How First Time Home Buyer Mortgage Programs Work

October 11, 2017

If you are shopping for a mortgage, you have probably seen all sorts of offers and advertisements aimed at first-time home buyers and wondered if these are really as good as they sound. In some cases, “first-time” programs are little more than attention getting marketing messages from lenders rather than actual assistance programs for people who may otherwise face challenges with qualifying for a home mortgage or finding a home loan at an affordable interest rate. With this in mind, it is important to understand the difference between mortgage lender marketing programs, actual loan programs, and financial assistance programs.

You can be a first-time homebuyer more than once

First of all, even if you have previously owned a home, you (or your spouse) may still qualify as a first-time home buyer. According to the U.S. Department of Housing and Urban Development, first-time homebuyer status is not limited to people who have never owned a home before (although that criteria obviously applies). For lending purposes, a first-time homebuyer includes anyone who fits one or more of these conditions:

An individual or a spouse who has not owned a primary residence for at least three years. This means married couples may qualify as first-time buyers even if only one of them meets this test.
A single parent who previously owned a home with a spouse while they were married.
Someone who has only owned a primary residence that was not attached to a permanent foundation (e.g., a mobile home) in accordance with applicable regulations.
Displaced homemakers whose only previous ownership was with a spouse.
Someone who only owned property that was not in compliance with local building code ordinances and which cannot be improved to meet building code standards for less than the cost of constructing a new residence.

Two types of programs

First-time homebuyer programs can be broadly categorized as either loan programs or financial support programs. Both types of programs can be helpful to first-time homebuyers.

Loan programs, such as those backed by the Federal Housing Administration (FHA), are available to all borrowers through various commercial lenders, but they have features that may be particularly attractive to first-time buyers with lower credit scores or little in the way of cash savings. Private lenders may also offer attractive loan rates and terms for first-time home buyers with good credit and the ability to make larger down payments on a home purchase.

Financial support programs for home buyers typically come from state and local government entities, although the federal government sometimes steps in to provide additional assistance during difficult economic times.

Loan programs

Mortgage loans are made by commercial lenders, such as banks, credit unions, or mortgage companies. These loans may be guaranteed by various organizations, both to protect lenders against borrower defaults and also to make loans more affordable for borrowers. Here’s how these various organizations work:

FHA. The Federal Housing Administration does not make loans, although they do insure loans made by commercial lenders to protect lenders if borrowers default on loan payments. FHA loans are available to all qualified buyers, and they can be particularly attractive to first-time home-buyers because the qualifications are easier. For example, a potential home buyer with a credit score of at least 580 may qualify for an FHA loan with as little as 3.5% of the purchase price for a down payment. Lower credit scores between 500 – 579 may also qualify with a larger down payment of 10%, though the interest rate on the mortgage loan will be higher.

VA. The Veteran’s Administration (VA) also guarantees portions of home loans provided by private banks or mortgage companies to active duty service members, veterans, and eligible surviving spouses. A home purchase loan guaranteed by the VA can help military vets and spouses purchase homes at competitive interest rates without the need to also make a down payment or purchase private mortgage insurance. Applicants must have satisfactory credit scores, along with sufficient income to meet expected monthly loan payments.

USDA Single Family Housing Guaranteed Loan Program. Similar to loan programs provided by FHA and VA, the United States Department of Agriculture (USDA) also provides loan guarantees to mortgage lenders so they can help borrowers with low and moderate incomes purchase homes in rural areas. The USDA program guarantees 90% of mortgage loan amounts for approved lenders to help offset the risk of offering 100% loans to eligible rural home buyers.

Freddie Mac Home Possible® Mortgages. The Federal Home Loan Mortgage Corporation (also known as “Freddie Mac”) makes it possible for lenders to offer home loans to buyers with down payments as small as 3% through the Home Possible®. Although this program is not limited only to first-time homebuyers, first-timers must first participate in a borrower education program.

Financial assistance

Financial assistance programs exist across all levels of government: city, state, and federal. These programs may provide assistance with funds for down payments, closing costs, or other expenses tied to the home purchase process. Here’s how they work:

Fannie Mae’s HomePath Ready Buyer Program. In 2015 the Federal National Mortgage Association (FNMA or “Fannie Mae”) launched the HomePath Ready Buyer program, which provides first-time home buyers up to 3% of the home’s purchase price in the form of a rebate to assist with closing costs. Participants must complete an online home buyer education course in order to receive the 3% rebate.

State-by-state home buyer programs. Many individual states sponsor a variety of home buyer programs designed to help first-time homebuyers and others qualify for home mortgages. Visit your state’s housing website to find details for your area.For example, first-time homebuyers with low or moderate incomes are eligible for the Texas Mortgage Credit Certificate Program as a way to convert mortgage interest into a federal income tax credit. New York state homebuyers can take advantage of the Conventional Plus program for down-payment assistance up to 3% of the home’s purchase price.

City & county homebuyer programs. Individual cities and municipalities may also offer assistance with home financing. For example, Miami/Dade County in Florida makes home financing assistance available to first-time homebuyers through a loan program facilitated between Miami-Dade County Public Housing and Community Development and local mortgage lenders. Similarly, the Mayor’s Office of Housing and Community Development in San Francisco provides loan assistance programs for first-time homebuyers. Consult with your city or county government offices for availability of similar programs.

As you review and evaluate the financial assistance or loan programs that may be a good fit for you, it is also a good idea to take inventory of your personal financial situation, such as checking your credit report (www.annualcreditreport.com), paying off credit cards and personal loans, and stashing more cash into your emergency fund. These tips and more are also available in 5 Steps to Buying a Home.

This post was originally published on Forbes Feb. 19th.

Retirement Might Be Cheaper Than You Think

September 21, 2017

If you’ve ever met with a financial advisor/consultant/planner/representative, etc. (think “salesperson”), he or she may have given you a colorful graphic that shows how shockingly expensive your future retirement is going to be after inflation drives up the cost of everything you are going to need to live your future life. Not surprisingly, a survey from the TransAmerica Center for Retirement Studies confirms that outliving savings is a huge fear among retirees.

Maybe not

The logical solution then is to invest as much money as you can for as long as you can to avoid going broke before you go on to the great beyond, right? I’m going to go out on a limb here and say something very un-financial-planner-like: Maybe not.

Don’t get me wrong. Saving and investing for retirement is something we all need to do. While a graph that shows exponential increases in our future spending needs can certainly be an effective way to stir up the emotions and sell mutual funds and annuities, does it really describe your likely future spending needs?

Looking at data from actual retirees

Being the nerdy analytic that I am, the reality of retirement appears to paint a different picture when we take a close look at real data associated with people who have actually retired and had to spend the money they saved during their working years. This might be a bit of encouraging news if you are frustrated by having to set aside so much of your current income for your own unpredictable and uncertain future.

A 30% decline after age 75

According to financial planner colleague, Michael Kitces, ongoing data compiled by the Bureau of Labor Statistics’ Consumer Expenditure Survey and the National Institute on Aging suggests that retirement spending after age 75 appears to decline by as much as 30% from spending that takes place during the first half of a typical retirement. Furthermore, even after accounting for increasing health care costs (as we age, more stuff wears out and needs a doctor’s care), the decline in overall retirement spending continues to outpace rising health expenditures.

Don’t stop saving though

Hopefully, I haven’t encouraged anyone to give up entirely on putting money aside for retirement. At the very least, we should contribute to an employer’s retirement plan at whatever level helps us qualify for the most matching dollars. Free money is free money; take it! It’s also important to point out that you might need to set aside a bit more of your income to put your savings efforts on track with your future needs, but maybe not as much as those financial salespeople would have you think. Being able to replace at least 80% of your future retirement income is a good rule of thumb, for instance.

How much do you really need?

How can you quickly see if your future savings will replace at least 80% of your pre-retirement income? A good way to balance your retirement savings efforts with your desire to satisfy occasional YOLO impulses is to run a quick retirement income calculation. Fortunately, there are any number of free retirement calculators available on the Web to help you do this. Here at Financial Finesse, we are partial to our own Retirement Estimator Calculator, of course.

In the spirit of unbiased (okay, somewhat less biased) financial education and guidance, here are a few more calculators you might want to check out, including the Ultimate Retirement Calculator or AARP’s Retirement Calculator, as well as Bankrate’s Retirement Calculator Center.

It’s still a good idea to save for your future retirement, just take any charts and graphs showing a huge shortfall from a financial salesperson with a grain of salt — he/she only makes money by convincing you to give him/her more of yours!

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Don’t Let a Backdoor Roth IRA Become a Trapdoor IRA

February 03, 2016

Updated February, 2018

I was talking with a married couple the other day who were happy that they both made high incomes but unhappy that they could not contribute to Roth IRAs and enjoy some tax-free income later in retirement. According to IRS rules, married couples who file their taxes jointly cannot contribute to a Roth IRA when their combined incomes exceed certain amounts.

However, they perked up a bit when I mentioned the possibility of still contributing to a Roth IRA – even with their high incomes – using an idea called a “backdoor” Roth IRA. It works like this: even though the IRS has an income limit on Roth IRA contributions, there is no income limit on Roth IRA conversions from a traditional IRA. So step one would be to open traditional IRAs (one for each of them) and contribute up to the annual maximum amount to each traditional IRA.

Step two would then be to convert their freshly funded traditional IRAs into Roth IRAs and pay tax on any growth that took place inside the traditional IRAs between the time they deposited money into them and the time they converted them to Roth IRAs (which should be close to nothing, assuming the steps are done within a week of each other). That’s how the “backdoor Roth IRA” works in its simplest form. But there may be a catch…

Pre-existing traditional IRA balances complicate matters

As with any financial strategy that may sound a little too good to be true, the backdoor Roth IRA strategy comes with an expensive gotcha if not done properly. Thanks to the IRS pro-rata rule, taxes on a converted traditional IRA are due not just on the funds being converted, but may also be due on any other non-Roth, never-taxed IRA monies, too.

As with any financial strategy that may sound a little too good to be true, the backdoor Roth strategy comes with an expensive gotcha if not done properly

For instance, suppose you also had a 401(k) from a previous job worth $45,000 that you rolled into a traditional IRA after leaving that job. Using the backdoor Roth IRA strategy, you deposit $5,500 of after-tax money into a separate traditional IRA and then quickly convert that $5,500 to a Roth IRA.

At first, it seems this conversion is tax free since the $5,500 traditional IRA didn’t grow to more than the original $5,500 before you converted it to a Roth IRA. The catch is that the pro-rata rule requires you to consider all untaxed traditional IRA money that you have, not just the money that you are converting when calculating any tax you may owe on the conversion.

Running the numbers

In this case, the after-tax $5,500 IRA contribution would be approximately 11% of your total traditional IRA funds ($5,500/[$45,000 + $5,500]), which means the IRS will assess taxes due against 89% of the $5,500 conversion. Instead of a $5,500 Roth IRA conversion that was more-or-less tax-free (no growth in the account yet), you will instead owe taxes on just over 89% of the $5,500 or $4,895, which would be taxed as ordinary income.

Avoiding the trapdoor

So how does one avoid this backdoor trapdoor? Ideally, anyone considering a backdoor Roth IRA should avoid rolling over any old 401(k) dollars into a traditional IRA until the calendar year after the conversion. If you’re going to use this as an ongoing strategy, you could either leave old 401(k)s in their old plans or roll them into your existing 401(k). If you’ve already rolled an old 401(k) into an IRA, you may be able to roll these funds into your current 401(k), assuming the plan allows for these incoming rollovers.

What if you have a traditional IRA that you’ve made past contributions into from years past? Well, you’re out of luck. You can still do the backdoor Roth IRA, but it won’t be tax-free.

Even though your income exceeds the limits, you can still contribute to a Roth IRA. You just have to use the backdoor. However, the key to a tax-free backdoor Roth IRA contribution is making sure there are no other untaxed traditional IRA dollars lurking in the background, ready to turn your backdoor Roth IRA into a taxable trapdoor IRA.

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When 0% Interest Looks More Like 44%

September 14, 2015

I happened to overhear the following conversation while visiting my local coffee shop the other day:

“Hey, nice laptop. Where did you get it?”

“We have this program at work where we can buy computers, electronics, furniture, appliances, and other stuff and pay for it with monthly deductions from our paychecks. This laptop will be paid for in 12 months, and I never had to use my credit card or pay any interest.”

Buy now and pay interest-free over 12 months with convenient payroll deductions? Sounds like a great way to buy, right?

Maybe. Maybe not.

The issue

Often touted as “employee purchase plans” or similar programs, companies engaged in this business can make it sound as if this is a great alternative to credit cards or personal loans to purchase items such as computers, household appliances and more – until you take a closer look at the total cost of the purchases you make under these programs. Granted, there are employee product purchase plans that allow employees to buy products at a significant discount. But too often, those who cannot obtain credit or who aren’t willing to save up cash for a purchase, buy these items at greatly inflated prices when less costly alternatives may be available.

An example

A popular employee purchase program offers a 40” named-brand LED television for $849.99 or “only” $70.83 per month over 12 months — all conveniently deducted from one’s paycheck, of course. There will also be additional charges for shipping and taxes, according to information buried in the fine print.

On the other hand, this same item can be purchased from a large online retailer (whose name is similar to a very large river in South America) for only $479! This is a savings of $371 or a whopping 44%. Of course, for someone who doesn’t have $479.00, that monthly payment of $70.83 can look pretty attractive. However, even for consumers who have poor credit or no credit, some creative thinking can help them find less expensive options for making these purchases.

Exploring the alternatives

For instance, there is Mom’s well worn and time-tested advice: save up for it and then buy it, particularly if the item is not something you absolutely must have to support your career or education. Using the earlier example of the monthly payments at $70.83, if we instead saved $70.83 in a savings account, it would take a little less than seven months to accumulate the much less expensive $479 purchase price offered by the online retailer. And if we kept saving $70 each month, we could use that money to build or improve our emergency fund, save up for a future vacation, pay off some credit cards, contribute to an IRA, etc.

But what if the item you want to buy is something you absolutely need right now? For example, my fellow java junkie at the coffee shop may have needed that laptop for some college courses she was taking in order to improve her career prospects. In that case, waiting seven months or more to save up for the purchase may not be practical.

When you can’t wait

Some other alternatives she could have considered instead of the expensive payroll purchase plan include borrowing from family members (a bit awkward at Thanksgiving), or she could consider borrowing some money from her 401(k) plan at work. There are pros and cons to borrowing against an employer’s retirement plan, of course, such as missing out on future investment growth or taxes and penalties if the loan is not paid back on time so we certainly do not want to use 401(k) loans as ATMs for frivolous purchases. But for overcoming occasional and relatively small financial tight spots, a 401(k) loan that you borrow from yourself and pay back over time may be a practical solution.

Better still, when you need or want to buy some new things, why not sell some old stuff you no longer use or like? An old fashioned yard sale still does the trick and modern technology can also help us quickly turn household items, collectibles, or heirlooms into quick cash. Social media sites are popular options for advertising your sale items, and there are well known websites such as ebay.com and craigslist.com you can use.

While you are busy thinning the herd and selling off excess possessions, this is a good time to also review your personal spending plan and see where some additional trimming can be done. In my case, cutting back on the weekly trips to the coffee shop can save me a tidy sum, though I may miss out on some interesting conversations.