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Giving—or Receiving—a Down Payment Gift? Here Are the Tax Consequences

June 7, 2019

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Searching for homes and scrolling through listing photos is fun, but saving up for a down payment can be a real challenge. That’s why some home buyers turn to family for a helping hand in the form of the gift of a down payment. But whenever a large stack of cash changes hands, Uncle Sam wants to know—and that means tax returns can get complicated. So before you give or get a down payment gift, make sure you understand their tax implications.

Who can give you a cash gift for a down payment?

If you’re buying a home, you can only use a cash gift from an immediate relative to help get a mortgage to buy a home. That means a parent, grandparent, sibling, or spouse. It’s also generally acceptable to receive gifts from a domestic partner, or significant other, if you’re engaged to be married.

“Keep in mind you will have to provide detailed documentation in the form of a gift letter to the lender that states the name of the donor, their relationship to you, the date and amount of the gift,” says Jennifer Harder, founder and CEO of Jennifer Harder Mortgage Brokers. You’ll also need a statement from the donor that the money was given with no expectation of repayment.

And watch out for this important condition: The general rule is, if you are putting a down payment of 20% or more, it can all be gifted money. But if your down payment is less than 20%, some of that needs to come from your own pocket.

How much of a tax-free gift can you give?

Any one person can give a gift of $15,000 or less to another individual and not have to pay taxes on it.

Here’s an example of how families can amass a bigger gift under that regulation: Each member of a couple trying to get help with a down payment can receive $15,000 from each parent. So Mom gives $15,000 to her daughter and $15,000 to her son-in-law, and Dad does the same. That means that one set of parents could give the couple a total of $60,000 tax-free. And then the husband’s parents could do the same.

“All that’s required is that it is a gift, meaning it’s made with disinterested generosity,” says Ann Brookes at Taxattorneyatlaw.com.

“The beauty of the gift tax is that any amount received that’s beneath the current $15,000 exclusion amount is not taxable to anyone,” says tax expert and CPA, Folasade Ayegbusi of accountingwithfolasade.com. She used the gift tax strategy to purchase her first home.

“I received a $10,000 gift and used it as my down payment,” she says.

What if the down payment gift is above $15,000?

Down payment amounts above $15,000 and received as a gift must be reported on a gift tax return by the person making the gift—not the beneficiary. But that doesn’t mean the donor will pay taxes.

“The gifts get tallied up over time and offset against the lifetime exclusion on gifts, which is currently $11.4 million,” says Brookes. “The purpose of filing the return is to track your lifetime gift amount, which will be used in calculating tax on your estate when you die.” If you give more than $11.4 million while still alive, the gift tax rate kicks in, which can be anywhere from 18% to 40%.

What if you don’t report the down payment gift?

There is generally a three-year statute of limitations on filing a gift tax return, although that doesn’t begin until a return is filed. If you do not file the gift tax return within that period, “the IRS can assess a gift tax, in addition to penalties and interest, on a reportable gift that was not adequately disclosed to the IRS on a return, years—even decades—after the gift was made,” says tax attorney Jennifer Correa Riera of Miami’s Fuerst, Ittleman, David & Joseph.

The post Giving—or Receiving—a Down Payment Gift? Here Are the Tax Consequences appeared first on Real Estate News & Insights | realtor.com®.

4 Good Reasons to Not Get a Mortgage Online

May 14, 2019

cnythzl/iStock; realtor.com

Applying for a mortgage these days can be accomplished entirely online—no need to schlep to a bank and suffer hand cramps filling out paperwork.

Instead, you can punch some basic info into an online mortgage site, and up pops a bunch of loan choices. An industry renowned for being slow and cumbersome is now wooing customers with the promise of ease, speed, and transparency. Rocket Mortgage, Quicken Loan’s online platform, for example, promises qualified customers approval in as little as eight minutes.

But taking out a six-figure loan is one of the most complicated and substantial financial transactions most people will ever make. Does it really make sense to handle it by pushing a few buttons on your smartphone?

Maybe for those with a typical 9-to-5 job and good credit.

“If you are a salaried employee with no overtime, no bonus—no funky income, if you will—just a plain-vanilla borrower, then sometimes the online mortgage does work,” says Brian Minkow, a divisional vice president and loan originator at Homebridge Financial Services, a non-bank lender. “You know: You have a five-year work history, you’re putting 20% down, and have an 800 FICO score.”

But then there’s everybody else.

———

Watch: How Long Does It Take to Improve Your Credit Score Enough to Buy a Home?

———

Here are some of the many reasons why those borrowers might consider taking more time with the process, including consulting with an experienced loan officer or mortgage broker.

1. You want to shop around for the best loan

First and foremost, it’s always in a borrower’s best interest to comparison shop on rates and fees, says Keith Gumbinger, a vice president at HSH.com, a mortgage information website. Speed and convenience alone do not always translate into a better price for borrowers.

“You should invest some time in it, do your research,” Gumbinger says. “Also, do your diligence on your credit. And think about how long you’re going to be in your home.” The reason? The length of time you estimate you are likely to be staying in the home can be a factor in whether you apply for a fixed or adjustable rate loan.

Gaining an understanding of different loan programs is a smarter approach than just “going online and filling out things,” says Minkow. “A lot of people really don’t know if they’re getting the right loan program, the right interest rate, the right down payment.”

The research process may ultimately lead you straight to the speedy online mortgage site as the best option anyway. But, Gumbinger says, “You won’t know that unless you go out and take a look around.”

2. You’re a first-time home buyer

Researching all your options is especially important if you’ve never purchased a home before, advises David Weliver, founder of MoneyUnder30.com, a personal finance advice site. First-time buyers should always talk through important details like rates, points, and closing costs with an expert. “After you’ve been through the process once, you have a better idea of what to expect and what information you’ll need to provide to make the process go smoothly,” he says.

Even those who have borrowed before may want to consult with someone if there is anything about their circumstances that might make qualifying more difficult. For example, Weliver says, “a real person could be a helpful advocate” for borrowers who are buying a second home or rental property, have spotty credit, or have inconsistent income.

3. You’re self-employed

About 15 million Americans are classified as self-employed, according to the Pew Research Center. While salaried workers generally only have to show the lender their W-2 tax forms to prove their income, self-employed workers “should expect that they will have to provide the lender with more income documentation, such as tax returns from the last few years,” Weliver says.

The fact is, some online lenders are more strict about documentation requirements than federal guidelines require, because they want to reduce their risk, says Minkow. That can make qualifying even tougher for a borrower who is already perceived as a higher risk—for example, applicants who have only been in their current job for a few months, or those who want to include overtime pay as evidence of their buying power. The lender will want to see proof that the overtime pay is consistent. “Certain guidelines say you have to show you have it for 12 months or 24 months—it depends on the loan,” Minkow says.

4. You want some extra handholding

Working with someone one on one may also help prevent last-minute problems when it comes time to buy that house. “I can’t tell you how many clients who have come to me after they’d gone online and gotten a pre-approval from a lender,” Minkow says. “Then they go to purchase a house, and halfway through the transaction, the online lender says all of a sudden, ‘You can’t get approved.’ The client freaks out. And that’s when they get ahold of someone like myself.”

Finally, there is the matter of personal preference. Not everyone likes the impersonal approach. Before applying for a loan, borrowers might consider whether they are the kind of person who appreciates a lot of help and attention in other shopping experiences. “If you like a hands-on environment, like a Macy’s, you’re a different kind of shopper than someone who enjoys going to a warehouse club,” says Gumbinger. “Your expectations going in will influence how satisfied you are with the process.”

The post 4 Good Reasons to Not Get a Mortgage Online appeared first on Real Estate News & Insights | realtor.com®.

Who’s the Best Mortgage Lender for You? How to Find Your Match

April 23, 2019

Mortgage Broker

iStock/fizkes

Most house hunts involve not only finding your dream home, but also selecting the best mortgage lender to finance this massive purchase.

So what do we mean by “best”? A mortgage with a low interest rate and fees, obviously, but it’s more than just the money. Ideally you want a mortgage lender who won’t leave you buried in paperwork, or confused by a slew of obscure terms you don’t understand.

In a recent survey, about 1 in 5 U.S. home buyers said they came to regret their choice in a lender. Don’t want to be one of them? Then be sure to ask yourself these questions below to home in on your perfect match.

How much money do I need?

A mortgage is by no means a one-size-fits-all product. Indeed, your budget plays a significant role in what lender you should choose.

If you’re looking to get a big loan, you’ll want to search for a lender that specializes in jumbo loans. In a nutshell, these are mortgages that exceed the loan limit of conforming loans, which is $424,100 in most areas. If you live in a high-cost area, the conforming loan limit is $636,150. But, after the housing crisis, many mortgage lenders pulled out of the jumbo loan market. After all, extra-large home loans pose a greater risk to the lender.

To get a ballpark figure of how much money you need—and the type of house you can afford—plug your income and other numbers into an online home affordability calculator.

Would I qualify for a conventional loan?

Most home buyers obtain conventional loans, since these mortgages tend to offer the lowest interest rates. But in order to qualify for a conventional mortgage, borrowers need to meet certain requirements—like, for instance, a credit score of at least 620, a down payment of 5% to 20%, and a maximum debt-to-income ratio of 43%, says Todd Sheinin, mortgage lender and chief operating officer at Homespire Mortgage, in Gaithersburg, MD.

The DTI ratio is how much money you owe in monthly debt obligations (on student loans, credit cards, car loans, and hopefully soon a home loan), divided by your monthly income. So, let’s say you’re paying $500 to debts and pulling in $6,000 in gross (meaning pretax) income. Divide $500 by $6,000 and you’ve got a DTI ratio of 0.083, or 8.3%. However, that’s your DTI ratio without a monthly mortgage payment. If you factor in a monthly mortgage payment of, say, $1,000, your DTI ratio increases to 25%.

If I don’t quality for a conventional loan, what are my options?

Most home buyers who don’t qualify for a conventional loan do still qualify for other types. The main options include FHA loans, VA loans, and USDA loans. Generally the requirements for these are looser—meaning lower down payments, lower credit scores, and higher DTI ratios. However, they still have their limits.

Federal Housing Administration loans, for example, let home buyers put down as little as 3.5%, but borrowers generally need a minimum credit score of 580, says Tim Lucas, editor at MyMortgageInsider.com.

Meanwhile, U.S. Department of Agriculture loans let borrowers put as little as 0% down, but these loans are available only in certain rural locations.

Veterans Affairs loans also require no money down, but are available only to veterans, active-duty service personnel, and select reservists or National Guard members. If you quality for these loans, they’re great options.

Am I willing to hire someone to do the legwork?

To find the best mortgage lender, it’s essential that you shop around. However, there’s one alternative: Hire someone to do the shopping for you.

You can do this by hiring a mortgage broker—an industry professional who can shop for multiple lenders simultaneously on your behalf. The caveat: Sometimes mortgage brokers get their commission paid by the borrower (that’s you) based on an agreed-upon fee that becomes part of your closing costs, while other times brokers get paid by the lender that’s ultimately chosen to fund the loan.

Typically, a mortgage broker’s commission is around 1% to 2% of the loan borrowed (or $1,000 to $2,000 per $100,000). The upshot: Though you might have to pony up cash to use a broker, this person can help you not only find a lender but also negotiate for you—meaning you don’t have to do any haggling yourself to nab a low-interest home loan.

Am I comfortable getting a mortgage online or prefer hands-on guidance?

Online mortgages are growing in popularity, particularly for younger home buyers: One recent survey by NerdWallet found that 64% of millennial mortgage applicants would prefer to get it all done digitally. Though online lenders often offer lower mortgage rates and fees, they’re not right for everyone.

If you care about the kind of one-on-one, face-to-face service you get when you work with a local mortgage lender, be aware that you don’t typically get that with an online lender (although many online mortgage lenders do employ loan officers you can speak to on the phone).

Another reason an online lender may not be a good fit: Many don’t employ mortgage specialists who know the ins and outs of your local market, which can be a disadvantage if you’re applying for a complicated loan, such as a mortgage for a self-employed borrower.

Nonetheless, “online lenders are great for conventional scenarios: salaried borrowers without financial or credit complications, and properties that are typical for the area in design, lot size, condition, and amenities,” says Richard Redmond, author of “Mortgages: The Insider’s Guide.”

The moral of the story: You’ll have to weigh your loan needs and comfort level of completing the entire mortgage process online before choosing an online lender.

Do I want to work with a small or large lender?

Choosing between a small lender, like a local credit union, and a larger national lender, such as Bank of America or Wells Fargo, is mostly a matter of preference. But knowing which you’d prefer can help you find the right lender to fit your needs. If you like personal service, it may make sense to choose a small mortgage lender in your local area. Indeed, the bigger the bank, the more business it does, which means you’re just one of thousands of clients, so it may not bend over backward to attend to your every whim, says Bruce Ailion, a mortgage broker at Re/Max Town and Country in Atlanta.

If you don’t have much time to waste, a larger lender may be a better choice, since the bigger banks have in-house underwriters and larger teams to process mortgage applications faster.

Another factor consider: Large lenders may have more payment options such as online payment or automatic mortgage deduction. Also, big banks often let you do everything online, from your mortgage application to account management. (Many local lenders don’t have as well-oiled online banking systems.)

To better weigh all your mortgage options, head to realtor.com/mortgage to compare lenders and learn more.

The post Who’s the Best Mortgage Lender for You? How to Find Your Match appeared first on Real Estate News & Insights | realtor.com®.

A Guide to Mortgage Interest Rates: Why They Go Down and Up, and What to Do

April 11, 2019

Mortgage interest rates are a mystery to many of us—whether you’re a home buyer in need of a home loan for your first house or your fifth.

After all, what does “interest rate” even mean? Why do rates swing up and down? And, most important, how do you nab the best interest rate—the one that’s going to save you the most money over the life of your mortgage?

Here, we outline what you need to know about interest rates before applying for a mortgage.

Why does my interest rate matter?

Mortgage lenders don’t just loan you money because they’re good guys—they’re there to make a profit. “Interest” is the extra fee you pay your lender for loaning you the cash you need to buy a home.

Your interest payment is calculated as a percentage of your total loan amount. For example, let’s say you get a 30-year, $200,000 loan with a 4% interest rate. Over 30 years, you would end up paying back not only that $200,000, but an extra $143,739 in interest. Month to month, your mortgage payments would amount to about $955. However, your mortgage payments will end up higher or lower depending on the interest rate you get.

Why do interest rates fluctuate?

Mortgage rates can change daily depending on how the U.S. economy is performing, says Jack Guttentag, author of “The Mortgage Encyclopedia.”

Consumer confidence, reports on employment, fluctuations in home sales (i.e., the law of supply and demand), and other economic factors all influence interest rates.

“During a period of slack economic activity, [the Federal Reserve] will provide more funding and interest rates will go down,” Guttentag explains. Conversely, “when the economy heats up and there’s a fear of inflation, [the Fed] will restrict funding and interest rates will go up.”

How do I lock in my interest rate?

A “rate lock” is a commitment by a lender to give you a home loan at a specific interest rate, provided you close on your home in a certain period of time—typically 30 days from when you’re pre-approved for your loan.

A rate lock offers protection against fluctuating interest rates—useful considering that even a quarter of a percentage point can take a huge bite out of your housing budget over time. A rate lock offers borrowers peace of mind: No matter how wildly interest rates fluctuate, once you’re “locked in” you know what monthly mortgage payments you’ll need to make on your home, enabling you to plan your long-term finances.

Naturally, many home buyers obsess over the best time to lock in a mortgage rate, worried that they’ll pull the trigger right before rates sink even lower.

Unfortunately, no lender has a crystal ball that shows where mortgage rates are going. It’s impossible to predict exactly where the economy will move in the future. So, don’t get too caught up with minor ups and downs. A bigger question to consider when locking in your interest rate is where you are in the process of finding a home.

Most mortgage experts suggest locking in a rate once you’re “under contract” on a home—meaning you’ve made an offer that’s been accepted. Most lenders will offer a 30-day rate lock at no charge to you—and many will extend rate locks to 45 days as a courtesy to keep your business.

Some lenders offer rate locks with a “float-down option,” which allows you to get a lower interest rate if rates go down. However, the terms, conditions, and costs of this option vary from lender to lender.

How do I get the best interest rate?

Mortgage rates vary depending on a borrower’s personal finances. Specifically, these six key factors will affect the rate you qualify for:

  1. Credit score: When you apply for a mortgage to buy a home, lenders want some reassurance you’ll repay them later! One way they assess this is by scrutinizing your credit score—the numerical representation of your track record of paying off your debts, from credit cards to college loans. Lenders use your credit score to predict how reliable you’ll be in paying your home loan, says Bill Hardekopf, a credit expert at LowCards.com. A perfect credit score is 850, a good score is from 700 to 759, and a fair score is from 650 to 699. Generally, borrowers with higher credit scores receive lower interest rates than borrowers with lower credit scores.
  2. Loan amount and down payment: If you’re willing and able to make a large down payment on a home, lenders assume less risk and will offer you a better rate. If you don’t have enough money to put down 20% on your mortgage, you’ll probably have to pay private mortgage insurance, or PMI, an extra monthly fee meant to mitigate the risk to the lender that you might default on your loan. PMI ranges from about 0.3% to 1.15% of your home loan.
  3. Home location: The strength of your local housing market can drive interest rates up, or down.
  4. Loan type: Your rate will depend on what type of loan you choose. The most common type is a conventional mortgage, aimed at borrowers who have well-established credit, solid assets, and steady income. If your finances aren’t in great shape, you may be able to qualify for a Federal Housing Administration loan, a government-backed loan that requires a low down payment of 3.5%. There are also U.S. Department of Veterans Affairs loans, available to active or retired military personnel, and U.S. Department of Agriculture Rural Development loans, available to Americans with low to moderate incomes who want to buy a home in a rural area.
  5. Loan term: Typically, shorter-term loans have lower interest rates—and lower overall costs—but they also have larger monthly payments.
  6. Type of interest rate: Rates depend on whether you get a fixed-rate mortgage or an adjustable-rate mortgage, or ARM. “Fixed-rate” means the interest rate you pay remains fixed at the same level throughout the life of your loan. An ARM is a loan that starts out at a fixed, predetermined interest rate, but the rate adjusts after a specified initial period (usually three, five, seven, or 10 years) based on market indexes.

Tap into the right resources

Whether you’re looking to buy a home or a homeowner looking to refinance, there are many mortgage tools online to help, including the following:

  • A mortgage rate trends tracker lets you follow interest rate changes in your local market.
  • mortgage payment calculator shows an estimate of your mortgage payment based on current mortgage rates and local real estate taxes.
  • Realtor.com’s mortgage center, which will help you find a lender who can offer competitive interests rates and help you get pre-approved for a mortgage.

 

The post A Guide to Mortgage Interest Rates: Why They Go Down and Up, and What to Do appeared first on Real Estate News & Insights | realtor.com®.

How to Lower Closing Costs: A Guide for Home Buyers

April 10, 2019

iStock/venuestock

If you’re buying a house, you might wonder how to lower your closing costs—a daunting list of fees that accompany a home purchase.

On average, typical closing costs can total anywhere from 2% to 7% of a home’s purchase price. So on a $250,000 home, closing costs could amount to anywhere from $5,000 to $17,500. In short: Closing costs are a huge chunk of change, and span a wide range of fees.

But, much like haggling on the price of a house, you can negotiate closing costs down to a more affordable level. The key is knowing which fees are fixed—and which ones have wiggle room that you can work to your advantage.

What are closing costs, anyway?

Before you can lower your closing costs, you need to know what they are. If you don’t need a mortgage, your closing costs will be limited, but if you do need a home loan, your closing costs will typically encompass the following fees:

  • Agent commissions
  • Attorney fees
  • Lender fees
  • Mortgage insurance
  • Title search fees
  • Recording fees
  • Property taxes
  • Transfer taxes
  • Appraisal fee
  • Title insurance

 

When do you learn what your closing costs will be?

You don’t have to wait until closing to find out how much your closing costs will be. You can get a sense of what you will owe in your loan estimate document, which federal law requires lenders to provide within three days of the loan application.

While the closing costs on this loan estimate document should be fairly accurate, you won’t receive the final number until three days before you actually close on your home. That’s when you’ll receive another document called your closing disclosure, which contains your final, official closing costs.

Closing costs you can’t change

First off, prepare to pick your battles, because not all closing costs are negotiable and worth wasting your haggling energy on.

“For example, the costs of title fees and government fees—transfer taxes, if applicable—are a big chunk of the cost, and a buyer cannot negotiate these,” says Heather McRae, senior loan officer with Chicago Financial Services, in Chicago.

Whether or not you, as the home buyer, have to pay these fees depends on where you live. In New York City, a condo buyer will typically pay transfer taxes, but sellers pick those up for co-op purchases, as well as for single-family homes in Westchester County, says Peter Grabel, managing director of Luxury Mortgage, in Stamford, CT.

How to lower closing costs

So, there’s not much wiggle room with taxes and local fees, but there are some areas where you can lower your costs. For example, some costs, such as title services, are provided by a third party, so you can look for a less expensive provider. Some areas with flexibility include the following:

  • Your title costs: Title insurance can vary widely across the U.S.—and even by type of home, says John Walsh, president of Total Mortgage, in Milford, CT. Sometimes title insurance is bundled with settlement services. You may be able to research and find a title and settlement company that is less expensive than the one your lender recommends. Some states require a borrower to use a lender-selected title insurance provider, but not all states do, according to Greg McBride, chief financial analyst for Bankrate.com. In states where you can find your own title insurance provider, you can look online for other title service providers that are less expensive, and then let your lender know about your preferred title servicing company.
  • Your lender fees: Another way to lower closing costs is by choosing the right lender. Some lenders may offer lower origination fees for customers who already have a checking or savings account at the bank and want to add a mortgage, says Peggy Lawlor, a mortgage strategy executive with Bank of America. For example, Bank of America just rolled out a Preferred Rewards program that offers up to $600 in reduced closing fees for customers, depending on the dollar amount of a customer’s deposits. If you’re dismayed by the lender fees on your loan estimate, contact other lenders to see if you can find a better deal.
  • The day you close: The day of the month when the mortgage closes can also affect costs, says Walsh. “If you close on Nov. 5, you have to pay the per diem interest from the 5th to the 30th; but if you close on Nov. 28, it’s only three days,” he adds. You’ll save a bit in interest costs if you close as close to the end of the month as possible.
  • Your closing attorney: Many borrowers stick with a lender-appointed attorney to represent them at the closing, but they are not required to do so, and you can hire your own, says Lawlor. So feel free to shop around for one who offers great rates.

 

How to negotiate closing costs

All in all, Michael Press of Penrith Home Loans, in Seattle, says that lowering closing costs is doable if home buyers are assertive and willing to put in the time to shop around.

“The most important first step for home buyers is to ask,” he says. For instance, he recommends home buyers ask their agent to negotiate a seller credit, which can significantly lower closing costs. A seller credit is when the seller agrees to pay all or part of the closing costs. Not every seller will be willing to cover closing costs, but sellers who have already purchased a home may be eager to close the deal as soon as possible. Plus, it typically doesn’t hurt to ask.

For home buyers purchasing newly constructed homes, Press recommends checking into builder incentives. Builder incentives are similar to seller credits, but they’re offered by the company doing the new home construction. To take advantage of builder incentives, you may need to work with a lender of their choosing, so be sure to look carefully at the offer as a whole to ensure it’s actually saving you money.

Anya Martin contributed to this report.

The post How to Lower Closing Costs: A Guide for Home Buyers appeared first on Real Estate News & Insights | realtor.com®.

3 Deadly Mortgage Mistakes to Avoid If You’re Self-Employed

April 9, 2019

Love being your own boss? Unfortunately, you might not love the process of applying for a mortgage when you’re self-employed.

Of course, you won’t be alone: The Bureau of Labor Statistics projects the number of self-employed workers in the U.S. will climb to 10.3 million by 2026, up from 9.6 million in 2016. Nonetheless, this growing group faces a few extra obstacles attaining a mortgage over full-time employees who receive a W-2.

The good news? By knowing what mistakes typically trip up these freelancers and business owners, you can avoid a ton of home loan hurdles and headaches. Here are three problems to watch out for if you hope to finance a home purchase soon.

1. Your income is high, but erratic

As they do with typical home buyers, lenders will check to see if your income is high enough to pay for the mortgage. Self-employed borrowers, however, must also show that that income is fairly steady without wild fluctuations that might cramp their ability to pay a monthly mortgage, says Todd Sheinin, lender and chief operating officer at New America Financial, in Gaithersburg, MD.

To prove the stability and viability of your business, you’ll have to provide at least two years’ worth of federal tax returns. (If you’re newly self-employed, some lenders will accept only one year of self-employment tax returns if you can also provide W-2s from an employer in the same field and your current income is at least as much as you earned from your previous employer.) Though some income fluctuation is acceptable, your business should be making steady or increasing revenue each year.

To validate your business income, many lenders will also require you to provide a profit and loss statement, or a 1099 form. The caveat? If your business carries debt and you pay those debts out of a personal checking account or charge them to personal credit cards, the business debt is going to negatively affect your debt-to-income ratio qualifications. The DTI ratio is what you owe in obligations like credit card payments, student loans, car loans, installment loans, car loans, personal debts, alimony, or child support, divided by your monthly income.

As a general rule, if you want to qualify for a mortgage, your DTI ratio cannot exceed 36% of your gross monthly income, says David Feldberg, broker/owner of Coastal Real Estate Group, in Newport Beach, CA. For example, let’s say you’re paying $500 to debts and pulling in $6,000 in taxable income. Divide $500 by $6,000, and you get a DTI ratio of 0.083, or 8.3%.

However, that’s your DTI ratio without a monthly mortgage payment. If you factor in a monthly mortgage payment of, say, $1,000, your DTI ratio increases to 25%. A higher DTI ratio could mean you’ll pay a higher interest rate, or you could be denied a mortgage altogether.

The challenge for self-employed workers is that mortgage lenders will consider only their taxable income when assessing their DTI ratio. (For W-2 employees, their pretax earnings are used.) So, if your company makes $5,000 a month in gross revenue, your taxable income might be only $4,000 if, say, your company has $1,000 in work expenses.

2. You mix business with pleasure on your credit cards

Like other borrowers, you’ll need a strong credit score to qualify for a conventional loan when you’re self-employed. Though a perfect credit score is 850, all scores above 759 are considered to be in the best credit score range, since this means you’ve shown an excellent ability to pay off your past debts.

Borrowers with outstanding credit qualify for the lowest interest rates, says Richard Redmond, author of “Mortgages: The Insider’s Guide.”

But know this: Using personal credit cards to pay for business expenses can hurt your credit score if you’re carrying a large balance from month to month, or you’re missing payments. Even just one missed payment can cause as much as a 90- to 110-point drop in your score, according FICO, creator of the widely used FICO credit score.

The moral of the story: “Don’t mix business expenses with personal ones,” Sheinin advises.

Not sure what your credit score is? You can check your score for free at CreditKarma.com or perhaps with your credit card company, since some (like Discover and Capital One) offer free access to scores and reports. You’re also entitled to a free copy of your full credit report at AnnualCreditReport.com.

3. You don’t have all your paperwork straight

In addition to requesting documents that show proof of your income, lenders will also be looking at your savings, financial assets, and monthly debt obligations “to make sure that you have the means to take on a mortgage comfortably,” according to Freddie Mac, a government-sponsored enterprise that helps thousands of Americans get home loans.

Here’s the paperwork you’ll have to provide:

  • A quarterly statement, or statements for the past 60 days, of all of your asset accounts, which include your checking and savings, as well as any investment accounts (e.g., CDs, IRAs, and other stocks or bonds)
  • Any other current real estate holdings
  • Residential history for the past two years, including landlord contact information if you rented
  • Proof of funds (e.g., bank account statement) for the down payment (If the cash is a gift from your parents, you need to provide a letter that clearly states the money is a gift and not a loan.)

 

Keeping up-to-date records of your business accounts is crucial, but having a tax preparer review these documents before you submit them to mortgage lenders can help you spot any inaccuracies. That could make the difference between getting approved or rejected for a mortgage, since “even small mistakes can hurt your application,” Sheinin says.

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I Got an Adjustable-Rate Mortgage and Wow, What a Ride!

April 6, 2019

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If you’ve ever asked anyone for mortgage advice, you’ve probably been told by well-meaning, conservative folks that in most circumstances, you should never get an adjustable-rate mortgage, aka ARM. The reason: Sure, an ARM’s initial low interest rate might look enticing, but as the name suggests, that rate will change later—and most likely go up.

Well, call me crazy, but my husband and I got an ARM. And it was so not what I’d imagined!

Curious to hear how this decision impacted our finances over five, 10 years—and beyond? Allow me to walk you through the details, and what I learned in the process.

Why we got an adjustable-rate mortgage

It all started back in 2007, when my fiancé, Jim, and I had found the perfect house for sale for $1.25 million—which I know sounds like a lot, but we lived in Los Angeles, where housing prices were ridiculous (and still are today).

adjustable rate mortgage
Our home in Los Angeles

Lisa Johnson Mandell

We’d both been scrimping and saving for decades. I’d just signed a book contract, and had extra funds from the purchase and sale of two condos previously. This was not my first trip to the real estate rodeo, nor was it Jim’s; he’d bought and sold a house as well. Even though $1.25 million was at the very top of our budget, we were ready to combine our savings and close the deal about a month before tying the knot.

Up until this point, I’d been a financially conservative, 30-year fixed-rate mortgage type of girl. Jim was more of a liberal, “Let’s check out our options” kind of guy. He was also very persuasive.

He told me, “Unless you plan to live in your house for 30 years and pay it off, a 30-year fixed doesn’t make sense. It’s better to pay the least to net the most.”

I reluctantly agreed. So we got an ARM, and to ratchet up my nerves further, it was an interest-only loan. That meant that for 10 years, we wouldn’t be paying back any principal at all. Jim said this was OK, since our home’s value was likely to rise, so we’d gain equity that way.

Or so we thought.

ARM: The first five years

On closing day, we put $225,000 down, leaving a cool million to finance. At the time, the best interest rates we could get on a five-year ARM was 5.875%. That meant our monthly payments would amount to $4,895 (rounding off numbers, for simplicity’s sake) for the first five years. After that, they’d adjust once every year for the next 25 years.

All was fine at first. But a year in, the housing bubble burst. Since we’d bought right when the market had peaked, the value of our home started dropping, fast.

For certain ARMs, the housing crash actually had a weird upside: Interest rates plummeted, so many ARM owners enjoyed lower mortgage payments than ever. Alas, our own ARM was fixed for those five years, so we couldn’t take advantage of that—and we couldn’t refinance because we were underwater on our mortgage and had so little equity in our home.

I figured that by the time our interest rate started adjusting four years later, mortgage rates would start going up.

ARM: Five years in

Yet once our five-year fixed-rate term was over, our interest rate began adjusting—even lower than before! Jim and I couldn’t believe our good luck. And it continued to adjust downward for the next five years.

One year, when our rate went below 3%, we were only paying $2,370 per month for a $1 million+ home. Woohoo! We took a nice cruise that year to celebrate.

ARM: Ten years in

But the fun came to a crashing halt at the end of our 10-year term in 2017.

At that point, interest rates rose to 4.7% … and continued to climb. Plus, due to our interest-only loan, it was now time to pay off principal and interest. Our monthly payments ballooned to over $6,300 per month.

When I showed Jim our new monthly payment, a panicked discussion ensued. We desperately tried to refinance, but by then, lenders had tightened up their restrictions on who could qualify—and our careers and incomes had changed considerably. My books had long since been published, and while I was thriving as a freelance journalist, that doesn’t look great on a loan application. As for Jim, he was in the middle of transitioning from successful small business owner to “Sci-Fi Rock Guy.” (I know. But remember: L.A.).

“At least we’re finally paying off some principal,” Jim said, sweat running down his forehead.

There was that. Almost $3,000 of our monthly payment was going toward principal, although that was cold comfort as we scrambled to make our monthly payments.

How we finally refinanced our adjustable-rate mortgage

Yet after about a year of numbly writing checks, we got a call from Darren Hammel, a sales manager at Wells Fargo, where we’d signed up for our ARM over a decade earlier.

“Your payments are really high,” he commented. “Would you like to look into lowering them with a refi?”

I was ecstatic. Jim was suspicious.

“Why would a bank want to lower our payments?” he asked. “And besides that, we won’t qualify.”

But Darren explained that we had a good history with Wells Fargo, and it behooved them to keep customers like us on their books. They were also willing to keep the refi expenses to a minimum—we would be charged very little for the pleasure of the transaction.

Ironically enough, we discovered that we could only qualify to refi if we went with that good old traditional 30-year-fixed interest rate. Yes, things had changed since we’d first applied for a home loan 12 years earlier!

Within no time, Darren worked his mortgage magic, and a few months later, we’re sitting pretty with a 30-year, 4.121% interest rate mortgage with nice, comfortable, predictable payments of $4,570 per month. And because Wells Fargo had that notorious computer breakdown in the middle of closing, we were given a $2,500 mortgage credit for our troubles. Nice!

So we are now better off than when we started, and the value our home has increased again. We have more equity in the place, even though we haven’t paid it down much. To tell you the truth, if we’d gotten a 30-year fixed-rate mortgage in the beginning, we wouldn’t have had to go through all the turmoil, and we’d have more equity in our home now.

Still, it could have been much, much worse. Had we not had money on hand to pay our mortgage, we could have lost our home.

It all worked out all right, but in the end, I’d have to say that I agree with those well-meaning, conservative folks: Signing up for an ARM imperiled my finances and peace of mind. I’m not saying there wouldn’t be instances where I’d try and ARM again, but I’d think about it very carefully.

After all, life, much like interest rates, is unpredictable.

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‘Can I Refinance While Buying a Second Home?’ Here Are the Mortgage Rules

April 3, 2019

Can I Refinance While Buying a Second Home?’ Here Are the Mortgage Rules

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As a buyer and a seller, you may be asking, “Can I refinance while buying a second home?” Maybe you’ve found a property that will be a killer investment at a bargain price. Or perhaps the beach cottage you’ve had your eye on for years just came on the market.

Whatever the reason, if you’re considering applying for another loan while refinancing your current home, the process can be a bit complicated. To give you the full picture, we consulted mortgage experts and broke down the rules.

‘Can I refinance an existing mortgage while buying a second home?’

There’s nothing wrong with refinancing one mortgage at the same time that you are buying an investment property or second home with a mortgage, according to Andrew Weinberg, principal and licensed mortgage broker at Silver Fin Capital Group, in Great Neck, NY.

The key factor to making both the refinance and new purchase work is to ensure you will qualify for the new home loan.

“This means taking into account your current home payment,” says Ralph DiBugnara, president of New York’s Home Qualified and vice president at Cardinal Financial. A mortgage bank can very easily tell you the total payments and loan amounts you’ll be able to carry based on your current income.

In some cases, you may even have to refinance to reduce your current mortgage payment to qualify for the new loan. Or you may need to cash out funds from the refinance to come up with the down payment on the new property.

The only ironclad rule is that you can’t refinance a primary residence while applying for a mortgage on a new primary residence.

Consider working with one lender for both mortgages

The benefit of doing both loans—refinancing and obtaining a new mortgage—is that you can deal with a single loan officer and provide most of your documents (e.g., tax returns, W-2s, pay stubs, bank statements, etc.) only once.

You can also optimize your loan balances and your monthly payment to a degree by doing both loans with the same lender, says DiBugnara.

If you need to work with two different lenders, both need to be aware of the other loan.

When refinancing and buying at the same time isn’t a good idea

You shouldn’t refinance a home you intend to sell in the next six months or so because it’s not cost-efficient.

“The closing costs don’t vary because you intend to pay off your loan in a short period of time,” says Weinberg.

Additionally, most refinances have a clause stating the borrower must stay in the home for at least one year. This means you cannot refinance a primary residence, close on a second home, and then immediately move into it permanently.

The differences between an investment and second home

When applying for your second mortgage, your lender will take into account how you plan on using the property. So it makes a difference if the second home is for investment purposes or is a vacation home for personal use.

“If the home is an investment, you can use proposed rental income as an add-on to your second income when qualifying for the second mortgage,” says DiBugnara.

But if you’re purchasing a vacation home, the new debt will count 100% against your current income and could prevent you from qualifying for a refinance and a second mortgage.

The good news for those looking to buy a beach cottage or winter retreat? Vacation home mortgage rates are typically lower than investment home rates.

“You can also typically put less money down—sometimes just 10%,” says Kylie Pak, owner of RedBrick Properties, in Richmond, VA, who specializes in property investing.

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How Much Is Capital Gains Tax on Real Estate? What Homeowners Need to Know to Avoid It

March 27, 2019

how much is capital gains tax on real estate

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What is capital gains tax? This is a prime question that might crop up when you sell your home for more than you paid for it. That’s good news for you, but the downside is, you may have to pay taxes on those profits in the form of capital gains tax. Yep, just as you pay income tax and sales tax, home sale profits are subject to taxation, too.

Complicating matters is the new Tax Cuts and Jobs Act, which is changing the rules. So if there’s ever a time to brush up on all things capital gains, it’s right now. Here’s what you need to know.

What is capital gains tax—and who pays it?

In a nutshell, capital gains tax is a duty levied on property and possessions you’ve held onto for more than a year that you sell for a profit—including your home.

Unlike other investments, home sale profits still benefit from a number of exclusions that might exempt you from capital gains tax entirely under some conditions, says Kyle White, an agent with Re/Max Advantage Plus in Minneapolis–St. Paul.

The IRS gives each person, no matter how much the person earns, a $250,000 tax-free exemption for a primary residence.

“So if you and your spouse buy your home for $100,000, and years later sell for up to $600,000, you won’t owe any capital gains tax,” says New York attorney Anthony S. Park. However, you do have to meet specific requirements to claim this exclusion:

  • The home must be your primary residence.
  • You must have owned the home for at least two years.
  • You must have lived in the home for at least two of the past five years.

 

If you don’t meet all these requirements, you may be able to take a partial exclusion for capital gains tax. For more information, consult a tax adviser or IRS Publication 523.

How much capital gains tax will you have to pay?

For capital gains over that $250,000-per-person exemption, just how much of a bite will Uncle Sam take out of your real estate sale? In the past, that depended on your tax bracket. Under the new tax law, capital gains rates are now based on your income, explains Park. Let’s break it down.

  • You’ll pay 0% in capital gains if… You’re a single filer earning less than $39,375, married filing jointly earning less than $78,750, or head of household earning less than $78,750.
  • You’ll pay 15% in capital gains if… You’re a single filer earning between $39,376 and $434,550, married filing jointly earning between $78,751 and $488,850, or head of household earning between $52,751 and $461,700.
  • You’ll pay 20% in capital gains if… You’re a single filer earning more than $434,550, married filing jointly earning more than $488,850, or head of household earning more than $461,700. For those earning above $488,850, the rate tops out at 20%, says Park.

 

Don’t forget, your state may have its own capital gains tax. And very high earners may owe an additional 3.8% net investment income tax.

Do home improvements reduce capital gains tax?

How much capital gains tax you’ll pay may also be reduced because of home improvements you’ve made. The money you spent on any home improvements—such as replacing the roof, building a deck, replacing the flooring, or finishing a basement—can be added to the initial price of your home to give you the adjusted cost basis of your home.

For example, if you purchased your home for $200,000 in 1990 and sold it for $550,000, but over the past 29 years have spent $100,000 on home improvements, that $100,000 would be subtracted from the sales price of your home this year. Instead of owing capital gains taxes on the $350,000 profit from the sale, you would owe taxes on $250,000. In that case, you’d meet the requirements for a capital gains tax exclusion and owe nothing.

Take-home lesson: Make sure to save receipts of any renovations and repairs, since they can save you big-time come tax filing season.

How capital gains tax works on inherited homes

What if you’re selling a home you’ve inherited from family members who’ve passed away? The IRS also gives a “free step-up in basis” when you inherit a family house. But what does that mean?

Let’s say Mom and Dad bought the family home years ago for $100,000, and it’s worth $1 million when they die and leave it to you. When you sell, your purchase price (or “basis”) is not the $100,000 your folks paid, but instead the $1 million it’s worth on their date of death.

How to avoid capital gains tax as a real estate investor

If the home you’re selling is a second home (i.e., vacation home) rather than your primary residence, avoiding capital gains tax is a bit more complicated. But it’s still possible. The best way to avoid a capital gains tax if you’re an investor is by doing a 1031 exchange. This allows you to sell your property and buy another one without recognizing any potential gain.

“In essence, you’re swapping one investment asset for another,” White says. He cautions, however, that there are very strict rules regarding timelines and guidelines with this transaction, so be sure to check them with an accountant.

If you’re opting out of the rental property investment business and putting your money in another venture, then you’ll owe the capital gains taxes on the profit.

Cathie Ericson contributed to this report.

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I Survived An Audit (and It’s So Not What You’d Expect)

March 26, 2019

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It was just a regular day: I opened my mailbox, grabbed the pile of what I assumed was a combination of junk mail and bills, and then I saw it—an envelope from the IRS.

At first glance, it looked like a bill, a big one. But as I scrutinized the letter more carefully, I realized it was much worse: I was going to be audited by the IRS.

IRS audits are the stuff of nightmares, but I’m here to tell you that I survived. In fact, although I was terrified at the time, the process wasn’t nearly as frightening as I thought it would be. In an effort to help demystify this process, here’s a reality check on all things auditing-related, from who gets audited to how to cope if it happens to you.

The good news about audits

Here’s the good news: “Audits, in general, have been going down year over year,” says Mike Savage, CPA and CEO of 1-800Accountant in New York City. “They don’t happen as much as people think they do, and the full-blown audit is something of the past.”

“[The number of audits] is below 1%,” says Francine Lipman, a tax law expert and professor at the University of Nevada, Las Vegas.

Tax audits may drop even more in the coming year. The Tax Cuts and Jobs Act of 2017, which went into effect for the 2018 tax year, significantly increased the standard deduction. This means that most homeowners are going to take it rather than itemize. According to Lipman, this lowers the chances of being audited, since the standard deduction is the same for all who take it, rather than being calculated based on your expenses.

What triggers an audit?

Certain red flags on a tax return may prompt the IRS to take a closer look. Here are some of the most common.

The home office deduction

When it comes to the home office deduction, “the rules are complicated and strict,” says Savage. “Most people mess them up. Your [home] office has to be 100% for business. You can’t even share the computer with your kids or use that space for anything at all other than your business.” So if you take this deduction, do so with care—and here are some suggestions for avoiding the mistakes people often make.

Tax credits

This is one of the areas most scrutinized by the IRS. “About one-third of all audits are on the earned-income tax credit,” says Lipman.

Tax credits are a powerful way to reduce your tax bill. Unlike tax deductions, which lower the amount of income on which you will be taxed, tax credits are deducted from the amount of tax that you owe.

For example, if you owe the IRS $5,000 for a given tax year, and you qualify for a $4,000 tax credit, your tax bill will be reduced to $1,000.  Some common tax credits include the child tax credit, which could offer a tax credit of up to $2,000 per child, the child and dependent tax credit, which is a credit based on day care expenses, and the earned-income tax credit, which is a tax credit of up to $6,000.

When it comes to tax credits, the burden of proof is on the taxpayer. This means that if the IRS isn’t sure whether you qualify, it’s up to you to provide the proof.

Proceeds from a home sale

If you purchased your home for $200,000 and you later sold it for $250,000, that $50,000 profit would be subject to capital gains tax. Many home sellers qualify to exclude those proceeds from their taxes, but watch out—once again, the burden of proof is on you.

“You can exclude a significant amount of gain on the sale of your residence,” says Lipman, “but you have the responsibility of proving that you qualified for that exclusion.”

You can exclude up to $250,000 of capital gains on real estate if you’re single, and up to $500,000 of capital gains if you’re married and filing jointly, provided that you meet the IRS requirements, which include:

  • Having owned the home for at least two of the five years before the date of the sale.
  • Having used the home as your primary residence for at least two of the five years before the date of the home sale.
  • Not having used this exclusion for another home sale within two years of the sale date.

Rental property

When it comes to rental property, it can qualify as either an investment or a business for tax purposes. If it qualifies as a business, you can take advantage of the many tax deductions associated with this, including what you spend on advertising, maintaining the property, and insurance.

According to Lipman, for your rental property to qualify as a trade or business, you need to spend 250 hours or more on the property. A hands-on, multiunit property may qualify as a trade or business, but renting out a single-family home may not, so make sure you know where you fall.

Not passing the ‘smell test’

According to Lipman, the “smell test” is whether your tax return makes sense. For example, if you’re a sole proprietor and you have significant losses and no other income, how are you paying your bills? Charitable donations should also line up with your income. According to Michael Raanan, president of Landmark Tax Group and an enrolled agent in Irvine, CA, taxpayers tend to claim about 3% of their income on average as charitable donations.

These aren’t the only triggers, of course. Ultimately, it comes down to the secret formula that the IRS uses to screen tax returns for discrepancies.

If you get an IRS audit notice, how should you respond?

The first step in dealing with an IRS notice: Don’t panic. The notices may give the impression that the IRS has already come to a conclusion. It may look like a bill, but that doesn’t mean you should just pay it.

For example, I carefully read through my audit notice. It looked as if there was a discrepancy with my business expenses as a freelance writer, and the IRS felt that I owed more (a lot more).

For the tax year I was being audited for, I had prepared my own taxes using software. I wasn’t going to deal with the IRS alone, though. So I scoured the internet to find a certified personal accountant who not only had stellar ratings and reviews, but was an “enrolled agent”—meaning that they’ve passed an IRS-administered test about tax laws and regulations.

When I met with her, she was no-nonsense and didn’t seem fazed at all by the IRS notice. She got right down to business and had me gather all my tax documentation, including receipts. I printed out my bank account statements for anything I didn’t have a receipt for and highlighted the relevant expenses.

Once I’d gathered all the right paperwork, my CPA submitted an amended return on my behalf that addressed the issue in question. At the end of the day, I still owed the IRS, but it was a three-figure bill rather than the heart-stopping five-figure one I’d received initially.

And while some audits still involve a visit to your place of residence or work, I was able to handle mine through the mail. It wasn’t the scary, interrogation-room scene I had been expecting.

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