injury occurred in your home. Other structures located on your premises that are used for business purposes are also not covered by the policy. This means your policy will not reimburse you for medical care required by a client who is injured in your home office. • Your tenants--Your homeowners policy will not cover you for damages or injuries suffered by the tenants who rent any part of your home. • Other insurance--If an injury or damage is covered by other insurance in addition to your homeowners policy, your homeowners insurance company will only pay its proportionate share of the amount due. • Theft by another insured--Your homeowners insurance will not cover you for a loss caused by a theft committed by another insured person under the policy. This means your policy will not cover you if your nephew (who lives with you) steals a valuable baseball card from the family room. • Multi-family dwellings--Structures that have more than two family-dwelling units cannot be covered by
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homeowners insurance.
Questions & Answers Your brother-in-law tells you that you can buy separate policies for property and liability insurance to protect your property and insure you against personal injury claims. If that's the case, why might you choose to buy homeowners insurance instead? Because buying a single homeowners policy provides you with the same property and liability insurance that you would receive from two separate policies. Plus, buying a single homeowners policy eliminates any chance of overlaps or gaps in coverage and might also be cheaper. If you build an addition to your house or otherwise increase its value, do you need to increase the amount of coverage? It is important that your policy continue to cover at least 80 percent of the replacement cost of your home. That way, the insurance company will pay you the full replacement cost for any damage up to the coverage limit. If you anticipate adding improvements to your home, or if you fear inflation will decrease the value of your policy, you can add an Inflation Guard endorsement to your policy. An Inflation Guard endorsement ensures that your coverage amount increases a small fixed percentage every year. If your house increases in value by 5 percent or more, you should contact your insurance agent to arrange for a new appraisal of the house. In this case, it might be worth increasing your policy's coverage amount. Is your car covered by your homeowners policy when it's parked in your garage? No. Cars are specifically excluded from personal property coverage. Only vehicles like motorized wheelchairs and lawn mowers, which are not usually registered with the state, are covered by personal property insurance. Your car is also not covered under the "Personal Liability and Medical Payments to Others" sections of your homeowners policy because insurance companies prefer you to insure vehicles with an automobile insurance policy.
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Flood Insurance What is flood insurance? Because standard homeowners insurance doesn't cover damage from flooding, you will need to purchase a separate flood insurance policy to obtain coverage for your home and its contents. Fortunately, flood insurance is widely available from insurance companies that participate in the National Flood Insurance Program (NFIP), a partnership between the Federal Emergency Management Agency (FEMA) and the private insurance industry. A handful of insurance companies also offer excess flood insurance policies that can supplement NFIP coverage. You are eligible to purchase national flood insurance if your community is one of the approximately 20,100 nationwide that participate in the NFIP. Participating communities must adopt certain floodplain management practices in exchange for the availability of flood insurance for their residents.
Do you need flood insurance? You should consider purchasing flood insurance even if you don't live in a high-risk area for floods. According to FEMA, approximately 25 percent of all flood insurance claims come from areas that are at low to moderate risk for floods. Even if you don't live near the ocean, a river, or other body of water, factors such as storms, melting snow, inadequate or overloaded drains, or hurricanes can cause serious flooding. Tip: If you are buying a home located in a high-risk flood zone, and are obtaining a federally backed mortgage, you will be required to purchase flood insurance.
How can you purchase flood insurance? If you decide you want flood insurance, start by calling your homeowners insurance representative. Although NFIP policies are backed by the federal government, they are sold through private insurers. If your current insurer can't offer you flood insurance, you can call the NFIP Telephone Response Center at (800) 621-3362. The response center can provide you with names of local agents or companies who can sell you flood insurance.
How much flood coverage can you obtain? You can purchase coverage for your home through the NFIP up to the following amounts: • $250,000 for the building • $100,000 for the contents If you own a home whose value exceeds the amount available through the federal program, you may want to look into purchasing excess flood insurance through a private insurer. Excess flood insurance covers amounts above the $250,000 federal limit, and unlike NFIP coverage, may cover your home for its full replacement cost. You may be able to purchase these policies even in high-risk flood zones. A few insurance companies have begun offering flood policies designed to replace NFIP coverage, but these policies are generally available only in low- to moderate-risk flood zones. Tip: Renters can also purchase contents coverage through the NFIP to protect their belongings from flood damage.
How much does flood insurance cost? According to FEMA, the average annual premium for a $100,000 flood policy is a little over $542 (FEMA, 2009).
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However, the cost of flood insurance depends on many factors, including the type of occupancy (e.g., single family, nonresidential), the amount of coverage, the deductibles you choose, and the location, design, and age of the building. Your insurance representative can give you a premium quote that accurately reflects your circumstances. You can also get a quick premium estimate at the National Flood Insurance Program's consumer website.
What else should you know about flood insurance? Here are some other facts you should know about flood insurance. First, you can purchase an NFIP policy at any time if you live in a participating community. You can even purchase it immediately before or during a flood. There is one catch, however. A 30-day waiting period generally applies before the policy becomes effective. Second, you can purchase an NFIP policy even if you live in a high-risk region for floods. As long as your community participates in the NFIP, insurance companies will be able to offer you a policy. Third, NFIP policies don't cover flooding from wind-driven rain or damage from hail. Your homeowners policy will likely cover these situations. Finally, NFIP policies offer some protection for flood-related basement damage but don't cover all types of damage. They ordinarily covers items such as furnaces, water heaters, foundation elements, stairways, and oil or natural gas tanks, as well as appliances such as clothes washers, dryers, and freezers. They don't cover basement structures such as finished walls, floors, ceilings, or personal belongings such as furniture or clothes. Keep in mind that your homeowners policy doesn't cover most types of basement flooding, either. Although flood insurance doesn't cover every situation, it's probably your best bet for dealing with basement flooding.
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Vacation Home Tax Considerations What are vacation home tax considerations? First of all, the IRS differentiates between vacation homes and second homes. The tax treatment of your additional residence will depend largely on how much time you (or a family member) use the property for personal purposes relative to the amount of time you rent it to others. Whether you own a vacation home or second home, you should understand what types of home-related expenses you can deduct on your federal income tax return and the extent to which they may be deducted. You should also know how to treat rental income. Definition: "personal use" of home For tax purposes, you must count as "personal use" any day your home is used by: • You or any other person having an ownership interest in the property • A member of your family or a family member of any other person having an ownership interest in the property (unless the family member uses the home as his/her primary residence and pays a fair rental value for the use of the home) • Anyone who, in return for use of your vacation home, allows you to use another home or dwelling unit • Anyone who pays less than fair market rent for the use of the home Example(s): This year, you used your vacation home for four days and allowed your daughter and her family to use it for three days. In addition, your sister (who has a 50 percent ownership interest in the vacation home) used it for seven days. She allowed her son to live in the home for six months. During that time, it was his primary residence and he paid fair market rent for it. Example(s): Here, the total personal use for the year is 14 days (your 4 days of use, your daughter's 3 days of use, and your sister's 7 days of use). Because your nephew paid fair market rent and used the home as his primary residence while living there, his use of the home is not counted as "personal use" for your tax purposes. Tip: If you use the bulk of a day spent at your vacation home to repair or maintain the home, you need not count this as a personal use day. This is true even if members of your family use the home for recreational purposes on the same day or days. Definition: "family member" Regarding personal use of your home, a member of your family is defined as a brother or sister, half-brother or half-sister, spouse, ancestor (i.e., parent or grandparent), or your "lineal descendant" (i.e., child or grandchild).
Vacation home tax treatment A vacation home may be defined as a second residence with a combination of personal and rental use, where the home is rented 15 days or more per year and your personal use exceeds the greater of 14 days per year or 10 percent of the days rented. • Deductions--You'll be allowed to deduct any casualty losses and property taxes you paid, as well as qualified residence interest (but only on one vacation home). Mortgage interest will only qualify as "qualified residence interest" if it is incurred with respect to your principal residence and one other residence. Thus, you will not be able to deduct the mortgage interest on more than one secondary
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residence or vacation home. There are also limits on the amount of indebtedness that may be taken into account in determining the amount of qualified residence interest that is deductible each year. For more information, see Home Mortgage Interest Deduction. • Rental income--All rental income is reportable. • Expenses--Expenses must be allocated or prorated between personal use and rental use of the property. Essentially, deductions (other than qualified residence interest, property taxes, and casualty losses) are limited to the amount of income generated by the property. These expenses include insurance, repairs, utilities, and depreciation (in that order); you are required to subtract these expenses from the rental income in a specified order. Allocation of expenses: specifics Limited expenses must be allocated in the following order: 1. First, expenses that are allowable regardless of the rental activity, such as qualified mortgage interest, property taxes, and casualty losses 2. Second, rental expenses that do not affect the basis of the property, such as utilities, management fees, maintenance fees, Realtor ® commissions, and advertising fees 3. Third, expenses that will affect the basis of the property, such as depreciation When applying these rules, the expenses in the second and third categories cannot produce a taxable loss. Rather, these deductions can be claimed only to the extent of rental income. However, any expenses limited under this rule may be carried forward and taken into account as a vacation home deduction for the following year. Proration of expenses Vacation homes are subject to a proration of expenses. The prorated amounts attributable to the rental activity are based on the number of days during the year that the home was rented. The rental portion equals the number of days the home is rented, divided by the total number of days during the tax year that the home was used for both rental and personal purposes. Example(s): Assume you used your vacation home for one month and rented it for the remaining 11 months of the year. Your expenses on the home during the year (including mortgage interest and property taxes) came to $9,200, and the total rent you received was $8,000. Example(s): In this case, you must show the $8,000 as gross income on your tax return, but you can offset this "gain" by 11/12 of the expenses you incurred on the property, up to the full $8,000 in rental income. However, any shortfall between your expenses and the rent you received on the home is not deductible. Tip: A controversy exists between the IRS and the U.S. Tax Court regarding proration of expenses when a vacation home is vacant for part of the year. The IRS position is that all expenses are prorated based on the period of actual usage or occupancy, rather than based on the entire year. Be sure to check the status of the law in your jurisdiction with your tax advisor. Example(s): Jill bought a vacation home in Colorado and uses it each year during the month of April. She rents it out for three months during the year; the property is vacant the rest of the time. Jill incurs the following expenses this year: qualified residence interest of $2,000, real estate taxes of $400, maintenance and utilities of $1,500, and depreciation of $2,500. If the gross rental income is $3,000, the proration under the IRS method is as follows: Example(s): Rental income. $3,000Deductions:1. Taxes and interest ($2,400 x ¾). ($1,800)2. Maintenance and utilities ($1,500 x ¾). ($1,125)3. Depreciation ($2,500 x ¾, but limited to remaining income). ($75)
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Example(s): Jill will report no income on her Schedule E for this rental property. The remaining $600 of qualified residence interest and tax ($2,400 - $1,800) is for personal use and may be deducted as an itemized deduction on Schedule A. For additional information about vacation homes, see Sale of Vacation Home: Tax Considerations. For information about passive activities and at-risk rules, see Converting a Residence to Rental Property.
Second home tax treatment A second home is a personal residence that you rent to others for fewer than 15 days per year. The tax treatment is as follows: • Deductions: You'll be allowed to deduct any qualified residence interest and property taxes you paid on the home during the year (subject to the normal limitations on mortgage interest deductions for primary and second homes). You can also deduct casualty losses. • Rental income: Rental income you receive is not subject to taxation. • Expenses: Expenses related to the rental of the property are not deductible. See also Home Mortgage Interest Deduction.
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Deductibility of Points and Other Closing Costs What is the deductibility of points and other closing costs? When you take a loan to purchase a first or second residence (or to refinance an existing loan on a first or second home), you generally will be charged closing costs (also known as settlement charges). These generally include points as well as attorney's fees, recording fees, title search fees, appraisal fees, and other loan or document preparation and processing fees. The question you will face is whether you can deduct these fees immediately or whether they are added to the cost basis of your home.
What are points? Points are costs that are often charged to you by a lender when you take a loan secured by your home. One point equals 1 percent of the loan amount borrowed. (For example, 1.5 points on a $100,000 loan would equal $1,500.) If the points are charged for services provided by the lender in preparing or processing the loan, then they are not deductible. However, if the lender charges the points as up-front interest and in return gives you a lower interest rate on the loan, then the points may be deductible. Tip: It doesn't matter whether your lender calls the charge points or a loan (or mortgage) origination fee. If this charge represents prepaid interest, it may be deductible.
Are points deductible and when? Points charged as prepaid interest are deductible over the term of the loan except when they are paid on a loan used to buy or improve your primary residence. Points are deductible for the tax year in which they are paid if you meet all of the following conditions: • Your loan is secured by your main home • Paying points is an established business practice in the area where the loan was made • The points paid were not more than the points generally charged in that area • You use the cash method of accounting (most individuals use this method) • The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes • The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged • You use your loan to buy or build your main home • The points were computed as a percentage of the principal amount of the mortgage • The amount is clearly shown on the settlement statement as points charged for the mortgage. The points may be shown as paid from either your funds or the sellers For more information on deducting points, see IRS Publication 936.
What if the points are withheld by the lender from the loan proceeds?
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If the loan is for the purchase of your primary residence, any points withheld by the lender will be deductible as up-front interest if (at or prior to the closing of the loan) you pay a down payment, escrow deposit, or earnest money equal to the charge for points. If, however, the loan is used to improve your primary residence, then the points paid related to the home improvement loan may be deducted in the year paid (if certain criteria are met).
Can you deduct points paid by the seller? Yes, these can be deducted by you as an up-front interest charge. However, because they are also considered a reduction in the cost of the home, you must lower your cost basis in the home by an amount equal to the points paid by the seller.
Can you deduct points charged on a mortgage secured by a second home? Yes, but they must be deducted ratably over the term of the loan. Example(s): If you pay $3,000 in points on a 30-year mortgage secured by a second home, you can deduct $100 in points each year during the term of the loan.
If you are amortizing the deduction of points on a loan over the term of that loan and the loan ends early, how do you treat the points you have not yet deducted? If the loan ends early (because, for example, you sell the home or refinance the mortgage), you may fully deduct the remaining points for the tax year the loan ends.
How are points paid on a refinanced loan treated? Points paid on a refinanced loan must be amortized over the life of the loan. However, there is one exception: If part of the loan is used to make improvements to your primary residence, you can deduct that portion of the points allocable to the home improvements made in the year the points are paid (if certain criteria are met). Example(s): Suppose you take a cash-out refinance mortgage for $100,000 and pay two points ($2,000). Then, $90,000 is used to pay off the principal debt owed on the old mortgage, $4,000 is used to pay off bills, and $6,000 is used to put in a new kitchen. Since 6 percent ($100,000 divided by $6,000) is used for home improvement, then $120 (6 percent of $2,000) may be deducted in the year the loan is taken. The remaining $1,880 in points must be deducted ratably over the life of the loan.
Can other closing costs be deducted? Other closing costs that are charged to you, such as attorney's fees, recording fees, title search fees, appraisal fees, owner's title insurance, and other loan or document preparation and processing fees, are not deductible. Rather, they are added into the cost basis of your home. Example(s): Over and above points, assume that your closing costs on a loan you take to purchase a $200,000 home total $1,500 dollars. Your initial cost basis in that home would be $201,500. Caution: Fees that you pay at closing, placed in escrow to cover costs that you will be required to pay later (e.g., fire insurance premiums), are not added to the basis of your home.
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First-Time Homebuyer Tax Credit Introduction The first-time homebuyer tax credit was originally established by the Housing and Economic Recovery Act of 2008. The credit was subsequently extended and modified by the American Recovery and Reinvestment Act of 2009 and the Worker, Homeownership, and Business Assistance Act of 2009.
Home purchases made April 9, 2008 through December 31, 2008 A temporary refundable credit equal to 10-percent of the purchase price of a principal residence, up to $7,500 ($3,750 if married filing separately) was available to first-time homebuyers who purchased a home on or after April 9, 2008, and before January 1, 2009. Generally, to qualify as a first-time homebuyer, you (and your spouse if you were married), could not have owned any other principal residence during the three-year period ending on the date of purchase. The credit was phased out for individuals with higher incomes. Specifically, the credit was reduced for individuals with modified adjusted gross income (MAGI) exceeding $75,000, and was eliminated for individuals with MAGI equal to or exceeding $95,000. For married individuals filing a joint federal income tax return, the credit was reduced if MAGI exceeded $150,000, and was eliminated for those with a MAGI of $170,000 or more. The credit at this time was effectively an interest-free loan. Individuals who claimed the credit for purchases made during this period of time are required to pay back the credit over fifteen years in equal installments. The fifteen year repayment period begins two years after the credit was claimed. So, if an individual claimed a $7,500 credit on his or her 2008 federal income tax return, he or she would start paying $500 a year back, beginning with his or her 2010 return. Caution: If an individual claimed the credit for a home purchase made during this period of time, and sells the home during the fifteen year repayment period, or the home ceases to be the principal residence of the individual during the fifteen-year repayment period, repayment of the credit is accelerated. Repayment is generally not accelerated if the home remains the principal residence of the individual's spouse. Tip: If the principal residence is sold during the fifteen-year repayment period, then the remaining credit amount would be due from the gain on the home sale. If there is insufficient gain, then the remaining credit payback is forgiven. Also, if an individual dies during the repayment period, the balance is forgiven. Caution: Although the repayment amount is limited to the gain realized upon the sale of the home, if the home is sold during the payback period, that gain is determined by reducing the basis in the home by the amount of the remaining unpaid credit. Caution: The tax credit could not be combined with the mortgage revenue bond (MRB) homebuyer program or the DC first-time homebuyer credit. Tip: The credit could also be applied against the alternative minimum tax (AMT).
Home purchases made on or after January 1, 2009 and before November 7, 2009 A temporary refundable credit equal to 10-percent of the purchase price of a principal residence, up to $8,000 ($4,000 if married filing separately) was available to first-time homebuyers who purchased a home on or after January 1, 2009, and before November 7, 2009. Generally, to qualify you (and your spouse if you were married),
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could not have owned any other principal residence during the three-year period ending on the date of purchase. The income phaseout ranges for the credit remain the same as the amounts that applied to qualifying 2008 purchases: Specifically, the credit is reduced for individuals with modified adjusted gross income (MAGI) exceeding $75,000, and is eliminated for individuals with MAGI equal to or exceeding $95,000. For married individuals filing a joint federal income tax return, the credit is reduced if MAGI exceeds $150,000, and is eliminated for those with a MAGI of $170,000 or more. While any credit claimed as a result of a qualifying purchase in 2008 had to be paid back over a fifteen year period, there is no such requirement for qualifying purchases made on or after January 1, 2009. However, if the home ceases to be an individual's principal residence within thirty-six months of the purchase, the individual must pay the credit back. If married at the time of purchase, the home must remain the principal residence of either spouse for the thirty-six month period to avoid repayment. If repayment is required, it is reported and paid on the federal income tax return for the year in which the home ceased being a principal residence. Tip: The credit can be applied against the alternative minimum tax (AMT). Caution: No District of Columbia first-time homebuyer credit is allowed with respect to the purchase of a residence after December 31, 2008, if the first-time homebuyer tax credit described here is allowable to such individual (or the individual’s spouse) with respect to such purchase.
Home purchases on or after November 7, 2009 and before July 1, 2010 A refundable credit equal to 10-percent of the purchase price of a principal residence, up to $8,000 ($4,000 if married filing separately) is available to first-time homebuyers who purchased a home on or after November 7, 2009 and before May 1, 2010. Homes purchased on or after May 1, 2010 and before July 1, 2010 can qualify for the credit if a binding written contract to complete the purchase by July 1, 2010 is entered into prior to May 1, 2010. Generally, to qualify you (and your spouse if you were married), could not have owned any other principal residence during the three-year period ending on the date of purchase. A refundable credit equal to 10-percent of the purchase price of a principal residence, up to $6,500 ($3,250 if married filing separately) is available to individuals who have maintained the same principal residence for at least five consecutive years in the eight year period ending at the time the new home is purchased during the time period described above. For purchases during this time period, the credit is phased out for individuals with modified adjusted gross income (MAGI) exceeding $125,000, and is eliminated for individuals with MAGI equal to or exceeding $145,000. For married individuals filing a joint federal income tax return, the credit is reduced if MAGI exceeds $225,000, and is eliminated for those with a MAGI of $245,000 or more. The credit is not available for any home with a purchase price exceeding $800,000. Additionally: • The credit is not allowed unless the individual claiming the credit is eighteen years of age as of the date of purchase. An individual who is married is treated as meeting the age requirement if the individual or the individual’s spouse meets the age requirement. • The credit is not allowed if the principal residence is acquired from a person who is closely related to the individual or the spouse of the individual. • No credit is allowed if the individual is a dependent of another taxpayer. • No credit is allowed unless the individual attaches to the relevant tax return a properly executed copy of the settlement statement used to complete the purchase. • The credit is not available to nonresident aliens Caution: If the home ceases to be an individual's principal residence within thirty-six months of the
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purchase, the individual must pay the credit back. If married at the time of purchase, the home must remain the principal residence of either spouse for the thirty-six month period to avoid repayment. If repayment is required, it is reported and paid on the federal income tax return for the year in which the home ceased being a principal residence. Caution: No District of Columbia first-time homebuyer credit is allowed to any taxpayer with respect to the purchase of a residence after December 31, 2008, if the first-time homebuyer tax credit described here is allowable to such taxpayer (or the taxpayer’s spouse) with respect to such purchase. Tip: The credit can be applied against the alternative minimum tax (AMT).
Special rules apply to members of the uniformed services Special rules apply to an individual who receives government orders (or whose spouse receives such orders) for qualified official extended duty service. If such an individual disposes of a principal residence after December 31, 2008 (or no longer uses the home as a principal residence) in connection with the government orders, no recapture of the first-time homebuyer credit applies by reason of the disposition of the residence. Any 15-year recapture with respect to a home acquired before January 1, 2009, ceases to apply in the taxable year the disposition occurs. In addition, the qualifying time period for the first-time homebuyer credit is extended for one year. Specifically, In the case of any individual (and, if married, the individual’s spouse) who serves on qualified official extended duty service outside of the United States for at least 90 days during the period January 1, 2009 through April 30, 2010, the qualifying time period for the first-time homebuyer credit is extended for one year, through April 30, 2011 (through June 30, 2011, in the case of an individual who enters into a written binding contract before May 1, 2011, to close on the purchase of a principal residence before July 1, 2011). Tip: Qualified official extended duty service means service on official extended duty as a member of the uniformed services, a member of the Foreign Service of the United States, or an employee of the intelligence community. Tip: Qualified official extended duty is any period of extended duty while serving at a place of duty at least 50 miles away from the taxpayer’s principal residence or under orders compelling residence in government furnished quarters. Extended duty is defined as any period of duty pursuant to a call or order to such duty for a period in excess of 90 days or for an indefinite period. Tip: The uniformed services include: (1) the Armed Forces (the Army, Navy, Air Force, Marine Corps, and Coast Guard); (2) the commissioned corps of the National Oceanic and Atmospheric Administration; and (3) the commissioned corps of the Public Health Service. The term “member of the Foreign Service of the United States” includes: (1) chiefs of mission; (2) ambassadors at large; (3) members of the Senior Foreign Service; (4) Foreign Service officers; and (5) Foreign Service personnel. Tip: The term “employee of the intelligence community” means an employee of the Office of the Director of National Intelligence, the Central Intelligence Agency, the National Security Agency, the Defense Intelligence Agency, the National Geospatial-Intelligence Agency, or the National Reconnaissance Office. The term also includes employment with: (1) any other office within the Department of Defense for the collection of specialized national intelligence through reconnaissance programs; (2) any of the intelligence elements of the Army, the Navy, the Air Force, the Marine Corps, the Federal Bureau of Investigation, the Department of the Treasury, the Department of Energy, and the Coast Guard; (3) the Bureau of Intelligence and Research of the Department of State; and (4) the elements of the Department of Homeland Security concerned with the analyses of foreign intelligence information.
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Electing to treat purchase as if made in prior year If an individual purchases a principal residence in 2009 and qualifies for the first-time homebuyer credit, he or she can elect to treat the purchase as if it occurred on December 31, 2008, claiming the credit on his or her 2008 federal income tax return (amending the return to claim the credit if necessary). Similarly, individuals who purchase a principal residence in 2010 can elect to treat the purchase as occurring on December 31, 2009 for purposes of the first-time homebuyer credit. Tip: For individuals who purchase a principal residence in 2010 but elect to treat the purchase as if it occurred on December 31, 2009, 2009 modified adjusted gross income (MAGI) is used to determine whether the credit is reduced or eliminated.
Allocating the credit between individuals who aren't married The first-time homebuyer credit can be allocated when two or more unmarried individuals purchase a principal residence. IRS Notice 2009-12 explains that when two or more individuals purchase a qualifying principal residence and otherwise satisfy all requirements, the first-time homebuyer tax credit can be allocated among the individuals using any reasonable method, provided the method does not allocate any portion of the credit to an individual who is not eligible to claim that portion. Reasonable methods include allocating the credit based on individuals' contributions toward the purchase price, and allocating the credit based on individuals' ownership interests. Caution: The total first-time homebuyer tax credit allowed for all individuals cannot exceed $8,000 ($6,500 if qualification for the credit is based on prior ownership of a principal residence for a period of at least five years).
Summary of general rules (table) Summary of general rules for first-time homebuyer tax credit When was the home purchased?
4/9/08 through 12/31/08
1/1/09 through 11/6/09
11/7/09 through 4/30/10 (through 6/30/10 if binding written contract before 5/1/10)
Maximum credit
$7,500 ($3,750 if married filing separately)
$8,000 ($4,000 if married filing separately)
$8,000 ($4,000 if married filing separately)
Reduced credit available to existing homeowners?
No
No
Yes-- homeowners who have maintained the same principal residence for 5 of 8 years ending on the purchase date eligible for maximum $6,500 credit ($3,250 if married filing separately)
Does credit have to be paid back?
Yes--generally over 15 years in equal installments
No, provided the home remains your principal residence for 36 months
No, provided the home remains your principal residence for 36 months
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Credit claimed on tax return for what year?
2008
Can elect to treat purchase as if it occurred on 12/31/08, claiming credit on 2008 return; otherwise claimed on 2009 return.
Purchase in 2009 can be treated as if it occurred on 12/31/08; otherwise claimed on 2009 return. Purchase in 2010 can be treated as if it occurred on 12/31/09; otherwise claimed on 2010 return.
Income phase out
$75,000 to $95,000 ($150,000 to $170,000 if married filing jointly)
$75,000 to $95,000 ($150,000 to $170,000 if married filing jointly)
$125,000 to $145,000 ($225,000 to $245,000 if married filing jointly)
Maximum purchase price
No maximum
No maximum
$800,000
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Popular Types of Mortgages Like homes themselves, mortgages come in many sizes and types. The type of mortgage that's right for you depends on many factors, such as your tolerance for risk and how long you expect to stay in your home. Here are some characteristics of various popular types of mortgages. Conventional Fixed Rate Mortgages
Adjustable Rate Mortgages (ARMs)
• • • •
Low risk 10- to 40-year terms Interest rate doesn't change Large down payment (compared to government mortgages) may be required • Payment remains the same
• Higher risk • Initial interest rate often lower than conventional fixed rate mortgage • Interest rate may go up or down • Interest rate usually adjusted annually • Rate adjustments may be limited by cap(s) • Payment caps can result in negative amortization in periods of rising interest rates
Government Mortgages
Hybrid Adjustable Rate Mortgages (ARMs)
• FHA, VA, or bond-backed • Interest rate sometimes lower than conventional fixed rate mortgage • Variety of programs available • Low down payment requirements • Liberal qualifying ratios • Attractive to first-time homebuyers • Higher insurance costs may apply for FHA loans • Payment remains the same
• Higher risk • Initial interest rate often lower than conventional fixed rate mortgage • Fixed term for 1-10 years, then becomes a 1-year ARM • May have option to convert to a fixed rate mortgage before becoming a 1-year ARM • Interest rate may go up or down • Rate adjustments may be limited by cap(s) • Payment caps can result in negative amortization in periods of rising interest rates
Jumbo Loans • Any loan over $417,000 or $729,750 in high-cost areas ($625,500 or $938,250 in Alaska, Guam, Hawaii, and the U.S. Virgin Islands) for a single-family home or condo (2009 and 2010) • Size of loan increases lender's risk, so interest rates are generally higher than for conventional fixed rate mortgages
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Less Common Mortgage Options Sometimes the more common fixed or adjustable rate mortgages aren't advantageous or aren't available because of your circumstances. Here are some less common mortgage alternatives and their characteristics. Graduated Payment Mortgages
Growing Equity Mortgages
• Fixed interest rate • Medium risk • Low monthly payments increase over 5-10 years, then level off for remainder of term (usually 30 years) • Initial low payments can result in negative amortization during early years of the loan
• Formalized prepayment method • Medium risk • Payments rise over 5-10 years, then level off for remainder of term • Excess payment applied to principal • Fixed interest rate usually lower than conventional fixed rate mortgages
Balloon Mortgages
Shared Appreciation Mortgages
• • • •
• Low interest rate in return for agreement to share appreciation of home value with lender upon sale or at a specified time • Low monthly payments • Medium to high risk; if value of home doesn't increase as expected, lender may charge additional interest
High risk Low interest Short term (3-10 years) Large final payment
Seller-Financed Mortgages Seller-Financed Mortgages* • Medium risk • Seller acts as lender • Terms are negotiated between you and the seller
Wraparound Mortgages
• Medium risk • Seller acts as lender • Terms are negotiated between you and the seller • Your mortgage payment repays both seller's original mortgage and any additional amount seller financed for you • Interest rate higher than on seller's mortgage but often lower than conventional fixed rate mortgages
*Note: FHA Seller-Finance Programs are eliminated as of October 1, 2008.
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Personal Liability Umbrella Insurance
Like a roof over your head, the liability coverage under your homeowners and auto policies is your primary layer of protection. But if you need additional liability protection of up to $1 million or more, you'll need to turn to an umbrella policy. Personal umbrella liability protection is secondary coverage that works in conjunction with your primary policy. When the liability limit of your primary policy is exhausted, the umbrella policy will open up, paying the balance of a liability claim against you (up to the umbrella policy's limit). For example, let's say you are found liable for a bodily injury claim totaling $1.3 million as a result of an auto accident. If your auto policy liability limit was $300,000 and you had a $1 million umbrella policy, your auto policy would pay the first $300,000 and the umbrella would cover the remainder of the claim.
Primary - When limits of primary liability policy are reached... Secondary - Umbrella policy opens up, providing secondary level of protection.
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Buying a Home There's no doubt about it--owning a home is an exciting prospect. After all, you've always dreamed of having a place that you could truly call your own. But buying a home can be stressful, especially when you're buying one for the first time. Fortunately, knowing what to expect can make it a lot easier.
How much can you afford? According to a general rule of thumb, you can afford a house that costs two and a half times your annual salary. But determining how much you can afford to spend on a house is not quite so simple. Since most people finance their home purchases, buying a house usually means getting a mortgage. So, the amount you can afford to spend on a house is often tied to figuring out how large a mortgage you can afford. To figure this out, you'll need to take into account your gross monthly income, housing expenses, and any long-term debt. Try using one of the many real estate and personal finance websites to help you with the calculations.
Mortgage prequalification vs. preapproval Once you have an idea of how much of a mortgage you can afford, you'll want to shop around and compare the mortgage rates and terms that various lenders offer. When you find the right lender, find out how you can prequalify or get preapproval for a loan. Prequalifying gives you the lender's estimate of how much you can borrow and in many cases can be done over the phone, usually at no cost. Prequalification does not guarantee that the lender will grant you a loan, but it can give you a rough idea of where you stand. If you're really serious about buying, however, you'll probably want to get preapproved for a loan. Preapproval is when the lender, after verifying your income and performing a credit check, lets you know exactly how much you can borrow. This involves completing an application, revealing your financial information, and paying a fee. It's important to note that the mortgage you qualify for or are approved for is not always what you can actually afford. Before signing any loan paperwork, take an honest look at your lifestyle, standard of living, and spending habits to make sure that your mortgage payment won't be beyond your means.
Should you use a real estate agent or broker? A knowledgeable real estate agent or buyer's broker can guide you through the process of buying a home and make the process much easier. This assistance can be especially helpful to a first-time home buyer. In particular, an agent or broker can: • Help you determine your housing needs • Show you properties and neighborhoods in your price range • Suggest sources and techniques for financing • Prepare and present an offer to purchase • Act as an intermediary in negotiations • Recommend professionals whose services you may need (e.g., lawyers, mortgage brokers, title professionals, inspectors) • Provide insight into neighborhoods and market activity • Disclose positive and negative aspects of properties you're considering Keep in mind that if you enlist the services of an agent or broker, you'll want to find out how he or she is being
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compensated (i.e., flat fee or commission based on a percentage of the sale price). Many states require the agent or broker to disclose this information to you up front and in writing.
Choosing the right home Before you begin looking at houses, decide in advance the features that you want your home to have. Knowing what you want ahead of time will make the search for your dream home much easier. Here are some things to consider: • Price of home and potential for appreciation • Location or neighborhood • Quality of construction, age, and condition of the property • Style of home and lot size • Number of bedrooms and bathrooms • Quality of local schools • Crime level of the area • Property taxes • Proximity to shopping, schools, and work
Making the offer Once you find a house, you'll want to make an offer. Most home sale offers and counteroffers are made through an intermediary, such as a real estate agent. All terms and conditions of the offer, no matter how minute, should be put in writing to avoid future problems. Typically, your attorney or real estate agent will prepare an offer to purchase for you to sign. You'll also include a nominal down payment, such as $500. If the seller accepts the offer to purchase, he or she will sign the contract, which will then become a binding agreement between you and the seller. For this reason, it's a good idea to have your attorney review any offer to purchase before you sign.
Other details Once the seller has accepted your offer, you, your real estate agent, or the mortgage lender will get busy completing procedures and documents necessary to finalize the purchase. These include finalizing the mortgage loan, appraising the house, surveying the property, and getting homeowners insurance. Typically, you would have made your offer contingent upon the satisfactory completion of a home inspection, so now's the time to get this done as well.
The closing The closing meeting, also known as a title closing or settlement, can be a tedious process--but when it's over, the house is yours! To make sure the closing goes smoothly, some or all of the following people should be present: the seller and/or the seller's attorney, your attorney, the closing agent (a real estate attorney or the representative of a title company or mortgage lender), and both your real estate agent and the seller's. At the closing, you'll be required to sign the following paperwork: • Promissory note: This spells out the amount and repayment terms of your mortgage loan. • Mortgage: This gives the lender a lien against the property.
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• Truth-in-lending disclosure: This tells you exactly how much you will pay over the life of your mortgage, including the total amount of interest you'll pay. • HUD-1 settlement statement: This details the cash flows among the buyer, seller, lender, and other parties to the transaction. It also lists the amounts of all closing costs and who is responsible for paying these. In addition, you'll need to provide proof that you have insured the property. You'll also be required to pay certain costs and fees associated with obtaining the mortgage and closing the real estate transaction. On average, these total between 3 and 7 percent of your mortgage amount, so be sure to bring along your checkbook.
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Applying for a Mortgage With all of the paperwork and questions that you need to answer, applying for a mortgage can be stressful. But knowing what's involved in the process can make things a lot easier. Here's some information to get you started.
Before you apply Do some homework before you apply for a mortgage. Think about what type of home you want, what your budget will allow, and what type of mortgage you might seek. Get a copy of your credit report, and make sure it's accurate; dispute any erroneous information to get it corrected. Be prepared to answer any questions that a lender might have of you, and be open and straightforward about your circumstances.
What you'll need when you apply When you apply for a mortgage, the lender will want a lot of information about you (and, at some point, about the house you'll buy) to determine your loan eligibility. Here's what you'll need to provide: • The name and address of your bank, your account numbers, and statements for the past three months • Investment statements for the past three months • Pay stubs, W-2 withholding forms, or other proof of employment and income • Balance sheets and tax returns, if you're self-employed • Information on consumer debt (account numbers and amounts due) • Divorce settlement papers, if applicable You'll sign authorizations that allow the lender to verify your income and bank accounts, and to obtain a copy of your credit report. If you've already made an offer on a house or condo, you'll need to give the lender a purchase contract and a receipt for any good-faith deposit that you might have given the seller.
Prequalification and preapproval In many cases, you'll want to know how much mortgage you can get before you look at homes so you won't waste time drooling over places that you can't afford. Your potential lender can either prequalify you or preapprove you for a mortgage. Lenders use several standard ratios to determine how much mortgage you're eligible for. Generally, if you're applying for a conventional mortgage, your monthly housing expenses (mortgage principal and interest, real estate taxes, and homeowners insurance) should not exceed 28 percent of your gross monthly income. In addition, your total long-term debt (monthly housing expenses plus other debt payments that won't be repaid within a year) should be no more than 36 percent of your gross monthly income. Government mortgage programs, such as FHA and VA mortgages, have higher qualifying ratios. Keep in mind that qualifying ratios vary among lenders, and you may still qualify for a mortgage even if you exceed the ratios listed above. For example, some lenders will allow higher ratios if you have excellent credit, a large down payment, or substantial savings, or meet other conditions. Prequalifying for a mortgage is simply a matter of a lender crunching these numbers to tell you how large a mortgage you'll qualify for based on those ratios. Remember, what you qualify for may not be what you can afford--only you can determine that after examining your own budget and lifestyle. Because the lender has not verified your income or examined your credit report, prequalification promises you nothing; it simply tells you how
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much mortgage you might get. Preapproval, however, means that the lender has checked out your income and credit. You'll get a letter of commitment stating that you'll be given a mortgage up to a certain amount. Preapproval lets you know exactly how large a mortgage you can get. In addition, it gives you more credibility as a buyer, since a seller can see in the lender's letter that you're going to get the mortgage if he or she accepts your purchase offer.
Finalizing the application As your mortgage application is processed and finalized, your lender is required by law to give you several documents. Within three business days of applying for the loan, the lender must inform you of the mortgage's effective rate of interest, or annual percentage rate (APR). If relevant, the lender must also give you consumer information on adjustable rate mortgages. In addition, the lender is required to give you an itemized good-faith estimate of your closing costs and a government publication that explains those costs. Since the home that you're purchasing will serve as collateral for the loan, the lender will order a market value appraisal of the property. The lender will not lend you more than a certain percentage of the value of the property. If your down payment will be less than 20 percent of the value of the property, your loan will require private mortgage insurance, and the lender will obtain insurer approval. If the lender has not already done so as part of a preapproval process, it will verify your employment and bank accounts as well as obtain and evaluate your credit report.
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Refinancing Your Mortgage When you refinance your mortgage, you take out a new home loan and use some or all of the proceeds to pay off the existing one. If you obtain a lower interest rate on your new loan than you had on your old one, you'll be saving money.
When to do it Generally, there are two good times when it's wise to refinance your mortgage. If you've got an adjustable rate mortgage, one of those times is during periods of rising interest rates. If you refinance to a fixed rate mortgage, particularly to a rate similar to your present low adjustable rate, you'll avoid the higher costs when the adjustable rates start going up. The other time it's a good idea to refinance is when you'll save money by getting a lower interest rate. In this case, you'll want to make sure that your monthly savings will pay back your refinancing costs while you're still living on the property. If you sell your home before your refinancing has paid for itself, you won't be saving anything. If you are experiencing cash flow difficulties, you may be tempted to lower your monthly mortgage payments by refinancing to extend the term of the loan. From a savings perspective, this is not a good reason to refinance. Unless you get a lower interest rate on the new loan as part of the bargain, you're not really saving any money; in fact, the reverse will be true. If you extend the term of your mortgage without changing anything else, you might loosen your tight cash flow situation, but you'll actually pay more total interest on the mortgage in the long run.
The cost of refinancing Your refinancing cost is the total of any points, closing costs, and private mortgage insurance (PMI) premiums that you pay when you take out the new loan. In addition, any lost tax savings must also be regarded as part of the cost of refinancing. There are times when lenders offer "no points, no closing costs" refinancing deals. Check the terms of the offer carefully to make sure that you understand what's involved. Points are prepaid fees. One point equals 1 percent of the amount you're borrowing, and any points you're charged are usually deducted from the mortgage proceeds you receive. Mortgage lenders typically charge one point as a loan origination fee. Beyond that, lenders may charge additional points on loans with interest rates below the current market rate. By doing so, the lender makes a little more money up front, and you get a lower interest rate on your mortgage. So, if you're going to stay in your house for a long time and can afford to do so, paying more points in the beginning may get you a better interest rate and save you more money in the long run. Your closing costs include a variety of fees, such as an appraisal fee, a title search fee, recording fees, and other fees associated with processing and finalizing your mortgage. If your loan-to-value ratio is greater than 80 percent of the appraised value of your property, you may also be required to carry PMI. The premiums for this insurance usually become a portion of your new monthly mortgage payment and thus reduce your savings from refinancing. In addition, you may discover hidden costs. For example, if you're paying less interest on your new mortgage, you'll have less to deduct on your income tax return. If this makes your tax payments higher, your savings will be further offset. Once you've determined what your refinancing costs will be, you can then determine how long it will take for your refinancing to pay for itself. To do so, divide the total of the points and closing costs that you paid by the net monthly savings that the new loan provides you. Your net monthly savings will be your interest savings less any PMI premiums and tax advantage losses expressed as monthly figures. For example, assume you refinanced $200,000. You paid two points and total closing costs of $1,800. You got a
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great interest rate on the loan, so you'll save $80 a month in interest charges. However, your PMI premiums are now $10 per month higher, and you've lost tax savings of $120 a year, or $10 per month. Your refinancing costs are $5,800--two points of $2,000 each and $1,800 in closing costs. Meanwhile, your net savings are $60 per month--$80 per month saved interest less $10 per month increased PMI premiums and $10 per month lost tax savings. If you divide $5,800 by $60, you'll find your refinancing will pay for itself in a little over 96 months.
No cash-out versus cash-out refinancing No cash-out refinancing occurs when the amount of your new loan doesn't exceed your current mortgage debt (plus points and closing costs). With this type of refinancing, you can typically borrow up to 95 percent of your home's appraised value. A cash-out refinancing occurs when you borrow more than you owe on your existing mortgage. In this case, you are often limited to borrowing no more than 75 to 80 percent of the appraised value of your property. Any excess proceeds remaining after you've paid off an existing mortgage can be used in any way you see fit, but the best use might be to pay off other outstanding high-interest debt, such as credit card debt. Cash-out refinancing has certain advantages. The interest rate that you'll pay on the mortgage proceeds will usually be less than the interest rate on the other debts (e.g., car loans, personal loans, credit cards, and even some student loans). Moreover, the interest paid on your refinanced mortgage is generally tax deductible, whereas the interest on consumer debt is not. There are disadvantages to this approach, too. Your refinanced mortgage is secured by a lien on your home. If you can't make the mortgage payments, the lender can foreclose on your home and sell it to pay the mortgage. Credit card or automobile lenders can't take your house away in this fashion. Moreover, unless you're well disciplined, you could pay off the high-interest (credit card) debt only to run it up again, further damaging your financial position. If you're going to explore a cash-out refinancing, do it only if all of the following are true: • Your savings make the refinancing worthwhile, even if it wouldn't give you the chance to repay other debt • Your savings are "real," due to a lower interest rate or a shorter loan term, and not due solely to tax factors, since tax laws may change • You're sure that you can afford the new monthly mortgage payment • You trust yourself (and your spouse) not to run up the repaid debt again Even if the rate on a new mortgage would be only slightly lower that what you've got now, refinancing is a good idea if your savings will outweigh the costs of refinancing during the time you own the home. If you're unsure how much longer you might live in a particular locale, use recouping your refinancing costs in five years or less as a good rule of thumb.
The Housing and Economic Recovery Act of 2008 The Housing and Economic Recovery Act of 2008 created (under the HOPE for Homeowners Act of 2008) a temporary refinance program within the FHA for homebuyers at risk of foreclosure. Lenders can write down qualified mortgages to 85 percent of the current appraised value and qualified borrowers can get a new 30-year fixed mortgage at 90 percent of the home's appraised value. The loan limit for this program is $550,440 nationwide, and the program is effective on October 1, 2008 and expires September 30, 2011. Be aware, however, that lenders are not required to participate in this program; they may volunteer to forgive loan balances down to 85 percent of current market value. Further, the borrower must share the newly-created equity and future appreciation equally with FHA. This obligation will continue until the borrower sells the home or refinances the FHA-insured mortgage. Moreover, the homeowner’s access to the newly created equity will be phased-in over five years.
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The Making Home Affordable Plan Part of the American Recovery and Reinvestment Act of 2009, the Making Home Affordable plan can help certain homeowners restructure or refinance their mortgages to avoid foreclosure. The Home Affordable Refinance portion of the plan allows owner-occupants of mortgages owned by Fannie Mae or Freddie Mac to refinance their mortgages without the usual 80 percent loan-to-value ratio restriction. Mortgage balances cannot exceed $729,750 for single-family homes, and cannot exceed 105 percent of the home’s current value. The program runs until June 1, 2010. The Home Affordable Modification portion of the plan assists responsible homeowners who are now struggling to afford their mortgage payments and who cannot sell their homes because prices have fallen significantly, in many cases making the value of the property less than what is owed on it. The intent of the program is to offer loan modifications that will bring a homeowner’s monthly payments to sustainable levels. Qualified applicants include owner-occupants in financial hardship or imminent danger of financial hardship, with any mortgage created on or before January 1, 2009, that does not exceed $729,750 for a single-family home, and that have current mortgage payments that exceed 31 percent of their gross monthly income. Applications must be filed by December 31, 2012.
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Tax Benefits of Home Ownership In tax lingo, your principal residence is the place where you legally reside. It's typically the place where you spend most of your time, but several other factors are also relevant in determining your principal residence. Many of the tax benefits associated with home ownership apply mainly to your principal residence--different rules apply to second homes and investment properties. Here's what you need to know to make owning a home really pay off at tax time.
First-time homebuyer tax credit You may qualify for a federal income tax credit of up to 10 percent of the purchase price of a principal residence (subject to the dollar limitations described below) if you meet certain requirements: • The home must be purchased on or after January 1, 2009 and before May 1, 2010. If you enter into a written binding contract before May 1, 2010, you can still qualify if you close on the home before July 1, 2010. (The time period is extended for members of the uniformed services and others who receive government orders for qualified official extended duty.) • If you, and your spouse if you're married, haven't owned a principal residence in three years, you may qualify for a credit of up to $8,000 ($4,000 if you're married and file a separate return). • For home purchases after November 6, 2009, you may qualify for a credit of up to $6,500 ($3,250 if you're married and file a separate return) if you, and your spouse if you're married, have maintained the same principal residence for at least five consecutive years in the eight years preceding the purchase. • For home purchases after November 6, 2009, you can't claim the credit if the purchase price of the home exceeds $800,000. Note: Special rules relating to the first-time homebuyer credit, not discussed here, apply to home purchases made on or after April 9, 2008, and before January 1, 2009. Generally, you won't have to pay back the credit (prior to January 1, 2009 the credit had to be paid back over 15 years in equal installments). There's one important exception, however: If the home ceases to be your principal residence in the 36 months following the purchase, you'll have to pay the credit back. If you're married at the time of purchase, the home must remain the principal residence of either you or your spouse for the 36-month period. The credit is reduced or eliminated for individuals with higher modified adjusted gross income ("MAGI"). The income levels that apply depend on your filing status and when the purchase is made: Qualifying home purchase: Filing status:
1/1/09 through 11/6/09
11/7/09 through 4/30/10
Married Filing joint Credit reduced if MAGI exceeds $150,000, eliminated when MAGI reaches $170,000
Credit reduced if MAGI exceeds $225,000, eliminated when MAGI reaches $245,000
All Others
Credit reduced if MAGI exceeds $125,000, eliminated when MAGI reaches $145,000
Credit reduced if MAGI exceeds $75,000, eliminated when MAGI reaches $95,000
Additional restrictions apply as well. For example, you can't claim the credit if you're a nonresident alien. And, for purchases after November 6, 2009, you can't claim the credit if you're under age 18 at the time of the purchase (unless you're married and your spouse is at least 18), or if you can be claimed by someone else as a dependent. If you purchase a qualifying principal residence in 2009, you can elect to treat the purchase as if it occurred on
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December 31, 2008. Similarly, a qualifying purchase in 2010 can be treated as if it occurred on December 31, 2009, allowing you to claim the credit on your 2009 federal income tax return.
Temporary additional standard deduction for non-itemizers For tax years 2008 and 2009, homeowners are able to claim an additional standard deduction for property tax if the taxpayer does not itemize. The additional amount that can be claimed is the lesser of: • The amount of real estate property taxes paid during the year to state and local governments; or • $500 ($1,000 if married filing jointly)
Deducting mortgage interest One of the most important tax advantages of home ownership is the deduction of mortgage interest. If you itemize deductions on Schedule A of your federal income tax return, you can generally deduct the qualified residence interest that you pay on certain home mortgages taken on your principal residence. (This also applies to second homes.) That is, you may be able to deduct the interest you've paid on a mortgage to buy, build, or improve your home, provided that the loan is secured by your home. Such a mortgage is known as acquisition indebtedness by the IRS. Your ability to deduct interest depends on several factors. Up to $1 million of acquisition mortgage debt ($500,000 if you're married and file separately) qualifies for interest deduction. (Different rules apply if you incurred the debt before October 14, 1987.) If your mortgage loan exceeds $1 million, some of the interest that you pay on the loan will not be deductible. Although this deduction also applies to certain home equity loans secured by your home, the rules are different. Home equity debt involves a loan secured by your main or second home that exceeds the outstanding mortgages on the property. Home equity debt is limited to the lesser of: • The fair market value of the home minus the total acquisition debt on that home, or • $100,000 (or $50,000 if your filing status is married filing separately) for main and second homes combined The interest that you pay on a qualifying home equity loan is generally deductible regardless of how you use the loan proceeds. For more information, see IRS Publication 936. Note: Qualified mortgage insurance payments paid in 2007 through 2010 can be deducted in the same manner as qualified mortgage interest, but only for mortgage insurance contracts issued on or after January 1, 2007 and before January 1, 2011. In addition, the deduction is phased out if your adjusted gross income exceeds $100,000 ($50,000 if married filing separate).
Tax treatment of real estate taxes Along with mortgage interest, you can generally deduct the real estate taxes that you've paid on your property in the year that they're paid to the taxing authority. Only the legal property owner can deduct the real estate taxes. In some cases, prepaid real estate taxes can be deducted in the year of the prepayment. Taxes placed in escrow but not yet paid to the taxing authority, however, generally aren't deductible.
Tax treatment of home improvements and repairs Home improvements and repairs are generally nondeductible. Improvements, though, can increase the tax basis of your home (which in turn can lower your tax bite when you sell your home). Improvements add value to your home, prolong its life, or adapt it to a new use. For example, the installation of a deck, a built-in swimming pool, or a second bathroom would be considered an improvement. In contrast, a repair simply keeps your home in good operating condition. Regular repairs and maintenance (e.g., repainting your house and fixing your gutters)
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are not considered improvements and are not included in the tax basis of your home. However, if repairs are performed as part of an extensive remodeling of your home, the entire job may be considered an improvement. If you make certain improvements to your home that improve your home's energy efficiency, you may be eligible for one or more federal income tax credits.
Deducting points and closing costs Buying a home is confusing enough without wondering how to handle the settlement charges at tax time. When you take out a loan to buy a home, or when you refinance an existing loan on your home, you'll probably be charged closing costs. These usually include points, as well as attorney's fees, recording fees, title search fees, appraisal fees, and loan or document preparation and processing fees. You'll need to know whether you can deduct these fees (in part or in full) on your federal income tax return, or whether they're simply added to the cost basis of your home. Before we get to that, let's define one term. Points are costs that your lender charges when you take a loan secured by your home. One point equals 1 percent of the loan amount borrowed. As a home buyer, you can deduct points in the year that you buy your home if you itemize your deductions. However, you must meet certain requirements. You can even deduct points that the seller pays for you. More information about these requirements is available in IRS Publication 936. Refinanced loans are treated differently. The points that you pay on a refinanced loan generally must be amortized over the life of the loan. In other words, you can deduct a certain portion of the points each year. There's one exception: If part of the loan is used to make improvements to your principal residence, you can generally deduct that portion of the points in the year that the points are paid. And what about other closing costs? Generally, you cannot deduct these costs on your tax return. Instead, you must adjust your tax basis (the cost, plus or minus certain factors) in your home. For example, if you're buying a home, you'd increase your basis with certain closing costs. If you're selling a home, you'd decrease your amount realized from the sale (i.e., your sale price). For more information, see IRS Publication 530.
Exclusion of capital gain when your house is sold Now let's see what happens when you sell your home. If you sell your principal residence at a loss, you generally can't deduct the loss on your tax return. If you sell your principal residence at a gain, however, you may be able to exclude from taxation all or part of the capital gain. Generally speaking, capital gain (or loss) on the sale of your principal residence equals the sale price minus your adjusted basis in the property. Your adjusted basis is the cost of the property (i.e., what you paid for it initially), plus amounts paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes. If you meet the requirements, you can exclude from federal income tax up to $250,000 ($500,000 if you're married and file a joint return) of any capital gain that results from the sale of your principal residence, regardless of your age. In general, an individual, or either spouse in a married couple, can use this exclusion only once every two years. To qualify for the exclusion, you must have owned and used the home as your principal residence for a total of two out of the five years before the sale. For example, you and your spouse bought your home in 1981 for $200,000. You've lived in it ever since and file joint federal income tax returns. You sold the house yesterday for $350,000. Your entire $150,000 gain ($350,000 - $200,000) is excludable. That means that you don't have to report your home sale on your income tax return. What if you fail to meet the two-out-of-five-years rule? Or what if you used the capital gain exclusion within the past two years with respect to a different principal residence? You may still be able to exclude part of your gain if your home sale was due to a change in place of employment, health reasons, or certain other unforeseen circumstances. In such a case, exclusion of the gain may be prorated. Additionally, special rules may apply in the following cases:
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• If your principal residence contained a home office or was otherwise used partially for business purposes • If you sell vacant land adjacent to your principal residence • If your principal residence is owned by a trust • If you rented part of your principal residence to tenants • If you owned your principal residence jointly with an unmarried taxpayer Note: Members of the uniformed services, foreign services, and intelligence community, as well as certain Peace Corps volunteers and employees may elect to suspend the running of the 2-out-of-5-year requirement during any period of qualified official extended duty up to a maximum of 10 years. Consult a tax professional for details.
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Opening the Door to Homeowners Insurance Your home is your castle, so the saying goes. And you're going to want to protect it. Homeowners insurance can give you just the protection you need. It provides coverage if your home is damaged or destroyed. It also covers your family's possessions and provides you with compensation for liability claims, medical expenses, and other expenditures that result from property damage and bodily injury suffered by others.
Why you need it You may need homeowners insurance because your mortgage lender requires it. But even if you own your home outright, you still need homeowners insurance to protect that which you can't afford to lose. It's really that simple. After all, you've spent years building up a solid financial foundation for you and your family. Without homeowners insurance, all of that hard work can go down the drain in a matter of minutes when, for example, a tornado devastates your house, a burglar robs and vandalizes your home, your dog bites and severely injures your neighbor, or your mail carrier slips on your front steps and breaks his leg.
Property coverage The main purpose of homeowners insurance is to protect your home and other structures, like a shed or detached garage. Your policy will cover not only the cost of the damage (the exact amount depends on your policy) but also your living expenses (up to a limit) while you wait for your home to be repaired. In addition to protecting your home, the typical homeowners policy covers your personal property, both on and off premises. Your personal property consists of the contents inside your home (e.g., furniture, appliances, clothing, jewelry) as well as outdoor items (e.g., sporting equipment, lawn tools). It's important to note that homeowners policies set specific dollar limits for certain types of personal property (e.g., jewelry, coins). Although policies vary, a typical homeowners policy provides coverage for damage to property caused by: • Fire and lightning • Windstorm and hail • Explosions • Theft or vandalism • Vehicles • Smoke • Falling objects • Weight of ice, snow, and sleet • Freezing of plumbing, heating, or air conditioning system • Riots But be aware that homeowners insurance does not cover a wide variety of perils (e.g., flood, earthquake damage). You may need to purchase an endorsement or separate insurance policy to ensure adequate coverage in these instances.
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• Replacement cost: This pays you the cost of replacing damaged property, with no deduction for depreciation, but with a maximum dollar amount • Actual cash value: This pays you an amount equal to the replacement value of damaged property minus a depreciation allowance Keep in mind that before an insurance company reimburses you for a loss, you'll need to satisfy a deductible.
Liability coverage In addition to insuring your property, the typical homeowners policy includes liability protection that provides coverage for damages caused by your negligence. Medical payments to third parties and your legal costs for any lawsuits brought against you are also included. Most homeowners policies provide a standard amount of liability coverage (usually $100,000) per accident.
Purchasing homeowners insurance Homeowners insurance policies are written individually, typically at the time you purchase a home or when you take out a mortgage on a home. For the most part, you'll want to purchase enough property coverage to cover the replacement cost of your home and its contents. The amount of liability coverage you'll need to purchase will depend on the assets you would like to protect (e.g., home, car, investments). The cost of homeowners insurance depends on the amount of your coverage, any endorsements you add to the policy, and policy deductibles. But since premiums for similar policies vary from company to company, it pays to shop around and compare rates.
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Insuring a New Home During Construction While the house of your dreams is being built, you should insure the structure and its contents. If you don't, you'll be exposed to unnecessary risks like fire or adverse weather that could damage or destroy your partially completed home. You should also protect yourself from liability by verifying that the people building your home carry proper insurance coverage.
You can insure your new home during construction with a homeowners policy One way to protect your new home during construction is to purchase a standard homeowners policy. This will cover any damage to your new house as it's being built. The time to insure your new home is before construction begins. Although it may seem a little odd to buy insurance protection for a structure that's still in the blueprint stage, remember that your house is vulnerable to damage during every phase of construction. For a time, you may need to carry one homeowners policy for your new home and another for your old home. There are temporary policies available that escalate the coverage amount as the construction progresses. Be sure to purchase full homeowners coverage after the home is completed.
Liability and theft coverage are provided A homeowners policy for your new house also provides you with liability coverage in case someone has a mishap while visiting the new home site. For example, if one of your friends trips during a tour of your dream house, his or her injuries may be covered. In addition, your policy provides coverage for the theft of building supplies, such as carpets, lumber, and roofing shingles (although your homeowners policy at your old house may also provide theft coverage at your new home). Uninstalled finished products like ceiling fans and the kitchen sink, however, are generally covered by your contractor's insurance. Keep in mind that your policy will not cover your personal property at your new house until the building is secure and lockable.
A dwelling and fire policy is another option Another option apart from standard homeowners insurance is to purchase a dwelling and fire policy. This type of policy can be purchased in comprehensive form, with property, liability, and theft coverage included. Or, you can buy a policy that covers only damage to the physical structure of your new home. A dwelling and fire policy may be a wise choice during construction of your new house if you have a standard homeowners policy on your old house that covers liability and the theft of items at the construction site.
Workers' compensation coverage Whenever a contractor or subcontractor steps onto your property to work on your house, you face the risk that someone may get injured and hold you liable. You can protect yourself from a potential lawsuit by verifying that the contractor and subcontractors have workers' compensation insurance. Ask to see proof. Get a copy of your contractor's certificate of coverage for both workers' compensation and contractor's liability insurance (which covers miscellaneous damage to your house by the contractor). All subcontractors should also make these documents available. You would be wise to call your contractor's and all subcontractors' insurance carriers to verify the information. Consult your insurance agent to be certain that the amount of workers' compensation is adequate and that the certificates are active. All general contractors should carry proper coverage for their employees, but you may need to extend the liability portion of your homeowners policy to cover underinsured subcontractors.
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What if you're the boss? Some do-it-yourself homeowners do most of the construction work on their homes by themselves, with a little help from their friends and family members. Other owners act as the general contractor and hire subcontractors to do the actual work. If you're building your own home, a homeowners policy covering the new home site will generally cover any injuries incurred by your friends and family members. If you are the general contractor, you are required by the laws of most states to carry a certain level of workers' compensation insurance to protect the people who build your new house.
Re-evaluate your coverage when construction is complete Once the building is complete, you should re-evaluate your homeowners insurance coverage. If you opted for dwelling and fire coverage, you will need to purchase a full homeowners policy. If you bought standard homeowners insurance, make sure that you have purchased the right amount, especially if you have made alterations to the original building plan. For instance, if you added an extra bathroom, you'll probably need to raise the amount of your coverage.
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Insuring a Condo or Co-Op Insuring a condo or co-op is a little different from insuring a typical home because you don't own the entire building. Usually, two policies are involved: the master policy provided by the condo association or co-op board, and your individual policy, which is typically written on a standard homeowners form, known as Form HO-6. If you know what the master policy covers and purchase individual coverage to fill in the gaps, you should have the protection you need.
The master policy The common areas you share with other owners should be covered by a master policy. These areas usually include the roof, stairways, elevators, and basement. Check the condo or co-op documents to be sure. If physical damage occurs to these areas, the repairs are covered under the master policy's provisions. The master policy also offers protection for liability incurred in the common areas. This means that if your guest or another person suffers a bodily injury while in a common area, the insurance company will step in to defend you and the other unit owners in the event of a lawsuit. Make sure that the master policy provides broad coverage. A cheap policy may save you and your fellow residents some money in the short term but may prove disastrous if the coverage is too limited. The condo association or co-op board should be able to provide you with the appropriate documents that explain the coverage. If the coverage appears inadequate, take steps to ensure that the association or board purchases a comprehensive policy.
Additional coverage for improvements It is important for you to know exactly what the master policy covers in order for you to purchase appropriate individual coverage for your unit and its contents. For instance, the master policy may cover individual units as they were originally built, but not improvements you have made to your property. You may need to buy an endorsement to cover any additions and improvements. A typical personal condo or co-op policy covers your personal property and other property, including private balconies, private entranceways, private garages, and other property that is your insurance coverage responsibility under your condo or co-op agreement.
What your personal policy will and will not cover Although the liability coverage on Form HO-6 is similar to that found in other homeowners policies, the property coverage is less comprehensive than that under the HO-3 form. This policy covers only the physical damage to your property and possessions caused by named perils specifically identified in the policy. These perils include fire, lightning, storm, explosion, riot, aircraft, smoke, vandalism, theft, broken glass, and volcanic eruption, to name a few. Review the perils covered by your policy, and remember that you may have the option to purchase coverage to protect you against additional perils. Certain perils specifically not covered are listed in the exclusions section of your policy. These typically include damage due to enforcement of building codes, earthquakes, flooding, power failures, neglect, war, nuclear hazard, or intentional acts.
The dwelling policy alternative You might be able to save money on personal condo or co-op coverage by purchasing a dwelling policy rather than a homeowners policy. Some comprehensive dwelling policies provide full coverage for property, liability, and theft. With others, you only need to buy the property coverage portion of the policy. This can save you money on your premium payments, but be certain your condo association or co-op board provides a strong master policy.
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Loss assessment Check your personal policy and pay particular attention to the paragraph titled Loss Assessment. This paragraph entitles you to collect up to $1,000 for loss assessments charged to you by the condo or co-op association. Loss assessments typically result from losses suffered by the condominium or co-op as a whole, such as damage to a roof that is not covered by the master policy at all or is subject to a large deductible. These uninsured damages are then passed through to all unit owners.
Loss settlement Your policy will specify the amounts you can recover in the event of a loss. Depending on the provisions of your personal policy, your insurance company may pay the total replacement cost of your property, which would allow you to replace or repair your lost or damaged items. Or, you may receive only the actual cash value (ACV) of your property, which is generally the current fair market value or the property's purchase price minus depreciation. Your settlement will almost always be less under the ACV method. Also, certain property items are assigned a specific dollar value for loss purposes, no matter what its age or condition. Loss settlement is always subject to the coverage limits described in your policy.
Read your policy before making a claim To qualify for payment from your insurance company, you must meet the conditions spelled out in your homeowners policy. Some conditions dictate your responsibilities before a loss occurs, and some dictate the actions you must take after the loss to remain eligible for coverage. Read your policy carefully to familiarize yourself with your responsibilities. If you need assistance, consult your agent to go over the details in your policy. Be sure you use an agent who is knowledgeable about condo and co-op policies.
Coordination of benefits under the master policy and personal policy When a loss is covered by both the condominium's or co-op's master insurance policy and your individual policy, your homeowners insurance will pay only for the balance of the loss that remains after the master insurance policy pays 100 percent of its limit.
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Insuring Your Vacation Home Vacation homes require a special type of insurance--one that protects your vacation home but doesn't overlap with your already existing homeowners insurance coverage. Here are some things to consider when insuring your vacation home.
What is covered under your primary residence's homeowners insurance? Most homeowners insurance policies provide limited coverage for personal property at an additional residence. However, if your coverage needs for your vacation home exceed this amount, you're going to want to fill this gap by purchasing a policy that will cover your vacation home in its entirety. One way to do this is to purchase a dwelling fire policy.
What is a dwelling fire policy? A dwelling fire policy is specially designed for a second home in that it provides coverage for the dwelling itself, along with your personal property. There are three types of dwelling fire policies: • Standard form: This covers the building and contents from the perils of fire and lightning, and the removal of property from the dangers of fire and lightning • Broad form: This covers your property from the above perils, plus windstorm, hail, explosion, riot and civil commotion, damage by aircraft or by vehicle, and smoke • All-risk form: This covers the property from damage for all perils that are not specifically excluded on the policy Just like your primary homeowners insurance policy, coverage for certain types of personal property may be limited (e.g., jewelry, money).
What about liability insurance? Your primary residence's homeowners policy will provide liability coverage for you at your vacation home. In fact, it will provide liability coverage for you anywhere in the world. However, if you need more liability coverage, you may want to either increase the limits on your primary residence's policy or purchase an umbrella policy.
How much does it cost? A dwelling fire policy is usually less expensive than your primary residence's homeowners insurance since it usually doesn't carry liability insurance. However, if your vacation home is located in a high-risk area (e.g., coastline, mountainside), if you rent your vacation home to others, or if you don't spend a lot of time there, your premiums may be higher. The good news is that you can usually save on your premiums by insuring your vacation home with the same company that provides coverage for your primary residence. A vacation home is a wonderful luxury. As with any home, it's important that your investment is properly protected with the right insurance. Consult your insurance agent if you have any questions regarding the type of coverage that you have or to determine if your liability coverage is sufficient.
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Which mortgage is better--fixed rate or adjustable? Question: Which mortgage is better--fixed rate or adjustable?
Answer: A fixed rate mortgage loan is a mortgage loan in which the interest rate remains the same from the day you take out the loan until the day you pay it off. Regardless of fluctuations in market interest rates, your interest rate never changes. Your payments remain steady, as well. The entire debt, including interest, is repaid in equal monthly installments. With an adjustable rate mortgage (ARM), your interest rate is initially lower than a fixed rate but then will be adjusted periodically to keep up with changes in interest rates. As your interest rate changes, the amount necessary to pay off your loan by the end of the term changes. Thus, your monthly payment amount is recalculated with each rate adjustment. There is typically an initial rate guarantee period, plus caps on how much your rate can increase in any year. If you are conservative by nature, have a fixed income, or believe interest rates are rising, a fixed rate mortgage may be an appropriate mortgage for you. With a fixed rate mortgage, changes in the economy will not affect your loan. Your interest rate and payment amount stay the same until the mortgage is paid off. ARMs are by nature less predictable than fixed rate mortgages because the interest rate and payment amount can rise or fall, sometimes substantially. With an ARM, you trade the predictability of fixed interest and payments for the possibility of lower interest and payments in the future. If you will be staying in the house only for a few years, the lower initial rate of an ARM makes sense.
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What's private mortgage insurance (PMI), and can my mortgage lender require me to have it? Question: What's private mortgage insurance (PMI), and can my mortgage lender require me to have it?
Answer: Lenders generally require you to purchase PMI if you are borrowing more than 80 percent of the value of the home you are purchasing (i.e., your down payment is less than 20 percent). Once you reach 20 percent equity in your house, your lender should remove the requirement for PMI. PMI guarantees your lender will be paid if you default on your mortgage, and without PMI, you may be unable to qualify for a mortgage. PMI does not protect you against losing your house in the event of a default payment. Moreover, the insurance company may be able to seek recourse against you for any default claim they pay to your lender. Typically, monthly PMI premiums are $45 to $65 per $100,000 borrowed. The cost of PMI depends on several factors, such as the amount of your down payment, the type of mortgage, and whether you pay premiums on a monthly basis or in a lump sum at closing. PMI premiums can significantly increase your monthly housing cost, but may be tax deductible. If you do not have at least 20 percent for a down payment, you still have a couple of ways to avoid paying PMI premiums. Consider asking if your lender is willing to increase your mortgage interest rate a quarter of a point rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly insurance premium. Also, certain types of mortgages, such as FHA loans and VA loans (for qualified veterans), do not require PMI. Talk to your lender about FHA loan or VA loan approval.
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I'm a first-time homebuyer, without a lot of cash to put down. What type of mortgage would be best? Question: I'm a first-time homebuyer, and I don't have a lot of cash to put down on a house. What type of mortgage would be best for me?
Answer: If you are a first-time homebuyer and don't have a lot of money for a down payment on a home, you may want to consider obtaining a mortgage through a government mortgage lending program such as those offered through the Federal Housing Administration (FHA) and the Department of Veterans Affairs, formerly known as the Veterans Administration (VA). Generally, these types of mortgage programs are an excellent choice for first-time homebuyers with moderate incomes, because the interest rates are set below current rates and little or no down payment is required. Consult your mortgage lender to see if you are eligible for either an FHA or VA mortgage. In addition to government mortgage lending programs, many mortgage lenders offer special programs for first-time homebuyers that require little or no down payment. Shop around and compare the mortgage rates and terms that various lenders offer to find a mortgage that is geared toward first-time homebuyers. Another option for individuals who have little or no down payment for a home is a rent with option to buy arrangement. A rent with option to buy arrangement allows you to rent a home for a certain period of time (usually three years) while you accumulate a down payment. At the end of the lease term, you have the option to purchase the home for a specified price. While you rent the home, part of each rent payment is credited toward the purchase price of the house, in effect creating a down payment.
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What's the Homestead Act? Question: What's the Homestead Act?
Answer: The federal Homestead Act, which was enacted in 1862, offered free 160-acre parcels of land to early settlers, or "homesteaders." Although this act was repealed in 1977, many states have enacted their own homestead laws. Some states use their homestead laws to encourage property ownership in certain areas by selling the property at a nominal price or offering special tax relief to buyers. Other states have homestead laws that protect your home against judgments and creditors. Consult a real estate broker or attorney to find out whether your state has enacted homestead laws and, if so, how you can take advantage of them.
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What's involved in getting a VA mortgage? Question: What's involved in getting a VA mortgage?
Answer: If you are a veteran who served in active duty during or after World War II, you may be eligible for a VA mortgage. Before applying for a VA mortgage, your eligibility must be verified by the Department of Veterans Affairs, formerly known as the Veterans Administration. To obtain a VA certificate of eligibility, complete VA Form 26-1880, titled Request for Determination of Eligibility and Available Loan Entitlement, and submit it to the nearest VA regional office. In addition to meeting the VA eligibility requirements, you must obtain a VA appraisal on the property you are purchasing. To obtain an appraisal, complete VA Form 26-1805, titled Request for Determination of Reasonable Value, and submit it to the local VA office. Once the appraisal has been completed and the appraiser's fee has been paid, a certificate of reasonable value will be issued. VA mortgage terms are generally favorable when compared to other types of mortgages. However, some variations in terms may exist from lender to lender. It may be worth your time to shop around and compare the interest rates, indexes, and closing costs of various lenders. Finally, keep in mind that although lenders act independently on most VA mortgage applications, some applications must be submitted to a VA office for approval. Once you fill out the application, your lender should notify you within 30 days as to whether your application and the amount of your loan have been approved.
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How much money do I have to put down to buy a house? Question: How much money do I have to put down to buy a house?
Answer: Typically, lenders require a down payment of 20 percent. However, several mortgage programs allow you to purchase a home with a much smaller down payment, such as Federal Housing Administration (FHA) mortgages and Veterans Administration (VA) mortgages (if you are a qualified veteran). In many cases, VA mortgages will not require a down payment at all, and FHA mortgages can require down payments of as little as 3 percent. If VA and FHA mortgages do not match your down payment needs, you may be able to obtain a conventional mortgage with a down payment of less than 20 percent with the additional cost of private mortgage insurance (PMI). Lenders generally require you to purchase PMI if you are borrowing more than 80 percent of the value of the home you are purchasing (i.e., your down payment is less than 20 percent). PMI guarantees that your lender will be paid if you default on your mortgage. Typically, monthly PMI premiums are $45 to $65 per $100,000 borrowed. The cost of PMI depends on several factors, such as the amount of your down payment, type of mortgage, and whether you pay premiums on a monthly basis or in a lump sum at closing. PMI premiums can significantly increase your monthly housing cost, but may be tax deductible (through 2010 only). If the idea of paying monthly PMI premiums does not appeal to you, consider asking if your lender is willing to increase your mortgage interest rate a quarter of a point rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly insurance premium. Some lenders offer no down payment or 100 percent financing mortgage programs that do not require you to purchase PMI. However, you will generally pay higher interest rates and closing costs on these loans, and there may be additional qualification requirements.
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Can I buy a house with no money down? Question: Can I buy a house with no money down?
Answer: Typically, lenders require a down payment of 20 percent of the home's purchase price. However, some special mortgage programs allow you to purchase a home with no down payment, such as Veterans Administration (VA) mortgages (if you are a qualified veteran) and no-down-payment or 100 percent financing mortgage programs. VA mortgage terms are generally favorable when compared with other types of mortgages. However, some variations in terms may exist from lender to lender. As for no-down-payment or 100 percent financing mortgage programs, you will generally pay higher interest rates and closing costs on these loans, and there may be additional qualification requirements. Besides special mortgage programs, you may be able to qualify for a conventional mortgage with no money down if you purchase private mortgage insurance (PMI). Typically, monthly PMI premiums are $45 to $65 per $100,000 borrowed. The cost of PMI depends on several factors, such as the amount of your down payment, your type of mortgage, and whether you pay premiums on a monthly basis or in a lump sum at closing. PMI premiums can significantly increase your monthly housing cost. Without PMI, however, you may be unable to qualify for a mortgage if you have no down payment.
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What are the advantages of making biweekly mortgage payments? Question: What are the advantages of making biweekly mortgage payments?
Answer: A biweekly payment plan is a formal method of prepaying your mortgage. Under a biweekly payment schedule, you make a payment on your mortgage every two weeks instead of once a month. Each of these payments is roughly equal to one-half of a normal monthly payment. By making biweekly payments, you end up making an extra payment over the course of each year (26 half payments are equal to 13 full payments). You also pay less interest in the long term, because payments are applied to your principal balance more frequently. Ask your lender if it offers a biweekly payment schedule and if it charges a fee for this service. Before you sign up for a biweekly payment schedule, ask your lender whether or not a penalty exists for dropping out of the program. Once you sign up for the program, you may discover that you cannot afford the extra payment or are unable to keep up with the biweekly payment schedule. If the structure of a biweekly payment plan does not work out for you, consider making monthly payments and adding a little extra whenever you can. You can also budget your money so that you are sending in one extra payment a year whenever possible.
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What is involved in buying a house that's for sale by owner? Question: What is involved in buying a house that's for sale by owner?
Answer: When you buy a home directly from the owner, also known as for sale by owner (FSBO), no real estate agent or seller's agent is involved. Rather, the buyer and the seller deal directly with each other. Generally, the process for buying a house that is FSBO is the same as buying a house with the assistance of a real estate agent. However, many home buyers are intimidated by the thought of going through the home-buying process without a real estate agent to provide forms, suggest financing, write the purchase and sale agreement, or negotiate the deal. Keep in mind that this lack of broker representation can actually be an advantage for buyers. First, the price of the home is not artificially inflated to cover the cost of the agent's commission. Second, you deal directly with the seller instead of having to make an offer through the seller's agent.
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Should I choose a mortgage with no points and pay a higher interest rate? Question: Should I choose a mortgage with no points and pay a higher interest rate, or should I put money toward points to lower the interest rate on a mortgage?
Answer: Points are costs that a lender charges you when you take out a loan on your home. One point equals 1 percent of the loan amount borrowed (e.g., 1.5 points on a $100,000 loan would equal $1,500). Generally, the more points that you pay up front, the lower the interest rate you will pay on your mortgage loan. This can save you thousands of dollars in interest over the course of the mortgage loan. If you pay points up front, you want to make sure that you recover the cost while you are still living in your home. If you move before you recover the costs of the points, you really won't be saving any money. You can determine how many months it will take for you to recover the cost of the points by dividing the amount you pay for points by the amount you save on your mortgage loan. For example, if you pay $1,000 in points up front and you save $40 a month in interest, it will take you 25 months to recover the cost of the points (1,000 divided by 40 equals 25). If you plan on staying in your home for less than 25 months, you will lose money on the points that you paid up front. Keep in mind that the cost of points is negotiable and is often split between the buyer and seller. Points may also be deductible on your income tax return.
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My mortgage includes an early-payoff penalty statement. What does that mean? Question: My mortgage includes a statement that a penalty may be imposed for early payoff. What does that mean?
Answer: Lenders will sometimes impose a penalty for early payoff or prepayment of a mortgage loan. Others will penalize you only if your payment exceeds a certain amount or occurs within a certain time period. Certain loans (i.e., fixed rate mortgages) are more likely to carry a prepayment penalty than others (i.e., adjustable rate mortgages). Federal credit union, Federal Housing Administration (FHA), and Veterans Administration (VA) mortgage loans can all be prepaid without penalty. Typically, you prepay a mortgage loan (that is, you send in more money than required) to reduce the amount of interest that is paid over the life of the loan, resulting in thousands of dollars in savings. To prepay your mortgage loan, you should read your mortgage contract or talk to your lender to clarify the terms of your mortgage loan and determine whether or not you will suffer a prepayment penalty. If your mortgage lender will not remove the prepayment penalty, you may be better off investing the extra sum elsewhere.It is important to note that if you do prepay your mortgage loan, it does not change your monthly obligation to your lender. Regardless of how much you prepay, you will be in default if you fail to make your minimum monthly payments.
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Should I buy a home or continue renting? Question: Should I buy a home or continue renting?
Answer: Most people face this question at some time in their lives. Buying a home is part of the American dream. It's also one of the biggest financial investments you'll ever make. One of the main advantages of buying a home is that you build equity in your property. For example, if you paid rent at $1,000 per month for 10 years, you would have spent $120,000 on rent and have nothing to show for it. However, if you had purchased your home and made $1,000-per-month mortgage payments for 10 years, you would have paid off a sizable portion of your mortgage. And if you decided to sell your home, you might make a profit. Before buying a house, remember that your lending institution will want proof that you have money saved for the down payment and closing costs. If your savings won't cover these costs, you should probably continue to rent for the short term while establishing an ambitious savings plan. Even though buying allows you to accumulate a valuable asset, renting also has advantages. You may spend less time doing maintenance than if you owned the home, and you could relocate to another home more easily. In addition, you would probably pay less per month for rent than you would for a typical mortgage payment. This would leave you with more money to spend on whatever you choose. Remember, it's not easy to buy and own a home. Many people continue to rent throughout their lives. But if you decide to buy a home, start saving now so that someday you will own the home of your dreams.
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Can I use a piggyback mortgage as an alternative to private mortgage insurance (PMI)? Question: Can I use a piggyback mortgage as an alternative to private mortgage insurance (PMI)?
Answer: If your down payment is less than 20 percent of the purchase amount when you buy a house, the lender will likely require that you buy PMI to ensure repayment of the loan. To avoid paying monthly PMI premiums, consider getting a piggyback mortgage, sometimes called an 80-10-10 mortgage. In a piggyback transaction, a bank or other finance company traditionally lends 80 percent of the purchase price, and the buyer makes a down payment of 10 percent. The remaining 10 percent is financed with a second mortgage. The interest rate for the second mortgage is usually significantly higher than for the primary loan. The cost of PMI may not be as much of a concern as it has been in the past. That's because federal law now requires that a lending institution cancel PMI when you have reduced the principal portion of your loan to 78 percent of the purchase price. Until recently, PMI was removed from a mortgage agreement on a case-by-case basis and often was paid by the borrower for the life of the loan. By comparison, a piggyback mortgage could be paid off, giving borrowers some control over how long they had to pay added monthly costs. In addition, PMI premiums for mortgages issued between January 1, 2007 and December 31, 2010 are now tax deductible for certain taxpayers, whereas formerly, this was not the case. A piggyback mortgage may still make sense, but you have to calculate which option is best for you. Keep in mind that some second mortgages require a balloon payment of all the outstanding principal at the end of the term, and that you may not be able to take out further mortgage loans until the piggyback mortgage is paid off. You might also consider some of the alternatives to both piggyback mortgages and PMI. If you have built a good relationship with your current financial institution, it may approve a portfolio loan for you. A portfolio loan is one that the lender keeps in-house rather than selling, so the lender may waive PMI, depending on your financial history. Another alternative is to find a lender that offers a slightly higher-than-market interest rate in exchange for waiving PMI. However, you will end up paying the higher interest rate for the life of the loan.
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Can my mortgage lender require me to have an escrow account? Question: Can my mortgage lender require me to have an escrow account?
Answer: Generally, your mortgage lender can require you to have an escrow account if you borrowed more than 80 percent of the value of the property you bought. (The percentage you borrow against the valuation of the property is known as the loan-to-value ratio.) Each month, in addition to your mortgage payment, the lender collects a prorated amount to be held in escrow. Your lender applies this amount to your annual private mortgage insurance premiums, homeowners insurance premiums, and property taxes. Private mortgage insurance protects the lender from loss in case it must foreclose on your property. You may petition to have this insurance coverage canceled once you can establish that your loan-to-value ratio is less than 80 percent. However, you'll still have to carry enough homeowners insurance to cover the replacement costs of the dwelling. Also, your property taxes may fluctuate from year to year, depending on the increase or decrease in your local property tax bill. Thus, the amount you may be required to keep in escrow may vary with changes in the valuation of your property. In addition to collecting the amounts necessary to meet these expenses, lenders typically hold a two-month surplus in escrow. Only a handful of states have passed laws requiring lenders to pay you interest on the funds held in escrow accounts. In some states, you, the buyer, are allowed to set up your own separate account (known as a pledge account) for escrowing these funds. You are also responsible for making the property tax and insurance premium payments yourself. Under these circumstances, you earn interest on the funds in the pledge account. If your loan-to-value ratio is less than 80 percent, you may be able to waive the need for an escrow account. To do so, let your lender or mortgage broker know up front in the lending process, because canceling an escrow account can be difficult once it's established. Your lender may require you to pay a one-time escrow waiver fee equivalent to one-quarter of one point. For example, if your mortgage is for $100,000, the fee would be $250.
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Does homeowners insurance cover losses that occur outside my home? Question: Does homeowners insurance cover losses that occur outside my home?
Answer: The only way to find out the answer to this question is to check your policy. Homeowners policies regularly provide protection for off-premise destruction or theft, which covers your possessions while they are outside your home. For example, if your luggage were stolen while you're on vacation, a homeowners policy containing off-premise protection would cover the loss. This type of protection can also protect your kids' stereo equipment and other possessions when they go off to college, but only if they live in a dormitory. After a child moves to an off-campus apartment, he or she will typically need to purchase a separate renters insurance policy to cover his or her personal property. If your homeowners policy does not contain off-premise protection as part of its standard coverage, you may be able to purchase this coverage for an additional charge. Check the liability portion of your policy to determine your level of coverage for accidents that occur outside your home. Homeowners policies typically cover accidents that occur on your property (e.g., the mailman slips on your sidewalk, or a neighbor is injured in your backyard). Many policies will even cover you for accidents that occur away from your property. For example, if you run a shopping cart over someone's foot at the grocery store, many policies will cover the medical bills. But again, the best way to know whether you're covered is to carefully read your homeowners insurance policy. You can also call your insurance agent or the insurance company and review your policy with them.
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I'm building a new home. Do I need to insure it while it's under construction? Question: I'm building a new home. Do I need to insure it while it's under construction? If so, how can I do this?
Answer: You should definitely insure your new home during its construction. If you don't, you're exposing yourself to a great deal of risk if fire, theft, or another event damages or destroys your partially completed home. One way to cover your new home during construction is by purchasing a standard homeowners policy. This will cover you for any damage to the building as it's being built and may provide some coverage for theft of building supplies (although the contractor's insurance should also cover this). A homeowners policy also provides liability coverage, which may come in handy if one of your friends trips during a tour of your dream house and decides to sue you. However, the policy will not cover your personal property until the building is secure or lockable. After construction reaches this point, you can add on coverage for your personal property. Another option is to purchase a dwelling and fire policy. This type of policy covers damage to the physical structure but provides no theft coverage. A dwelling and fire policy may be an appropriate choice if you are living in your old house during construction, because the homeowners policy on that house would cover theft of items from the construction site. Dwelling and fire policies also provide liability coverage, just like a standard homeowners policy. When the building is complete, you should re-evaluate your coverage. If you opted for dwelling and fire coverage, you'll need to purchase a full homeowners policy. If you bought standard homeowners insurance, make sure you have purchased an adequate amount, especially if you've made alterations to the original building plans by adding on a room or upgrading the building.
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How can I reduce the cost of my homeowners insurance? Question: How can I reduce the cost of my homeowners insurance?
Answer: There are many ways you can save on the cost of your homeowners insurance premium, with some possibilities existing within the policy itself. Most insurance companies offer several different credits for certain characteristics and circumstances. Your state may offer discounts, as well. Insurance rates will vary depending on the home construction and location. The more fire-resistant the building materials, the lower the rates will be. Brick homes have lower rates than wood-frame homes. Rates are also affected by how close your home is to a fire hydrant. The town in which you live affects the rates, with each town being graded by the state or the insurance company. The grades reflect proximity to the closest fire department, road accessibility, congestion, and other characteristics that would affect the fire department's ability to get to a house fire quickly. Insurance companies will often issue credits to their customers for the following: • Having protective devices, such as smoke and burglar alarms • Homes that are less than 15 years old • All occupants in the home are nonsmokers • Insuring both your auto and home with the same company for a multiple-policy discount • Renewing the policy with the same company Selecting a higher deductible and reducing or omitting coverages can also help you save money. Check your policy to be sure you're not being charged for insurance coverage you don't need. Some states offer credits in partnership with insurance companies and businesses. For example, you could attend a state-sponsored home safety workshop and receive a credit on your homeowners premium or a discount at participating home supply stores. Ask your insurance agent or insurance company for further information.
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I need to file a claim on my homeowners insurance. How do I do this? Question: I need to file a claim on my homeowners insurance. How do I do this?
Answer: If you have a loss and believe that your homeowners insurance will cover it, gather as much information as possible about the event that caused the loss. If it was a theft, report it to the police right away and then get a copy of the police report. If the loss involves damaged property, take photographs or a video. While the memory is fresh in your mind, write down what happened. Minimize the possibility of further damage if possible--many homeowners insurance policies will cover the cost of any damage-control efforts. For example, if you have broken windows, get them covered immediately. When you have the information ready, call your insurance agent or insurance company representative. It's important to call as soon as possible after the loss. Your agent or company representative will fill out a claim form with you and give you any special instructions. When you have filed your claim with the insurance company, the company will assign a claims adjuster to your case. If the damage is severe, the adjuster will visit the site to examine the property and determine the amount of reimbursement. If the claim is one of liability, the adjuster will work to determine who is liable. Often, when the damage is small and straightforward, you can work with the adjuster over the telephone. Some people hire their own independent claims adjuster. This adjuster represents you and works with the insurance company to be sure you receive a fair settlement. You can do some things ahead of time that will help if you ever have to file a claim. For example, keep receipts of your valuables. Also, take pictures of valuables when you purchase them--"before" pictures are always helpful to a claims adjuster. Keep the copies of receipts and photos outside the house, so you won't lose them if the house is damaged. The more information you and your adjuster have about the loss, the smoother the claims process will go.
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Will I have trouble getting homeowners insurance if my dog has bitten someone in the past? Question: Will I have trouble getting homeowners insurance if my dog has bitten someone in the past?
Answer: When you apply for homeowners insurance, an underwriter reviews your application. Part of this review involves examining any losses that have occurred while you have lived in your home. If your dog has bitten someone in the past and an insurance claim was filed, it doesn't necessarily mean you will have a hard time obtaining insurance. It depends on why the incident occurred, how the situation was handled, and what changes have been made to ensure the dog doesn't bite anyone again. Some of the questions an underwriter could ask are: • What caused the dog to bite someone? Was the dog provoked, or did he or she attack for no reason? • How serious was the injury? • What is the breed of the dog? • How old was the injured person? • Has the dog bitten people before? • Is the dog kept on a leash or otherwise secured? • What steps have you taken to make sure the dog won't bite anyone again? You should be able to obtain a homeowners policy or renew the one you currently have if the dog has bitten someone only once as a result of being provoked, is not a vicious animal, is not on the insurance company's list of prohibited breeds, and is kept secured in the yard. If your dog has bitten people several times and is not well secured, you will probably have trouble getting insurance. Your insurance agent can be your advocate in a case like this. He or she has an established relationship with underwriters at several different insurance companies. The agent can answer an underwriter's questions, guide you through any changes you need to make, and then help you obtain the insurance you need.
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How can I insure my possessions during a move? Question: How can I insure my possessions during a move?
Answer: There are several ways to insure your possessions while you're moving. Perhaps your current homeowners policy includes coverage for your personal property during a move. The policy may cover your possessions at the new location for a limited time, also. The same coverages, exclusions, and deductibles apply while you're moving as they would for a regular homeowners claim. If your homeowners policy doesn't include this coverage, you can purchase a policy that's specifically designed to insure possessions during a move. It's known as a floater and is effective only during your move. Or, you can add a floater to the coverage already provided by your homeowners policy. A third alternative is to rely on the insurance offered by the moving company. You'll want to see its policy before you hire a moving company so you'll know what's covered and what isn't. Also, pay attention to insurance limits. If the company's insurance is not up to your standards, purchase a floater. If you have a loss during a move, the mover's insurance is primary. That is, the mover's insurance company will pay first. Your insurance pays only after the mover's insurance limits have been depleted. For example, the mover's policy has limits of $10,000 and your floater has limits of $25,000. If you have a $15,000 loss and the movers are at fault, the mover's policy will pay $10,000 and your policy will pay $5,000. As you review the combined mover's insurance and your own, pay attention to what they cover and how much. Know what the exclusions are and what the deductible is. Your insurance agent can help you be sure your possessions are adequately covered.
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I'm placing some items into self-storage. Will they be covered under my homeowners insurance? Question: I'm placing some items in a self-storage facility. Will they be covered under my homeowners insurance policy?
Answer: Your homeowners insurance policy provides coverage for your personal property anywhere in the world, subject to the special limits of liability under Coverage C and the policy's exclusions and conditions. Since these exclusions include losses from perils that might especially pertain to stored items, including water back-up or flooding, rodents, insects, and earthquakes, make sure you understand what's covered and what's not before placing any items in storage. Check your policy or call your agent if you have any questions.
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Why do I have to purchase homeowners insurance in order to obtain a mortgage? Question: Why do I have to purchase homeowners insurance in order to obtain a mortgage?
Answer: Your home is the collateral for the mortgage loan you're obtaining, so until you pay your mortgage in full, your lender has a financial interest in your property. As a condition of making the loan, your lender will require you to purchase a certain amount of homeowners insurance that will protect both you and the lender in the event that your home is damaged or destroyed. Generally, at the closing or a few days before closing, you'll be asked to submit proof of coverage, with the lender named as loss payee. If you have any questions, ask your mortgage lender or your insurance company or agent for more information about what's required.
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What is a hurricane deductible? Question: What is a hurricane deductible?
Answer: Homeowners insurance policies in states that are at high risk for hurricanes often contain a separate deductible for hurricane damage. This deductible is usually much higher than the deductible that applies to other losses, and may either be a flat dollar amount (e.g., $500) or a percentage of the dwelling coverage amount. To illustrate how the percentage deductible works, let's say that your home is insured for $200,000 and your policy has a 2 percent hurricane deductible. If your home sustains damage from a hurricane, you'll need to come up with $4,000 out-of-pocket for repairs before your homeowners policy pays anything. Available deductibles vary by state and even among insurance companies within a state. Some hurricane deductibles are triggered only in the event of a named storm, whereas others are triggered when winds reach a certain speed. Some homeowners policies may have other storm-related deductibles as well, such as deductibles for windstorm or hail damage. The best way to determine what coverage you have and what deductibles apply is to read your policy, and call your insurance agent or company if you have questions.
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Should my partner and I buy a house together even though we're not married? Question: Should my partner and I buy a house together even though we're not married?
Answer: If you want to buy a home with your partner, go ahead. Together, you may be able to qualify for a larger mortgage than if one partner alone applied for the loan. However, be aware that unmarried partners have some unique considerations that married couples don't have. The laws dealing with the distribution of property when a couple splits up or a partner dies are few and vague when the couple is not married. So it's crucial for unmarried partners to have a detailed written agreement regarding their respective ownership interests in the property and their intentions for distribution of the property if either partner should die or if the relationship ends. Both partners should also keep thorough and accurate records of their respective contributions. You and your partner can own the property in one of many ways, including: • Joint tenants with rights of survivorship • Tenants in common • Individually in one of your names • In trust Joint tenancy with rights of survivorship means that when one partner dies, the surviving partner automatically owns the entire property, bypassing the probate process. This way of owning property may make it more difficult to sell your share of the property without your partner's consent. However, it may also offer creditor protection because neither partner owns a separate share; instead, both own equal rights in the entire property. As tenants in common, you and your partner each can leave your portion of the property to whomever you choose in your wills. Creditors of tenants in common may have an easier time attaching the property than if it were owned jointly with rights of survivorship. You and your partner may decide that only one of you will own the property. However, if you choose individual ownership, beware. The person named on the deed will be able to sell the property without the consent or even the knowledge of the other partner. You can also choose to own the property in trust, with the trust agreement spelling out the rights and obligations of each partner. You'll want to get advice from an experienced attorney on all of the ownership options available to you and your partner.
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We just bought our first home. What can we deduct from the settlement statement? Question: We just bought our first home. What can we deduct from the settlement statement?
Answer: If you took out a mortgage to purchase your home, you probably paid settlement costs in addition to the contract price. These costs generally include points, attorney's fees, recording fees, title search fees, appraisal fees, and other loan or document preparation and processing fees. The only settlement costs you can deduct are home mortgage interest and certain real estate taxes. You deduct them in the year you bought the home if you itemize your deductions. Certain settlement costs can be added to the basis of your home. Other settlement or closing costs, however, cannot be deducted or added to the basis. If the loan was for the purchase of your primary residence, the points withheld from the loan proceeds will generally be deductible as up-front interest if you paid a down payment, escrow deposit, or earnest money equal to the charge for points. Generally, you can also deduct any points paid by the seller. Real estate taxes are usually divided so that you and the seller each pay taxes for the part of the property tax year that each owned the home. You can deduct the taxes you actually paid during the year. However, you cannot take a present deduction for taxes paid in escrow for a future tax bill. Other closing costs that you paid are not deductible and must be added to the cost basis of your home. You can include in your basis the settlement fees and closing costs that you paid that are associated with buying your home. You cannot include in your basis the fees and costs associated with getting a mortgage loan.
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Does my homeowners insurance cover what's in my yard? Question: Does my homeowners insurance cover what's in my yard?
Answer: In general, yes. Though the land itself is excluded, your homeowners policy provides broad protection for the personal property and structures located in and around your yard. A standard homeowners policy includes several types of coverage: • Coverage A: Insures your home, including an attached garage or room addition, against physical damage • Coverage B: Covers other structures on the premises, including detached garages, fences, swimming pools, and driveways • Coverage C: Covers your personal property and household possessions • Coverage D: Covers loss of use and various items such as debris removal, tree replacement, and shrub replacement Check your policy or call your insurer if you have any questions about what's covered and what's not.
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What are points, and do they affect my insurance rates? Question: What are points, and do they affect my insurance rates?
Answer: Your state's Department of Motor Vehicles probably uses some kind of point system to rate its drivers. Each state has its own point system, but typically, numerical values are assigned to different types of driving violations. The more serious the violation, the higher the point value. For example, you might get only one point for a speeding ticket, but three or more points if you're convicted of drunk driving. The bottom line is that, as you accumulate points, your driving record gets worse in the eyes of both your state and the insurance industry. And that can mean higher auto insurance rates for you. The purpose of these higher rates is not to punish you for an accident or other violation. Believe it or not, insurers want to charge premiums that are fair and appropriate. Since statistics show that people who've committed driving infractions are likely to do so again, it's only reasonable that your premium should go up after an infraction. How much it goes up usually depends on the insurer. An insurance company may use its own point system to calculate rate increases. Your insurer's point system probably resembles your state's point system--both assign you points based on the number and types of violations you commit. Your insurer then uses these points to apply surcharges to your policy, which drives up your rate. Your insurer gets information on your driving record by checking with your state's Department of Motor Vehicles. There are certain times when you can bet that your insurer will run a check. For example, expect your driving record to be reviewed anytime you want to increase your coverage or make other changes to your policy. Of course, your record will also be checked when you first apply for coverage and when it comes time to renew your policy. Depending on how bad your record is, an insurer could even deny you coverage.
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Will my condo association's master policy cover my property? Question: Will my condo association's master policy cover my property?
Answer: The master policy that your condo association maintains is designed to cover the common areas you share with other tenants. It may also cover the structure of your individual unit as it was originally built, and perhaps the fixtures within your unit. To cover your personal property and get comprehensive protection, though, you should purchase a special form of homeowners insurance designed to meet the needs of condo and co-op owners. This is known as an HO-6 policy. An HO-6 policy will cover your personal property in the event of losses caused by certain perils named in the policy. Typically, these perils include fire, smoke, explosion, vandalism, theft, riot, lightning, storm, broken glass, aircraft, and volcanic eruption. To cover additional perils, you may want to purchase separate protection. Under your condo association's guidelines, certain items may be treated as your insurance responsibility and will not be covered by the master policy. Along with the named perils coverage for your personal property, your HO-6 policy will probably provide insurance protection for additions and other improvements you make to your property, as well as private balconies, private entranceways, and private garages. Like a standard homeowners policy, your HO-6 policy should also provide liability coverage. So, if you're found liable for bodily injuries to others and/or damage to their property, your HO-6 policy will generally cover you up to certain limits.
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Do I need title insurance if I'm buying a condominium? Question: Do I need title insurance if I'm buying a condominium?
Answer: Your title to any real estate, including a condominium, is proof of your interest in that property. But what if your title were faulty? It could be a forgery, or it might have been recorded improperly. The property could be subject to unpaid tax liens or other assessments. If any of these were the case, you could lose the condominium and still be required to repay any money you borrowed to purchase it! If you take out a mortgage to buy the condominium, you'll probably have to get a lenders title insurance policy. This covers only the mortgage lender's interest in the condominium for the life of the loan. You'll want to get an owners title insurance policy, which protects your interest in the condominium for as long as you own it. If any questions arise about the legitimacy of your title, your title insurance company will defend your rights in court. If you suffer a title-related loss, the insurance company will pay for this in accordance with the policy terms. When you buy title insurance on a condominium, you'll be issued an American Land Title Association condominium endorsement. Some title issues (e.g., document defects that invalidate the property's classification as a condominium, or unpaid assessments associated with the unit you buy) are unique to condominiums. The condominium endorsement form certifies that your title is free of such defects or encumbrances.
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Can I save money on my homeowners insurance premium if I install a home security system? Question: Can I save money on my homeowners insurance premium if I install a home security system?
Answer: Yes. Most home insurers offer discounts to policyowners who protect their homes with an alarm or other security system. Home security discounts can range between 5 and 20 percent. The size of this discount varies from insurer to insurer and is based on the complexity of the system you choose (e.g., dead bolts versus a fully loaded monitoring system). Other discounts may be available if you have certain safety devices (e.g., smoke detectors, sprinkler systems) installed in your home. Check with your insurer to see what other discounts it may offer.
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My property is close to a river. Do I need flood insurance? Question: My property is close to a river. Do I need flood insurance?
Answer: Considering the potential damage that flooding can do to your home, you should seriously consider flood insurance. Flooding from a river (or any other source, such as melting snow, heavy rains, or inadequate drainage) is not covered under your homeowners insurance policy. To get coverage, you'll need to purchase a separate flood insurance policy. Start with your insurance agent. Many companies that issue homeowners policies also issue flood insurance policies. Or, you can call the National Flood Insurance Program at (800) 621-3362 for a list of insurers that write these policies. Keep in mind that if your home is located in a flood zone and you're obtaining a federally backed mortgage, your lender will require you to purchase flood insurance. Whether your property is located in a flood zone will be determined by special flood-zone maps prepared by the Federal Emergency Management Agency. If your property is located in a minimal-risk area, your lender won't require flood insurance, though you can certainly purchase it on your own.
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How do I insure my historic home? Question: How do I insure my historic home?
Answer: A standard HO-8 homeowners policy is designed to address the needs of people who have older homes with historic value. Although these policies cover the cost of standard repairs, they don't provide replacement cost coverage and--depending on your home--may not always be the best choice. Several insurance companies specialize in homeowners policies for historic homes. These insurers can write a custom policy to suit your needs. Such a policy can include coverage limits that are greater than those offered by a standard policy. In addition, these policies generally offer the option of guaranteed replacement cost coverage. If you decide to go with an insurer that specializes in historic home coverage, you can expect a residential consultant or appraiser to visit your home and conduct a thorough inspection. In some cases, historic district associations require that all repairs conform to their criteria for maintaining the historic integrity of your property. For example, you might have to replace the balusters on your damaged widow's walk with exact duplicates of the originals. In making such repairs, you may need the services of suppliers or artisans with special parts or skills. Because insurance companies that offer historic home coverage often have the appropriate contacts, they may be able to put you in touch with the people you'll need. Historic home coverage policies may also offer features not included in a standard homeowners insurance policy. Often, there's little or no limitation on the additional living expenses they'll cover if you have to vacate your home while repairs are made. In addition, they'll frequently cover occurrences such as sewer backups that standard policies don't, and the coverage limits for personal property (e.g., jewelry or fine art) are sometimes substantially higher than with a standard homeowners policy. Of course, the cost of a specialized policy for a historic home is higher than that of a standard policy.
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I'm planning to add an in-law apartment to my home. How will this affect my homeowners insurance? Question: I'm planning to add an in-law apartment to my home. How will this affect my homeowners insurance?
Answer: Typically, an in-law apartment is either attached to or built within your home. Determining how an in-law apartment will affect your homeowners insurance depends largely on your insurance company. Generally, if the in-law apartment is considered to be a part of your primary dwelling, then your homeowners insurance policy will cover both the apartment structure and its contents. However, if your insurance company considers the apartment to be a separate dwelling, then your homeowners policy will still cover the structure itself but won't cover the contents of the apartment. In this case, the tenant would need to purchase a renters insurance policy to protect the contents of the apartment. But what criteria does the insurance company use to determine if the apartment is a separate dwelling or a part of your home? That's entirely up to the company. In some cases, the presence of a private entrance marks the apartment as a separate unit. Other insurers are more liberal; the apartment may be considered a separate unit only if it has its own mailing address or utility hookups. Still others base the decision on who resides in the space--if it's a relative, the apartment may be considered part of your home; if not, the apartment is considered a separate dwelling. Before you frame an outside entrance or install that whirlpool bath or even hire an architect to draw a plan, find out if your local zoning rules allow for in-law apartments. Check with your insurance agent to determine how your addition will be classified. If the apartment will be considered a separate dwelling, make sure the tenant will have renters insurance, even if the tenant's a relative. If the apartment will be considered part of your home, check your policy to make sure it'll cover the additional space and the contents.
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Do I need flood insurance if I buy a third-floor condo on the beach? Question: Do I need flood insurance if I buy a third-floor condo on the beach?
Answer: Because you live so close to the water, it may be a good idea to buy flood insurance, especially if you live in an area that's prone to coastal flooding (e.g., southern Florida). And don't assume that you're safe from flooding just because you live on the third floor of your condo building. If a severe flood wipes out the ground floor of your building, all of the other units in the building (including your own) may become uninhabitable as well. Unfortunately, your condo owners insurance doesn't protect you against flood damage. Although the flood insurance carried by your condo association provides some protection for the building, the common areas, and your condo unit itself, these master flood policies generally don't cover the personal property in your condo unit (e.g., furniture, jewelry, clothing). To get the complete coverage you need, you'll have to purchase flood insurance. This type of insurance protects your personal property against flood damage and may also supplement the building/unit coverage provided by your condo association's policy. To buy flood insurance, you must live in a community that takes part in the National Flood Insurance Program (NFIP); most high-risk communities have joined this program. The NFIP offers flood insurance through private insurance companies and agents, though the policy you buy is backed by the federal government. You can locate a company that sells flood insurance in your area by contacting the NFIP at (800) 621-3362.
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Is landscaping covered under my homeowners insurance? Question: Is landscaping covered under my homeowners insurance?
Answer: Yes, in most cases, but the coverage is limited under many homeowners insurance policies. Most policies specify one coverage limit for each item damaged or destroyed, and a separate limit for each incident that occurs on your premises. For example, $250 per item and $1,000 per incident are common coverage limits, though some policies may provide much higher limits. Many insurance companies will let you increase your landscaping coverage limits by buying an optional policy endorsement. You're probably wondering exactly what landscaping coverage includes. A homeowners policy generally covers your plants, shrubs, trees, and lawns, but not mulch and supplies. And what about covered perils? Standard homeowners landscaping coverage provides protection against fire, lightning, explosion, riot or civil commotion, vandalism, criminal mischief, theft, and damage caused by automobiles or aircraft not owned or used by you. You're generally not covered for damage caused by insects or pests, wind, and other weather conditions, though policy endorsements may be available to fill these gaps in coverage. In addition, your homeowners policy may cover the cost of removing fallen trees from your property after a storm (up to a specified limit). But this coverage may apply only under certain conditions and may be subject to a deductible.
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Are hunting rifles covered under my homeowners insurance? Question: Are hunting rifles covered under my homeowners insurance?
Answer: Yes. Hunting rifles, like personal stereos, VCRs, and other personal property, are covered under your homeowners insurance for loss, theft, or damage. The standard policy typically provides up to $2,500 for such claims. But if you're a collector, the value of your firearm collection may exceed this limit. Ask your insurance agent about adding a floater to your homeowners policy that will provide additional coverage. If you accidentally injure someone on your premises, your homeowners insurance will cover some or all of the damages (e.g., medical bills, property damage, and liability claims). For additional coverage, you can buy a specialized policy, such as sporting firearm insurance, collectors firearm insurance, or gun club liability insurance, to meet your needs. Ask your insurance agent or broker for more information.
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If my home is destroyed, will my homeowners insurance cover my living expenses until I rebuild? Question: If my home is completely destroyed by a storm, will my homeowners insurance cover my living expenses until I can rebuild?
Answer: Many homeowners policies will pay the cost of so-called additional living expenses, such as food, housing, and utility hookups, while you're waiting for your house to be rebuilt. But check your policy carefully to see if you have this coverage. If your policy contains a clause for additional living expenses, the amount of benefits is limited to a certain percentage of your total homeowners insurance coverage. A time limit may also be imposed on the coverage period for such living expenses. You may want to contact your insurer to find out what specific types of services it will and will not cover. Different companies have different methods of paying out money to clients for additional living expenses. If you qualify, you may receive an initial payment right away, or you may have to wait for a reimbursement as part of your overall loss claim. Whatever method your insurer uses, be sure to keep all of your receipts. You may be ineligible to receive payment without them.
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Are manufactured homes safer these days? Question: Are manufactured homes safer these days?
Answer: No longer the little tin trailers you can hitch to your car and pull from place to place, manufactured homes are dramatically safer since Congress passed legislation authorizing the Department of Housing and Urban Development to regulate their design and construction. If a manufactured home has been built since June 15, 1976, it must meet the specifications of the National Manufactured Home Construction and Safety Standards. These standards are designed to improve the overall quality of manufactured homes and to reduce personal injuries and property damages. They require, among other things, that the homes be built of fire-resistant materials and be capable of withstanding certain wind speeds. Like any homeowners insurance, policies for manufactured homes address three areas of risk: damage to your home, damage to or theft of your personal property, and your legal liability for injuries to others or damage to their property. Unfortunately, though manufactured homes are much safer than they used to be, they're still less safe than conventional dwellings. This heightened risk is reflected in the cost of homeowners insurance for these homes. Though manufactured homes are not more likely to catch fire than conventional dwellings, they often suffer more extensive damage when they do. In addition, because the walls in manufactured homes are often not as well insulated as those in conventional homes, water pipes may be more likely to freeze. Manufactured homes are also more vulnerable to storm damage, because they are lighter than site-built homes and more likely to tip over in high winds. For this reason, many states and insurance companies require manufactured homes to have a permanent foundation or to be secured with ground anchors to reduce the risk of damage during a tornado or other severe storm. These factors, among others, make the homeowners premium for manufactured homes more expensive than for conventional homes. When purchasing your coverage, shop around and look for a reputable company that specializes in these policies.
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