3 Common Home Buying Mistakes You Probably Haven’t Thought Of

June 13, 2017

When the real estate market is hot like it is right now, I can’t help but compare it to “whack-a-mole” — as soon as a listing goes up (or in some places, even before), it seems like it’s sold. I can’t help but think of buyers who often have to make a buying decision within hours of touring a new listing or risk missing their chance to “whack” and score their dream home.

When preparing to shop for a new home, most people do a great job following the general financial guidance such as:

Reviewing their credit scores,
Paying off high interest credit card debt;
Saving 20% for a down payment; and
Coming up with a budget to spend only 25%- 35% of their monthly take home pay on housing (this includes mortgage, interest, taxes, HOA fees AND insurance).

But when the market hits “whack-a-mole” status, I’ve found that few people give much thought beyond the basics. Digging into my own, “don’t ask me how I know,” file, here are three more considerations that buyers should keep in mind as they shop, no matter how hot the market is:

Think about selling before you buy. Unless you are 100% certain that this is your “forever home,” consider your future buyers before making an offer. One of the biggest mistakes I made when I bought my first home was that I failed to consider how “sellable” my home would be if I wanted to move in the future. Several years later when I did move, I had a hard time selling because I owned in a struggling school district, which eliminated parents as potential buyers, as well as others who knew that a school district could make or break your ability to re-sell. Before you make an offer, do some quick research on the neighborhood and school district so that when you decide to move, you’ll be able to cast the widest net and capture as many potential buyers as possible.
Shop around for everything. If my #1 mistake was not considering a future move, a close second was not shopping for all of the products and services I would need in the home-buying process. My Realtor was not bad, but I relied on her for everything, including finding a mortgage. When I reviewed my mortgage options after the fact, I realized that I could have gotten a much lower interest rate. I also realized that I paid too much for my appraiser, home inspector and even my homeowner’s insurance and Realtor’s commissions. (I still #FeelLikeASucker) Do not make my mistake – no matter how awesome your Realtor is, ask about her commissions. Shop for mortgage rates and compare your options.
Buffer your budget. No matter how many websites you read about homeownership, some expenses are going to catch you off guard. For instance, I grossly underestimated utilities. I created my budget using the average my Realtor gave me, not realizing that it was an average or really what that meant. So when I moved in record cold temperatures in January, my gas bill was much higher than average. My moving expenses were also slightly higher than I expected, and I failed to factor in the fact that I was paying the final utility bills for my old apartment, while also paying utilities for my new home. To avoid becoming house poor in your first month, make sure you add an extra 10%-20% to your first couple months’ planned spending to account for the unexpected.

Following the guidance above may take some extra time, but trust me, it will pay off in spades and your dream of home ownership won’t turn into a cautionary tale.

Is It Time to Downsize?

June 12, 2017

Last week I wrote about why my husband and I decided to upsize our home, so this week I’d like to take on its opposite: downsizing.

Downsizing — selling a larger home and moving into a smaller one — seems much more popular than upsizing these days. Mobile homes and RV trailers have been brilliantly rebranded as “tiny houses,” and there are hours of weekly television programming devoted to stories about families selling larger homes and moving into much smaller ones. In fact, my nine year old son, who is an avid fan of tiny house television, has been campaigning for us to move into a smaller home. (He is not likely to convince me.) However, you don’t have to go “tiny” to downsize. Any home that is going to be less expensive to own and maintain can be considered downsizing.

Why downsize?

Downsizing is a natural response to changes in your family needs and financial priorities. Downsizing to a less expensive and/or smaller home may be right for you if:

The kids are grown up and you don’t need that much space anymore;
You can’t afford the house you are in with its related costs while still funding other goals such as retirement, paying off debt or building emergency savings;
You want to move to a better school district but homes are more expensive there.
You are prioritizing financial independence over increasing your current lifestyle;
You seek a home that makes it easier to live in as you get older (e.g., single story, walkable neighborhood, etc.); or
You want to spend less time maintaining your home and more time enjoying life.

Downsize your costs without downsizing your space

I live in the New York City area, where housing is very expensive. A common topic of conversation between my husband and I, especially when paying property taxes, is whether we should sell our home then take the equity and buy the same house in a less expensive state. We wouldn’t have a mortgage, and all our related costs would be lower.

Our friends recently did just that. They sold their home in a neighboring town and bought a larger, yet less expensive home in a southern state – near a beach! It may be hard to move while you are building your career or putting your kids through school, but not so hard to do when you are empty-nesters like our friends.

Alternatives to downsizing

For new retirees, there are other ways to downsize costs without downsizing amenities. Here are a few ideas:

Co-housing: An intentional community with private homes that share common spaces and responsibilities, co-housing is a growing practice among seniors from the Flower Power generation.
Share your home: Many retirees are looking to share their homes, either by renting out rooms or apartments in their own homes, in order to reduce costs and have companionship.
Move overseas: Adventurous retirees are moving overseas in droves, to less expensive ex-pat friendly retirement destinations where the cost of living is lower but the lifestyle is pleasant.

Why stay put?

If your total housing costs (mortgage, taxes, insurance, utilities, maintenance) are 35 percent or less of your net income (income after taxes), there’s no need to rush to downsize. There are plenty of reasons to stay put for the time being:

You may like your current home and its size fits your family.
You like your neighborhood and schools.
Your home can be easily modified to “age in place.”
You want to stay near your grown children or aging parents.

Moving is a big decision and our sense of community is often connected to a physical location. If your housing costs are not breaking the bank and you’re not sure if it’s the right time to move on, it may make sense to stay put until you have a clearer idea of where you want to go and what makes sense for your goals going forward. You can always change your mind in the future.

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here and on Twitter @cynthiameyer_FF.

Are You Really Ready To Upsize Your Home?

June 05, 2017

Real estate season is in full swing — everywhere I look in my area there are homes with “For Sale” signs. There are some larger homes for sale in my neighborhood, and the families who buy those neighbors’ homes have multiple children and want room to grow and an excellent public school system. Have you been wondering whether it’s time to make a move to go bigger? How do you know if you should stay where you are for the time being instead? Here are the factors to consider:

What can you afford?

You’ll have the most financial freedom in your life if you keep total housing costs (mortgage, taxes, insurance, utilities, maintenance) to 25 to 35 percent of your after-tax income. For example, if your family take home is $4,500 per month, your monthly housing costs would range from $1,125 to $1,575. With a 20 percent down payment and a 30 year mortgage at 4 percent, that’s a purchase range of approximately $212,000 to $300,000 (see calculation here). I realize the 35 percent ratio could be a challenge in an insanely expensive city like Los Angeles or New York, where housing costs can eat up to half or more of a family’s income, but it’s a helpful guideline for maximum financial ease.

Why upsize to a bigger home?

When we moved back to the United States after an overseas assignment in Bermuda, a country with a very high cost of living, it was the bottom of the U.S. housing recession. Great deals on large homes in good school districts were available, so we upsized our living space to have room for three kids and lots of visitors, and still spent less than our previous location’s housing costs. This house will be too large for us once all the kids are grown up, but for now, we’re happy with the decision. Upsizing may be right for you if you can afford it and:

You would like the space for all your kids;
Grown children or grandchildren are moving in with you;
One or more parent(s) are moving in with you;
You’re moving to a less expensive state and you can afford more house for the same cost;
You need more space for a home office/business; or
You’ve always wanted to have a big house – it’s a serious bucket list item.

You’ll upsize a lot more than your mortgage

Caution: with a bigger house or bigger acreage, you’re upsizing more than your mortgage. Everything costs more: property taxes, homeowner’s insurance, home maintenance, furniture, painting, landscape, etc. Make sure you take those increased costs into account when figuring out how much you can afford.

If your mortgage is 30% bigger, your other bills will be as well. For example, if you upsize from a $200,000 mortgage to a $300,000 mortgage you should expect your related costs to go up by a third as well. Upsizing can also prompt “keeping up with the Joneses” syndrome, where you feel like you must compete with neighbors who have a more lavish lifestyle. Finally, if you frequently have visitors, do you really need or want to accommodate them in your home, or would it be better and cheaper to put them up in a nearby hotel over time than to pay the costs of upsizing?

Or should you stay put?

A bigger house is a bigger financial commitment. If you can’t afford the total costs, you’ll be “house poor.” If you just can’t decide what your next home purchase should be and at what price it makes sense, there are plenty of reasons to stay put instead of upsizing to a larger home:

You like your current home and its size fits your family;
You enjoy your neighborhood and your neighbors;
You and your spouse don’t agree on what to do next;
You don’t want your kids to have to change schools;
The costs of selling a home and buying a new one may not make it worth it to move right now; or
You believe real estate prices will rise on your street over the next few years, so you are willing to wait to sell.

Moving is a big decision. Our sense of community is often connected to a physical location. You may find that going bigger gives you a more spacious and satisfied feeling, assuming you can swing the additional expense. On the other hand, if you’re not sure if it’s the right time to move on, it may make sense to stay put until you have a clearer idea of where you want to go and what makes sense for your goals going forward. There’s always next spring to revisit the question.

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here and on Twitter @cynthiameyer_FF.

What You Need to Know About Keeping or Tossing Tax Records

April 19, 2017

The basic reason you need to keep any tax documentation is so that if the IRS comes calling with questions about what’s on your return, you can prove the numbers. The most acceptable rule of thumb is that for anything you used to put numbers on your tax return, you should keep it at least three years or seven if you’re toeing any lines with what you put on your return. This includes receipts, cancelled checks, tax forms and even bank statements.

But the fact is that any official tax form you receive, such as a W-2, 1099 or 1095-B, was also provided to the IRS. That’s why if you forget to include, say, that withdrawal of your old job’s 401(k) on your return, the IRS WILL send you a letter reminding you (and requesting a little extra for penalties and interest). So do you really need to keep your copy? The answer is a bit of a “yes but…” and you obviously want to keep anything that wasn’t on an official tax form like receipts for donations or property tax statements.

The biggest “but” is that in terms of what the IRS accepts, there is no need to keep a paper copy of anything that you can easily obtain digitally. Since my accountant prefers to receive documents online anyway, I scan everything to a removable jump drive and just keep that in a safe place for three years. Besides being able to substantiate what you put on your tax return, here’s why you need to keep…

W-2s – These are mostly in case you want to do something like buy a house, refinance your mortgage or some other activity that requires you to prove your income.

Bank account statements – In case you are doing any type of mortgage application, the bank will want at least the past 60 days of any checking or savings accounts you hold.

Brokerage account statements – If your only transactions for the year were dividends and interest received, then you can get rid of the statements and just keep the 1099 that you received showing the income for the standard three years. However, if you purchased investments (including dividend reinvestment of a mutual fund), you’ll want to keep the statements as long as you hold the underlying investment plus three years. This is so that when you do sell, you’ll be able to properly calculate any gains or losses based on what you paid for the shares. The “plus three years” is because once you sell and claim the gain or loss, it becomes a tax document.

Receipts for home improvements – That new roof you had to put on your home may have been your least favorite purchase of the year, but if you’re lucky enough to eventually sell your house for a gain greater than the exemption amount ($250,000 for single, $500,000 for married), you’ll be able to reduce the gain by the cost of any improvements you made to the home throughout the years. One simple way to keep track would be to keep a running list, either in Excel, in Google Sheets or even by hand. Then scan and store the receipts with the other tax documents for the year of the expense.

Home sale/purchase documents – Besides providing evidence of any basis you used to calculate a gain (or lack thereof) on the sale of your home, you’ll want to keep these documents in case you need them on future mortgage applications. When my husband and I purchased our home, the title agency uncovered something that indicated he still owned the home in Michigan that he’d sold years before. He had to show them the sale document in order to avoid compromising our purchase.

IRA-related forms – If you ever made a non-deductible contribution to a traditional/pre-tax IRA or converted a traditional/pre-tax IRA to a Roth IRA, you’ll need the documents proving that so when you begin your distributions, you can avoid paying taxes twice on any of your savings. It’s best to create a separate file just for these forms and when they come in the mail each year, either scan them or place them into their designated place.

While you really should keep all tax documents for at least three years, make it seven if the interim years include red flag items like self-employment income, a home office deduction or large non-cash donations. The IRS really has a seven year statute of limitations to audit returns if they have any reason to believe abuse of the tax code. (That statute of limitations disappears if they uncover massive tax fraud so just don’t go there, okay?) The above list is meant to share exceptions or alternate reasons to save certain documents. Again, it’s okay to store your documents digitally, just make sure you’re shredding the originals to help avoid identity theft.

Kelley Long is a resident financial planner with Financial Finesse, the leading provider of unbiased workplace financial wellness programs in the US. For more posts by Kelley or to sign up to have her weekly post delivered to your inbox each Wednesday, please visit the main blog page and sign up today.

What Qualifies as Deductible Mortgage Interest? (The Answer Might Surprise You)

March 22, 2017

When it comes to being able to deduct the interest you pay on a mortgage, most people correctly assume that this applies to a home that you use as your primary residence. (There are some wonky rules around limits on the deductibility of certain types of mortgage interest from home equity loans or loans in excess of $1 million, which are best explained by Figure A on this page.) But many are surprised to learn that they may also be able to deduct interest paid on a second home and are even more surprised when they learn what the IRS considers a “qualified home.” Generally speaking, in order to be considered a home, a property must have sleeping, cooking and toilet facilities.

This means a boat, camper, or even a tricked out old ambulance could qualify as long as it has a bed, a stove and a toilet on board, and as long as any loan you took out to purchase the property is secured by the actual property. In other words, if you used a credit card to buy that fancy yacht, you can’t deduct the interest you pay on your card. But if there is a loan document that you signed that basically collateralizes the boat/home (aka if you don’t pay the loan back, the lender can repossess the property and sell it to satisfy the debt), it’s a mortgage and the interest is technically tax deductible. In most cases, the lender will send you a Form 1098 showing how much interest you paid. That’s one clue that you have an actual mortgage.

Another surprising aspect of the rule is that you don’t have to live there full time. In fact, you don’t even have to use it at all during the year as long as it’s not rented out. Note that if your second home is rented out, you may still qualify to deduct the interest. You just have to use it more than 14 days or more than 10% of the number of days it is rented, whichever is longer. If you don’t meet that qualification, you may still realize a tax benefit from interest paid, but it will be applied against the rental income you generate.

You shouldn’t go out and buy a second home, boat or RV you can’t afford just for the tax deduction, but it is worth knowing, especially if you’re looking into buying a second home for your future retirement or just a place to vacation throughout the years. If you’re thinking of taking out a loan to buy a boat or RV, make sure you shop around to get the best rates. Dealers often offer financing deals, but it’s worth it to double check that your bank or credit union can’t offer you a better deal. You can use this mortgage loan comparison tool to compare up to 3 loans and see which is the best financial deal.

How to Avoid Taxes on a Home Sale

January 20, 2017

Someone recently asked me if they were going to have to pay taxes on the sale of their home. They were downsizing out of a big house and were going to move into the “in-law quarters” of one of their children’s homes. This person was absolutely 100% convinced that he was going to have to pay taxes on the gains from the sale of his house since he wasn’t “rolling the gains” into a bigger house.

When I told him what the tax code says about capitals gains tax, he told me I was wrong. So with him in the office, I called a friend (on speaker) who is a CPA and asked what the tax implications were for selling a home. The CPA said exactly what I said, without prompting, and the soon-to-be-seller was still dubious.

So what is the real story on how the gains from selling a home are treated? According to IRS Topic Guide 701, you can exclude up to $250,000 (single) or $500,000 (married) of gains from the sale of your house IF it has been your primary residence for 2 out of the last 5 years. That’s it. It’s that simple.

There is no rule today about what you have to do with the proceeds. There were things like that in the tax code in the past, but the tax code is an ever-evolving entity. The biggest test is the 2 out of 5 years, which is very easy for most home sellers. IF the house has been your primary residence for the last 2 years, you’ve got a $250,000 or $500,000 tax-free gain.

If you’re married and your home has appreciated by $600,000, CONGRATULATIONS!!! The tax on the sale of your home will be $600,000 (gain) – $500,000 (exclusion) = $100,000 (taxable gain) * 15% (capital gains rate) for a $15,000 tax upon sale. You can buy a house, watch it go up in value by $600,000 and only pay $15,000 in taxes! The tough part is finding a house that goes up in value by $600,000!

Here’s how you could possibly use this piece of the tax code creatively and to your advantage in a time when housing prices are rising. It’s a hypothetical situation and I can’t imagine anyone really doing this, but it illustrates the tax code’s interesting nature. You’d have to live as a bit of a minimalist to make this work. Moving a bunch of “stuff” can be time consuming and expensive, so the less you have to transport from one place to the next, the easier this is. This only works if your home value increases regularly……

Step 1 – Buy a house.

Step 2 – Live in it for 2 years.

Step 3 – Buy a second house, move into it and rent out house #1.

Step 4 – Live in house #2 for 2 years and buy house #3, renting out houses #1 & #2.

Step 5 – Sell house #1 by the end of year 5 and the gains are tax-free since it was your home in years 1 and 2. You could sell house #2 as well and pocket the tax-free gains.

With this example, you can see that if you’re willing to move A LOT and housing prices rise quickly, you could potentially never pay taxes on the gain from the sale of a house. In the real world, though, the IRS code allows most of us to sell a home with zero or a very small capital gains tax in comparison to our overall gain. Fortunately, for the dubious person in the meeting recently, he used his own laptop, went to www.irs.gov and was able to find that my answer was indeed factually correct. By the time the meeting ended, he was a surprised and happy home seller.

7 Questions to Ask a Prospective Real Estate Agent

January 05, 2017

Whether you’re looking to buy or sell a home, one of the most important decisions is who you select as your real estate agent since this will likely be the person you work most closely with during the transaction. You can identify prospective agents by asking family members, friends, and other professionals you work with (financial planner, accountant, lawyer) for recommendations. Then be sure to interview several of them and ask the following questions:

1) Are you a REALTOR®? People often use the terms “realtor” and “real estate agent” interchangeably, but they’re not always the same thing. While all REALTORS® are licensed real estate agents, not all real estate agents are REALTORS®. The main difference is that as members of the National Association of REALTORS®, REALTORS® have to follow an additional code of ethics. While this doesn’t mean that every REALTOR® is more ethical than every non-REALTOR®, it certainly can’t hurt to choose someone who has at least made a commitment to a higher ethical standard and is subject to penalties for violating it.

2) Who do you work for? As a seller, your agent always works for you. But as a buyer, be aware that an agent can also be working for the seller. Even “buyer’s agents” often work for a “dual agency” that represents the seller as well. You can search for an “Exclusive Buyers Agent” here.

3) How long have you been working in the area I’m buying/selling in? This question has two objectives. The first is to screen out agents that may be new and just starting out. You probably don’t want to be their “learning experience.”

The second is to measure their experience in your particular neighborhood. An agent who’s unfamiliar with the area you’re interested in may only be slightly more helpful than one who’s new to the business. After all, much of their value comes from bringing the kind of local, specialized knowledge that you may not be able to find with an online search.

4) How will you work with me? As a buyer, some of what you’ll want to know are how the agent will find prospective homes, how often they’re available to show places to you, and how they would handle multiple offers. As a seller, you’ll want to know how they will market the home and the fee that they’ll charge (which is negotiable but top agents will charge more). In either case, ask if the agent will let you cancel the agreement if you’re not satisfied with their service.

5) Who else do you work with? Agents typically play the role of quarterback with the other professionals that may be involved (mortgage broker or loan officer, home inspector, real estate attorney, and title and homeowner’s insurance agents) and can help you select them. Ask for a list of their recommended professionals, but be aware that if they are labeled as “affiliated,” the agent may be receiving compensation from them.

6) Do you have references? If an agent is experienced and has a lot of online reviews, you may not need to ask this question. However, it can be an important one for a new agent. Not having any references might be a red flag. You may also want to check your state’s real estate regulatory agency to see if any complaints were filed against them.

7) What documents do I need to sign? Make sure you look at them before signing and keep copies. If you’re a buyer, you’ll want the buyer’s broker agreement, agency disclosures, purchase agreement, and buyer disclosures. If you’re a seller, you’ll want the agency disclosure, listing agreement, and seller disclosures.

Finally, don’t’ forget the importance of personal chemistry when choosing a real estate agent. They may answer every question correctly, but if you just don’t feel comfortable with them, you’re probably better off with someone else. Buying or selling a home can be stressful so you’ll want an agent that can help alleviate rather than add to that stress.

What to Expect When Closing on a Home

November 28, 2016

You’ve found your perfect home, you’ve qualified for a mortgage to buy it and it’s passed inspection by a qualified home inspector. Now it’s time to sign on the dotted line. A closing is the last step in buying and financing real estate.

If you are buying a home for the first time, you’ll be in for a surprise. There’s a lot more to do in order to cross the finish line. Here’s how to make sense of the process:

Your lender will ask for a lot of documentation

Your mortgage lender has given you approval for your loan, conditional on you documenting your income and assets. Be prepared to submit:

Tax returns
Account statements
Pay stubs
Documentation of the sources of recent, large bank deposits

Your lender is likely to have a “trust but verify” attitude towards your documents. They want to see everything. Make sure you include every page, including the mysterious “this page left intentionally blank” one that you think doesn’t matter. Lenders typically run an additional credit check on borrowers right before closing date, so make sure you don’t do anything which could jeopardize your loan, such as opening a new credit card, taking a car loan or switching jobs.

You’ll need homeowner’s insurance

You will need to give proof of your new homeowner’s insurance policy to your lender, so start shopping around. Ask your real estate agent for suggestions on insurance carriers if you are new to the process. Make sure to get at least three written quotes before you decide on a policy. For more tips on shopping for a homeowner’s policy, see this blog post. FYI, if you live in a flood or earthquake zone, those aren’t included in a traditional policy, so decide if you need flood insurance or earthquake insurance.

You can’t bring cash to a closing

The cash you need to close can’t actually be paid in large bills. Make sure you receive and understand the written instructions on whether to bring a cashier’s check or plan for a wire transfer of funds on the closing day.

Review your loan estimate

It’s up to you to understand the terms of the loan agreement you’ll be signing. Your lender will send you a loan estimate. Review this very carefully and make sure that the written terms of the loan match what you’ve discussed. You can use this guide from the CFPB as a framework. Be proactive about asking your lender questions if there are differences in what you have discussed and the loan estimate terms.

You can shop around for closing service providers

Closing costs can be expensive, especially costs relating to title. Not all of them are fixed, however. You can shop around for services in section c of your loan estimate (“Services You Can Shop For”):

Title costs, including insurance, title search and settlement agent
Pest inspections
Survey

Receive a closing disclosure and other key documents

Your lender is required to give you a closing disclosure statement three business days prior to your closing. Use this checklist as a guide to double check that all the details on the closing disclosure are correct. If you find that something isn’t correct, contact your lender immediately and ask for an explanation. Ask for your other closing documents in advance in order to review them:

Mortgage (also called security instrument)
Promissory note
Initial escrow disclosure
Right to cancel form

You may want to consider hiring a real estate attorney to review your documents before closing.

Take a final walk through

The last step before you start signing paperwork is to take a walk through the home with your real estate agent to make sure the home is still in the same condition it was when you made your initial offer. Make sure that everything that the seller agreed to repair is repaired and that items they agreed to leave in the home (such as a washer/dryer, air conditioners or curtains) are still there. If there are big problems, this could potentially push back the closing or even void the deal. See this article for more walk through tips.

Don’t sign anything you don’t understand

Read everything you’ll be signing and ask questions about things that don’t seem clear or seem different from what you expected. This is the step that many homeowners skip and later regret. Remember, it’s up to you to understand the legal documents you are signing. Use the CFPB’s closing checklist for things to review before, during and after your closing. Don’t sign anything until you are comfortable that it’s correct!

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here, and on Twitter @cynthiameyer_FF.

Do You Have a Taxable Estate?

November 10, 2016

To keep pace with inflation, the IRS recently announced a higher estate tax exemption for next year of $5.49 million. For most people, this estate tax exemption means they don’t have to worry about the estate tax because it only applies to the value of estates above that amount. However, there are several main reasons why your estate may be more likely to be taxable than you think:

The estate tax applies to non-financial assets too. It’s easy to see the value of your retirement, investment, and bank accounts, but don’t forget any real estate or business interests you may have. The IRS may also value them higher than you expect.

The tax is on your gross estate. If you own a $1.5 million home with a $1 million mortgage, you may think only your $500k of equity is part of your estate, but the entire $1.5 million is actually included. The same is true for any other property you have with secured debt.

Your estate includes life insurance proceeds. Even though you don’t see a dime of it, life insurance death benefits are included in your estate. This alone could be several million dollars for many people.

Your state may have a lower estate tax exemption. In addition to the federal estate tax, a handful of states impose their own estate tax with rates as high as 20% (Washington) and their exemptions are often lower than the federal one. For example, New Jersey’s state estate tax exemption is only $675k.

The estate tax will likely change. The tax code is constantly changing and the estate tax is no different. Depending on the outcome of future elections, we could see a higher estate tax or even no estate tax at all. Given the rising national debt and the fact that taxing upper-income people is one of the few deficit-reducing policy proposals that polls well, the former may be more likely.

Chances are, you still won’t have to worry about paying the estate tax even with all these caveats. However, if it turns out that you do have a taxable estate, you’ll want to speak with an estate planning attorney about what options you have to minimize the tax burden on your heirs. It’s a good problem to have but a problem nonetheless and one you’ll want to know about before it’s too late.

Are You Ready to Buy A Home?

November 03, 2016

With all the speculation about interest rates possibly moving up soon, I’ve been hearing a lot of talk from people about buying a home. You may want to buy, but are you ready? The answer involves a lot more than what interest rates are expected to do. Here are some questions to ask yourself:

How’s your credit? If you’re planning to get a mortgage, one of the first things the mortgage company will do is run a credit check. To get the best rates, you typically need a score of 740 or above. If yours is lower, you’ll pay higher rates or you may not even qualify for a mortgage at all.

One of the quickest ways to improve your credit is to order a copy of each of your 3 credit reports from annualcreditreport.com (free every 12 months) and dispute any errors you may find that could be hurting your score. Another is to pay down credit card or other consumer debt, which also improves your debt/income ratio. If neither of these can improve your score in time, you may just have to build a positive record of on-time payments and wait for your score to rise over time.

Do you have enough savings for a down payment and closing costs? Ideally, you would have enough savings to put down 20% to avoid paying PMI, although mortgages with lower down payment requirements are available. You’ll also likely need another 2-5% of the purchase price for closing costs plus whatever you plan to spend on furniture, renovations, etc. This should be in addition to your emergency fund, which will be even more important with your home on the line.

Can you afford the higher payments? Contact a mortgage broker or loan officer to get a quote and see what your monthly payments would be with different purchase prices. Don’t forget to include estimated costs for insurance, taxes, utilities, and maintenance/repairs. Then see how this would fit into your current spending. It’s important to do this analysis before you even start looking at homes so you don’t fall in love with one and then talk yourself into being able to afford it.

Would buying be cheaper than renting? The rule of thumb is that you need to keep a home at least 3-5 years to make it worth the transaction costs and the risks of the home falling in value. You can do a more precision calculation with this Rent v Buy calculator from the New York Times that factors in everything from how long you plan to keep the home to the tax benefits of home ownership to the opportunity cost of not being able to invest the money you spend on the down payment. If you have a really good deal on rent, or home prices are particularly expensive, or you just don’t plan to stay put for long enough, renting may actually be more financially beneficial.

Are you ready emotionally? The numbers may make sense but they won’t matter if you don’t actually feel comfortable buying. Being a homeowner means freedom from a landlord but it also means being tied down to a home that you’re responsible for. No financial calculation can tell you if you’re ready for that.

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How to Make an Offer for a Home

November 02, 2016

If you’re a fan of home-buying shows that follow couples who are seeking a home in a new city, looking for a deal to flip or even searching for a much smaller home to live more simply (how do they do that???), then you’re probably familiar with some of the factors that go into looking for a home that provides a good value without over-paying. But one thing those shows don’t broadcast are the negotiations for price and how people actually arrive at what they will offer. Making an offer for a house is not just a wild guess. There are some things you and your real estate agent can do to find a price that will be accepted without overpaying. Here are some expert tips:

First, ask your agent to do a comparative market analysis (CMA). This is basically a mathematical analysis of homes that are similar to the one you’re looking at, including the number of bedrooms and baths, the square footage, the neighborhood, etc. and evaluates whether yours is priced in line with recent sales and other current listings. The CMA report will include the specifics of the properties used in the comparison so you can use your judgment as to how relevant the comparable pricing may be.

Keep in mind that it’s the sales price that matters, not the list price. There’s a rehabbed home in my neighborhood that’s listed for 50% more than the buyers paid a year ago. Sure they’ve done a lot of work to the property, but enough to double its price? Since it’s been on the market for several months now, I’d say that prospective buyers feel the same. Once the home sells, then we’ll know what it’s really worth.

As you’re deciding on what price to offer for “your” property, pay attention to the adjusted average sales price in your CMA. First, throw out comparables that are extreme, like a teardown/rebuild that was sold as a foreclosure or on the higher end of the spectrum, homes that are overly upgraded or way nicer than the one you’re looking at. Then adjust the average price by how the remaining comparables actually compare to yours:

Are they smaller or larger? More beds/baths or less?
Do they contain similar upgrades and features? (When we bought our top-floor condo, we felt it was only comparable to other top-floor units, even though many of the similar sales in our neighborhood were middle or ground floor. We were willing to pay a premium to not have footsteps overhead)
Are they actually in the same neighborhood? Depending on where you are looking, one street over can make a difference in price, so pay attention to proximity.
How long ago were they sold? The more recent the sales transaction, the more relevant the sales price.

Use your powers of reasoning to decide how comparable these other homes actually are. The averages aren’t worth much if there’s nothing nearby that’s similar to yours. That’s one of the issues with estimator sites like Zillow. It uses publicly available information to estimate values, but doesn’t adjust for things like inferior location or big upgrades post sale.

For example, Zillow shows our property losing $25k in value in the two years since we purchased due to several foreclosures and low sales prices on our street in the past year. What Zillow doesn’t “know” is that this is one of the hottest neighborhoods in the US right now and all of those properties were teardowns being rebuilt into multi-unit condo buildings similar to ours that will sell for possibly $100k more than our purchase price. Once those condos sell, I expect the estimated value of our place to far exceed what we paid.

Finally, knowing where the market is in terms of trends will play an important role in determining your offer price. Here are some factors to consider:

Buyer’s market versus seller’s market: If it’s a seller’s market, you may find yourself competing with other buyers and making several offers. In a buyer’s market, you’ll have more time to do analysis.
Number of days on the market: If you’re looking at a home that’s been on the market for a couple months, especially in a seller’s market, you’ll definitely be able to offer a lower price than if the property was just listed.
Timing: Generally speaking, spring and summer are hotter markets than fall or winter. The other timing factor is interest rates. Don’t buy a house just because rates might go up soon, but if you’re planning to buy, potential rate increases could add a sense of urgency that limits your bargaining potential.
Seller’s motivation: If you can suss out why the current owners are selling and you learn that it’s due to a pending divorce, job relocation or other more urgent need, you’ll know you can probably go lower than if they were just seeing if they could sell.

At the end of the day, your agent will be a tremendous source of guidance and advice in this area, which is one reason it’s important to find someone who specializes in the neighborhood you’re looking in. Here are two final tips when making your offer:

Make your best offer on your first offer. Assuming the sellers will counter could lead to a flat out denial, especially if you’re competing with other potential buyers. It can be tempting to play the “how low can we go” game, but if you really want the house, don’t play the game.

Don’t offer more than what the property can appraise for. Plenty of people learned this the hard way back in 2008–2010 after they paid top dollar for homes that ended up appraising tens of thousands of dollars less than they owed after the bubble burst. If a seller accepts your too-high offer and the appraisal comes back lower, you could end up back to square one without a deal.

Stick to what you can afford and accept that if you don’t get the house you want, it wasn’t meant to be. We had this experience with the first offer we made and our agent saved us from making a big mistake. We lost to someone who offered $25k more than the listing price, which in retrospect was a bad move… for the other buyer.

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Lessons in Home Buying

September 20, 2016

I was recently at an overdue dental appointment talking to the dental hygienist, Jana. I try to talk about anything that distracts me from the drilling and moans of pain I hear in the other booths. She started telling me about her new home purchase and how she used lessons learned from her last property to make a better decision – like giving her kids free reign to run around the house. I will admit that I have never heard of this as a house hunting strategy, so I asked for more info and below is what I learned from our conversation:

Test drive a new house. She said the mistake she made with her first home was that she did not think to check on how soundproof the home was, especially with four kids. When she was looking for a new home, she brought all of her kids with her and unleashed them in the prospective homes to test the sound quality of the different rooms. If you value peace and quiet with kids, have your kids go upstairs and be loud (they will love this), walk through the rooms, and close the doors to gauge the sound quality of the rooms

Neighbors are your best friends. Jana mentioned that after she bought her home, she talked to the neighbors and learned most of them were moving out within the next few years because the neighborhood was recently redistricted into a not-so-great school system. This time she walked around prospective neighborhoods and struck conversations with neighbors who were not shy about telling her about the good, the bad and the ugly of the community. This saved her from potentially buying a home in an area that she learned was having major traffic issues during rush hour traffic – enough that some of the neighbors had formally complained.

Don’t just relay on what a real estate agent tells you. Visit a neighborhood you are thinking of living in during different hours to get an idea of the traffic flow and talk to neighbors. Many are not shy about giving you their opinion.

You get what you pay for. For the first home she bought, she went with the home inspector that was the cheapest. She was not present during the inspection and ultimately paid the price with plumbing, appliance and roofing issues. This time, she interviewed home inspectors and paid an additional fee for a more thorough inspection. She also stayed for the entire inspection, asked questions along the way and was able to get a rough idea of whether the repairs were small or large.

She said the lessons she learned saved her from making another home buying mistake and helped her get into the home of her dreams. Take the time, like Jana did, to take the extra steps to make sure you are choosing the right home for you. It will go a long way into making your home buying experience a good one.

How This Millennial Couple Bought Their First Home Before They Thought They Were Ready

August 17, 2016

We often discuss planning for obstacles in our financial planning workshops, acknowledging that even the most perfect plans need contingencies. Life happens! So when our director of PR, Danielle, and her husband Adam discovered they were expecting their first child a few years before they had planned to start their family, they obviously had to shift some of their other plans. “Obstacles” aren’t always negative things!

Danielle shared with me that she and Adam had a 3 year plan that included purchasing their first home before having kids, so when they found out they were expecting, the home purchase plan was pushed back. When she announced they were closing on a home less than 7 months after their son was born, I had to know how they worked that out! Here’s what I learned and what we can all learn from prioritizing goals and examining our spending, in an edited interview with Danielle:

Me: When did you and your husband start thinking about buying a house?

Danielle: We’d been talking about buying a home since we got married in 2014 as part of a three-year plan, but when we found out we were having our little boy earlier than we’d planned, buying our first family home became a ‘when we can’ sort of goal that sat on the back burner for about a year. We kept saving but weren’t looking seriously and were even discussing renewing the lease on our apartment when we filed our 2015 income taxes. The straw that broke the camel’s back was our tax guy telling my husband, “You need more kids and a house” to write off as we were paying a ton in taxes. We started our search then.

Me: Did it happen on the timeline that you planned?

Danielle: Surprisingly, it happened before we had planned. We didn’t think we could afford a home or were ready for the responsibility. When we realized that we’d saved enough for the required down payment and could get a pretty low rate because of the current economy, we thought now’s the time!

Me: What were the initial financial moves you made to start the process?

Danielle: We had to get our financial ducks in a row, so to speak. First, we checked our credit scores to see what kind of a rate we could get. My husband works in mortgage, so we had a pretty firm grasp on what we could qualify for and what the best program was for us based on our income and down payment savings.

We crunched the numbers to decide what our maximum monthly payment could be and then after dreaming a bit, settled on what a comfortable payment would be, and started looking. I am SO glad we stuck to the lower amount, even after looking at some awesome homes in our peak price range! We also decided to pay off some credit cards to make sure we could qualify since my husband’s income, being commission-based, could get complicated through the loan process.

Me: Did you make any changes to your spending in order to save for a down payment?

Danielle: Yes! We had been cutting back for about a year prior to looking, like going out to eat less and cutting our cable back from the full package to a basic package while using Netflix instead. I also have a hybrid car, so I started charging it more instead of filling up for more mileage on less money. We cancelled magazine subscriptions we weren’t using, and I cancelled my gym membership because our apartment complex had a pretty nice one on the premises.

My husband and I are pretty impulsive, so saving money is hard for us, but we knew we had to change those habits – especially if we were going to be responsible for a mortgage! We have been working hard to do that and it’s paying off. We also said “NO” a lot more to friends who invited us out for social events. Not only were we trying to save more in general, we were expecting a baby so we knew saving needed to be our number one priority!

Me: What tips or tricks did you learn from working at Financial Finesse that helped in this process?

Danielle: I have learned so much about simple ways to save money that can really equal large amounts of savings. I remember sitting at the counter with my husband and talking about where we could cut back. At first, it felt like nowhere!

But when we really began to break it down, we found hundreds of dollars every month we could save. That was pretty cool. I’ve also learned a lot about using credit wisely and keeping your debt to income ratio balanced, which paid off in the home buying process.

Me: Was there anything you wish you’d known before about buying a house that you have learned?

Danielle: Yes! I didn’t realize how difficult it is to buy a home in a competitive market like Southern California. It was extremely frustrating and at times, I couldn’t help but feel like the industry is pretty biased in some areas.

We were finding it was hard to even get our offers looked at. We were beat on several homes by all-cash offers, which is to be expected. What caught us off guard was that we were being completely overshadowed by offers that were being written by an agent acting as both the selling and buying agent.

This seemed crazy to me. How is this legal? It made it impossible for anyone who wasn’t working with the selling/buying agent to get a look.

When we lost a home we really wanted because the agent held off on even showing our offer to his client in order to give his buying clients a chance to put theirs in first, we learned our lesson and ended up going through the selling agent ourselves on the home we finally did get. As a result, we had to pay our agent outside of contract for all of his work with us AND the selling agent for getting our offer accepted. We were so desperate at that point, we went ahead with it, but if we weren’t needing a home (our lease was up in 3 weeks at this point!) we probably wouldn’t have done it.

Me: How does this change your financial picture going forward?

Danielle: It has helped us lay down our roots to really start planning for our future. We look around our new place and think, “Wow this is ours!” and it feels so good to not be paying someone else’s mortgage! Now that we have a home with a comfortable payment, we are focused on saving for our son’s education, preparing for more children and saving for our retirement someday. It was definitely the right decision for us even though we didn’t anticipate making the move for another year.

Me: What words of advice do you have for other young families who are thinking about buying their first home?

Danielle: Do your research. Don’t rely on what listing agents are sending or telling you. Go to open houses yourself and talk to the agents.

Get a scope of what the seller is looking for. It’s always good to get as much information as you can about what you’re going into. Compare loan rates at different financial institutions and ask about first-time home buyer programs.

Also, don’t skimp out on the inspection! My husband and I spent nearly $1,000 on three different home inspections because we decided to go with a very thorough inspector instead of a cheaper, less thorough one. As a result of what he found, we backed out of two homes that would have ended up being financial nightmares for us down the road.

Finally, start saving now. We didn’t honestly think we could buy a home this soon after having our son, but saving was pretty painless, and it wasn’t nearly as hard as we expected to cut back on things we rarely used anyway. Pick 2-3 small expenses you can cut and start there. You’ll find that it’s kind of fun to see how much you can save every month!

Thank you so much to Danielle for sharing this experience and wisdom! For tips on applying for a mortgage, check out Five Things to Know About Applying for a Mortgage. Now you tell me – what things did you learn as you saved and shopped for your first home? Anything you’d do differently? Please email me, share on our Facebook page or send me a tweet @kclmoneycoach.

Should You Buy or Rent?

August 11, 2016

This is a question I recently got on our financial helpline and one that I’m struggling with myself right now. The conventional wisdom is that renting is “throwing money away,” but owning a home also involves throwing away a lot more money than it may seem. One way to see this is by using a “Buy vs Rent” calculator like this one from the NY Times. Not only are you paying interest on the mortgage, there’s also maintenance costs, taxes, the opportunity cost of not being able to invest any extra money you put towards buying, and the transaction costs of buying and selling. Here are some things to consider before making one of the biggest financial decisions of your life:

How long do you plan to stay? For most people, this is probably the single biggest deciding factor. The longer you stay, the more buying usually makes sense because it takes time for the financial benefits to outweigh closing costs and real estate agent commissions, not to mention the risk that the home could actually be worth less when you try to sell it. It’s generally better to rent if you plan to stay less than 3-5 years.

What mortgage rate can you qualify for? To get the best mortgage terms, you typically have to have a credit score of at least 750 and put down 20%. If your credit isn’t so great or if you can’t make much of a down payment, you may want to delay buying until your credit or savings is in better condition.

Where would you invest any extra savings? If you can save more by renting and earn a good return on those savings, renting may be better. For example, if you’re not contributing enough to max your employer’s match, or have high-interest debt to pay down, or are just an aggressive investor, the return on your savings can be quite high.

What’s your tax bracket? The higher your tax bracket is, the more you can save by deducting mortgage interest and property taxes. Just be aware that you only benefit to the extent that these itemized deductions exceed your standard deduction.

How handy are you? As a homeowner, you won’t be able to call the landlord anymore when something needs to be fixed. If you can keep maintenance costs down by doing a lot of your own work or even by being a savvy shopper, buying might be more beneficial.

I’ve been renting, but I’m now considering buying a home. I should be able to qualify for a good mortgage rate and I’m in a moderately high tax bracket. On the other hand, I think I can also earn a decent return on my savings if I rent, and I’m not the most handy person.

The tie-breaker might be how long I would plan to live in my next home, which is a tough call that involves a lot of big life decisions. In the end, the decision to buy or rent often comes down to an emotional one. There’s nothing wrong with that as long as you’re aware and okay with the financial consequences as well.

Why Homes Actually Tend Not To Be Disappointing Investments

July 28, 2016

One thing I often hear people say (except right after the crash in the real estate market), is that their home was the best investment they ever made. However, a New York Times article titled Why Land and Homes Actually Tend to Be Disappointing Investments points out that real estate has increased by only .6% a year in real terms from 1929 to 2015 compared to a 3.2% average annualized increase in GDP over that same time period. The problem is that comparing just increases in price ignores a lot of the financial benefits of home ownership:

You don’t have to pay rent. If you don’t buy a home, you’ll probably have to pay rent and unlike a mortgage payment, rent tends to go up at least as much as inflation and never goes away. In fact, one of the biggest factors I’ve noticed in whether people are on track for retirement is whether they will have a paid off home by the time they retire. This “imputed rent” (or income from your home in the form of not having to pay rent) is one of the main sources of return. If you’d like to see whether buying or renting makes more financial sense for you, you can see how all the factors come out with this NY Times Rent v Buy calculator.

Real estate allows you to use leverage. Let’s suppose you purchase a $100k home and put down 20% or $20k. If the home appreciates with inflation by 2%, it’s now worth $102k. That doesn’t sound so great until you realize that the $2k increase in your net worth is actually 10% of the $20k you put down.

Being able to borrow from your home can help you in other ways too. Once you have equity, you can generally get a revolving line of credit or a home equity loan against it with relatively low interest rates and deduct the interest from your taxes. This can be useful in an emergency or to pay off higher interest credit card debt. (In that case, be sure you can make the payments because your home will be on the line if you can’t.) When you reach age 62, you can also take a reverse mortgage that allows you to supplement your retirement income by borrowing from your equity without having to make payments as long as you live in the home.

You’re less likely to over-react to market downturns. One of the biggest mistakes people make with stocks is to stop buying or to even sell when an investment goes south, only to miss the recovery. It’s not as easy to stop making your mortgage payments and if anything, people are less likely to sell when their home value is down.

Don’t forget the tax advantages. Not only can you deduct the interest and property taxes, you can also sell it and pay no taxes on up to $250k of gain (or $500k if you own it jointly) as long as it was your primary residence for 2 out of the last 5 years. You can also defer the taxes if you immediately reinvest the sale proceeds in a new real estate property, and if you pass it on to your heirs, they can sell it without paying capital gains taxes on all the gains during your lifetime.

You can rent it out. While you live in it, you can rent out an extra bedroom to a long term tenant or possibly for shorter stays on sites like AirBnB. If you move out, you can also rent out the entire home as an investment property (which also allows you to deduct depreciation and other expenses from your taxes).

There’s an emotional return. Not every benefit can be measured precisely in dollar terms. Homeowners also benefit from knowing that their home is truly their own. They can make renovations as they want and don’t have to be concerned with being kicked out by a landlord.

When looking at real estate as investment, don’t just focus on historical appreciation. Be sure to understand all the pros and cons. Then maybe one day you’ll be saying it was your best investment too.

Yes, the Investing Game is Rigged

July 14, 2016

Do you ever feel like the investment game is rigged against the “little guy?” In some ways, that’s true. The “little guys” (and gals) generally don’t have enough money to access institutional funds (except maybe in their employer’s retirement account), can’t afford to hire the top investment managers, aren’t allowed to invest in hedge funds, and don’t qualify for some of the best bank rates. The value of many of those investment managers and hedge funds is dubious though. On the other hand, here are some investments for each asset class that the “little guy” actually has an advantage in:

Cash: Reward Checking Accounts. These accounts are insured and if you meet their requirements, they can pay up to 5% in interest and often reimburse ATM fees. The catch is that the high interest rate is only on the first $5-20k, depending on the institution. That may not be worth the hassle for wealthier individuals with hundreds of thousands or even millions in cash, but may be the entire cash savings for the rest of us.

Bonds: US Government Savings EE Savings Bonds. These bonds are fully backed by the federal government, do not fluctuate in value, and are tax-deferred (and tax-free for education expenses if you meet the criteria). Their interest rate is pretty low right now, but they’re guaranteed to at least double in 20 years, providing a minimum 3.6% rate of return. In comparison, the rate for 20-year treasury bonds is only 1.82%, and they can lose value if interest rates rise. However, each person can only purchase up to $10k a year of Series EE bonds, which is one reason why wealthier individuals and institutions stick to regular treasury bonds despite the lower rate and higher risk.

Stocks: Micro Cap Stocks. Studies have found that these stocks with a capitalization of less than half a billion dollars have produced higher returns than larger stocks even when adjusting for risk, and they tend to move differently from other stocks so they can help diversify a portfolio. Because these stocks are generally too small to be purchased by mutual funds and are seldom followed by Wall St analysts, they also offer more opportunity to find bargains. (In fact, this inability to invest in the smallest of stocks has made investing harder for Warren Buffett compared to when he first started.)

Alternatives: Direct Real Estate. The main reason that it’s so hard to beat the stock market is because knowledge about stocks is publicly available. It’s like trying to find money on the street when everyone else is looking too. That’s not true of the real estate market though. Big investment firms can’t afford to hire people to inspect every piece of real estate and even if they could, most properties are too small to be worth it for them.

When you’re buying your home or an investment property, you have the ability to add value by researching the location, having the property inspected, negotiating the price, fixing it up, and then managing it. All of that work can translate into higher returns. (Don’t forget that it is work though.)

Wall St has a lot of advantages over the rest of us, but that’s not always true when it comes to investing. You have the opportunity to earn returns that the Buffetts of the world can only dream of. So yes, the investing game is rigged…in your favor.

How Much is Your Rental Property Earning or Losing?

July 07, 2016

One of the benefits of investing in stocks, bonds, and mutual funds versus in direct real estate is that it’s a lot simpler. A good example is when it comes time to answer a key question: how much money am I actually making or losing in this investment? With stocks, bonds, and funds, this is relatively easy because it’s all spelled out for you on your statement. You can see how much you’ve collected in interest and dividends and how much the investment has gained or lost in value since you purchased it. With real estate, it’s not quite so simple.

After a couple of years of owning rental properties, including having a few big repairs, an eviction, and vacancies that lasted for months, I decided to sit down and calculate what I was really earning (or losing). The good news is that 4 out of my 5 properties have a positive cash flow of about $200/month over the last 6 months, which is about what I expected when I purchased them. The bad news is that the last property had a negative cash flow of about $500/month since it was vacant during most of that time. (Fortunately, I have a tenant there now.) This netted out to a positive cash flow of about $300 per month.

I was glad to see I wasn’t in the red even with a vacant property, but that still didn’t look very encouraging. However, when I annualized it as a percentage of what I spent on the properties, it came out to be a 5% positive cash flow. If you’ve seen interest and dividend rates lately, that’s not too bad. With the tenant in the 5^th property, it would come to about a 17% return on cash. If you have rental properties or are thinking of investing in one, here are some of the factors to consider in determining the return on your investment:

Cost Basis: This is the upfront cost of purchasing the property (the down payment and closing costs) as well as the cost of any improvements you make. (Only some of the closing costs are included in the basis for tax purposes.)

Rental Income: This is the easiest part to measure. If you’re thinking about buying a property, assume a vacancy of at least one month per year.

Rental Expenses: This is the toughest part to measure and estimate. If you have a property, be sure to keep records so you can tally them up. Don’t forget to include the costs of advertising the property to prospective tenants and any property management fees in addition to the mortgage, property taxes, and insurance. You also need to separate maintenance/repairs from capital improvements since they affect your profitability (and taxes) differently. For prospective properties, maintenance costs tend to run 1-4% of the property value, depending on it’s condition.

Tax Breaks: In addition to non-improvement expenses, you can deduct mortgage interest, property taxes, and depreciation.

Cash Flow: Take your total rental income, subtract your expenses (including taxes on the rental income), and then add in your tax breaks. This is how much income you actually pocket.

Return on Cash: Take your annual cash flow and divide it by your cost basis. This is the cash return on your investment.

Total Return on Investment: Take your cash flow and add in any appreciation in the value of your property and reductions in the mortgage balance to get your total return. Then divide it by your costs basis to get your total return. This is the most fair comparison to your total return on other investments.

When you look at all the ways you can make money (rental income, tax breaks, and building equity), real estate can have some of the highest investment returns. (You can use this calculator to make the calculations above.) But with high returns, comes high risk. Sometimes those risks are obvious, but other times they come in the form of small costs that can add up to big losses over time. Make sure you do the math on any property to see if it makes financial sense to buy, hold, or sell.

Quiz: Do You Have Landlord Potential?

March 21, 2016

[fusion_text]Online or on cable these days, you’ll find many self-described real estate experts who want to teach you their systems for finding and financing great real estate deals. According to these self-described millionaires, people can make money in real estate if they think like an investor and have the right system. The temptations they offer are many: inflation-adjusted income, rising home prices, leverage and avoiding stock market risk. I’m a rental property investor myself, so I know firsthand both the benefits and the challenges.

While single family homes, commercial properties and multi-family units may be good investments for some people, they are not for everyone. The truth is, rental real estate investing may seem safer than it really is. Each property investment has unique risks. A rental real estate investment that remains vacant or results in large, unexpected maintenance costs could be financially devastating.

Still, real estate evangelists aside, rental property investments can contribute to your income diversification, net worth and financial security if you choose wisely and at the right time. How will you know when you’re ready to be a landlord? Take this assessment to find out if you have landlord potential. Give yourself one point for each “yes” answer:

My financial position:

____I have zero credit card and other high interest debt

____My credit score is 740 or higher.

____I have enough cash to put down 20% of the value of the property

____I have enough cash to pay for any necessary renovations

____I have enough cash to cover vacancies and maintenance on the target property for a year

____I am already contributing the maximum to my retirement plan at work ($18,000 plus $6,000 catch up contribution if 50 or older)

____I am already contributing the maximum to a Roth or Traditional IRA ($5,500 plus $1,000 catch up contribution if 50 or older)

____I am maxing out other work-sponsored employee benefits that fit my financial situation (e.g., HSA, FSA, etc.)

____I have enough other income to pay the rental property mortgage if there’s a sustained period of vacancy

____Total financial position score

Did you score 8 points or higher? Then you can move on to the next round.

If you scored 7 or lower, you aren’t yet in a strong enough financial position to be a rental property investor. Without sufficient cash reserves, a real estate investment that turned out badly could send you into bankruptcy. If you carry balances on your credit cards, the most important investment you can make is paying them off. Before you even consider diversifying into individual rental properties, make sure you are on track to meet your retirement goals and maximize all your tax-advantaged benefits at work.

Real Estate Knowledge:

____I’ve read some basic guidebooks on rental real estate investing and landlording, such as Nolo’s First Time Landlord

____I’ve done a review of rentals in my target neighborhood and I know average rents, time on the market, crime and school statistics

____I have owned my own home for more than three years, so I have a very good idea of how much time is needed to take care of one

____I don’t yet own a home, but I plan to buy a multi-unit property and live in one unit

____I have enough time to manage the property myself

____I’ve run the numbers, and the gross monthly rent on my target property is 1% or more of the total property value

____I can afford a property manager and the investment is still profitable

____ I like to fix things and do home improvement work around the house

____I understand that one or a few properties in the same area are not a diversified investment and that means there is higher risk

____I have run income and expense projections for the property for a year, including worst case scenarios

____I have researched the pros and cons of different legal entities in my state to hold the property, such as a limited liability company

____I have spoken to a mortgage lender and am confident I’ll be approved for financing

If you scored at 8 on real estate knowledge and 8 on financial position, it looks like you have landlord potential. Happy property hunting!

If you scored 7 or lower, take some time to rethink this. Will this be a profitable investment? Do you have the time to manage the property yourself? Are there risks you are not comfortable taking? What additional steps are needed before you move forward?

How did you do on the quiz? Do you have landlord potential? Email me at [email protected] or follow me on Twitter @cynthiameyer_FF.

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5 Things to Know About Applying for a Mortgage

December 09, 2015

Even though interest rates are likely to begin rising again (haven’t we been saying that for a couple years now?) mortgage rates are still reasonable, and buying a home these days is still cheaper than renting in most areas, providing you’re planning to stay for a bit. Buying a house is more than just a financial decision, but if after considering all the factors, you’ve decided that now is the time to buy, prepare yourself for the mortgage application process. And I mean gird yourself because it is a royal pain. Here’s what to expect: Continue reading “5 Things to Know About Applying for a Mortgage”

Passive Income Strategies For Retirement (And Now)

September 28, 2015

Last week, I had lunch with my good friend Brian who just happens to be a local realtor. Normally when we hang out, it is on the soccer field so as a result, we don’t get to discuss business too often. However, our recent discussion was a little different because we actually had time to talk about some passive income strategies. Continue reading “Passive Income Strategies For Retirement (And Now)”