Every once in a while I decide to go and have a little look at the status of my house and check what my mortgage balance looks like.  I don’t look at it that much because, hey, Ive got 25 years left on the loan and nothing has changed much but as I look through transaction after transaction I can’t help but cringe every time I look at the !@#$ PMI payment.  It sort of reminds me of leach.  It sucks a very small amount of blood on any given day, but man is it annoying and over the course of a lifetime really leaks a lot of blood.

Whoa whoa Jesse, what the hell is PMI?

It stands for private mortgage insurance.

It’s what most lenders make you have if you don’t have 20% down payment on your house. What makes 20% the end all be all of lending? Well,mortgage companies have found that if you have less than 20% equity you are are more likely to default on the mortgage. So the good news is that PMI allows you to get into a house sooner such as in my case where I was in college and had a good paying job but not much saved up.  The bad news is that it is money going down the drain.

As it is I pay roughly $70/month in PMI and I have 15% equity in my home.  I would need an extra 15k as of right now to get to 20% equity.  At my current rate that will happen in 2012.  I did some calculations and three years of an extra $70/month would cut off an extra year, an extra $200/month would make it 2 years of paying to cut off the next two.  Thats assuming no house appreciation but at this point who knows with the housing market.  As it stands that additional money would be much better spent on other things, like high interest student loan and getting ready for the new house.  Not to mention my renters (article coming soon) pay the entire mortgage so its just plain easy to let things be.

So in my case guess the leach gets to keep on suckin.

Yes, sucks to be you Jesse, but how about if I do pass the 20% mark?

In that case then yes, you can drop your PMI.  Call your lender to find out who you need to talk to that can get it done.  A lot of times the mortgage company will not drop your PMI on its own, you have to be proactive.  Not only that, but they may try and delay you and/or tell you no.  If it comes to it there was a law passed  a while ago that says that you must be given a written statement as to when you’ll be allowed to cancel your PMI AND the lender must allow you to cancel PMI when your equity is 22% or higher.  So get out there if you’re to that point and save yourself some money!

As you all know there has been all sorts of stuff going on lately.  I thought about writing about the crazy tornado that came through here, less than three blocks away this week but I will wait on that until we go take some pictures today.   In the meantime, there has been an ongoing effort to rent out my house.  Its been quite an experience, thats for sure.  Here is a collection of things I have learned:

1) If you go with a management company it may be easier on you but it may not be worth it.
The absolute cheapest I could find was 9% of rent per month, they hold $400 for “possible maintenance”  regardless of the fact that I will be doing all of the maintenance and they hold renter’s deposit for the entirety.  Considering I am renting my house out for about $1250 per month, add in the “bank charge” and that is approximately $115 per month in rent lost.  Now lets add $120 for lost interest on the $1650 they are holding.  That comes out to $1500 loss per year.  That was a lot for me to swallow.

2) Nothing is a done deal until its actually in writing
I have had 3 different renters so far that have been “sure” only to have things come up.  Nothing is a done deal until it really is a done deal.

3) Try to find people you know
The easiest tenants to find are those that you know need a place.  In my case I have been  attempting to go through my brother to get his friends into the house.   The jury is still out but hopefully the guys that are interested work out.

3) Advertise Advertise Advertise
I underestimated  what it would take to get people into my house…I figured “its a college town and my house is better than most” which is absolutely true…the problem is that most students are going through management companies so none know about my house. Sign out front, ads in the paper, ads on facebook, ads at the college, the list goes on and on.  If you’re not into the “property scene” you are facing bigger hurdles.

5) Keeping your house in showable condition is tough
Especially when there are people living in it.  Its a constant job to keep things in the proper condition.

Anyone else been through trying to do this?  Any additional tips? Thoughts?

One readers email reads: “Jesse, you post less than half the time anymore. I love Matt but are you forsaking us?” As many of you know by now, I got engaged this month. Well I have some other big news: we are building a new house. Thats also why I haven’t been able to post as much lately.

I hadn’t posted on it yet because there has been a ton of haggling and shinanogans going on to make things work. The short story is that my fiance lives a ways outside of Fort Collins, while I live in the college area of Fort Collins. We are remedying this by compromising: building a house right outside of town in a brand new development area. Its a seven step process:

1) Find plot we like
2) Have BBQ and drink beer
3) Negotiate with builder
4) Have BBQ and drink beer
5) Sell Lauren’s house & rent out Jesse’s house
6) Build house
7) Have BBQ and drink beer

First the plot we liked:

Its hard to see there, but behind us is the mountains with a great view. Ill have to put up another pic sometime. Next we picked our house:

Next the negotiation:

Something to keep in mind when you are negotiating when building a new home particularly in the case of a semi custom home is that the builder probably has pre-arranged incentives that may or may not be flexible. For national builders a lot of times they are not too flexible on what they will do simply because they deal in so many masses that it is not worth it to try and bend to every potential buyer. But here are my tips that we used successfully to get roughly $32,000.00 off in incentives and add ons.

1)  Ask about incentive programs
Many times the builder will have some sort of program where they will take money off of the base price of the house if you use their lender.  The trick here is to make sure that if you do use their lender, make sure to insist that the builder also pay closing costs.  The reason for this is that if they are not paying closing costs you may end up with very high closing costs due to the lender knowing you are “stuck with them.”  If the builder is paying the closing costs (which 90% will agree to according to my credit union) their lender will have a harder time trying to tack extra points onto closing.

2) Ask for more
In our case to upgrade the basement from 740 feet to 1500 feet it was an $8000 upgrade.  The builder wouldn’t budge on this but they did offer an extra couple of grand at the design center (non structural upgrades).

3) Have other options
If you are willing to walk away from the builder, many times they will do extra to get you to come back.  Having real alternatives gives the ability to play one builder against another.

Ill be adding and updating as we go along in the process, things are heating up!

Even though things are correcting right now, a lot of people have seen the value of their home double or more over the last eight years, creating an interesting alternative retirement plan for those who did not previously have one.  Great, if you are in that position.  The money train is arriving.  But the most important question for those who are planning not only to live in their house, but to live off of it is, what is the best way to get to my equity?  An interest only home equity is no good, that adds another bill and the interest rate is going to be higher than my rate of return on the money I pull out.  It also doesn’t get rid of any existing mortgage debt.

For some of the more “senior” Americans in this position, the reverse mortgage has become a popular solution to all of these questions.  But what is a reverse mortgage, how does it work, and is it really a good idea?

What is a Reverse Mortgage?

A reverse mortgage is, “a special type of loan used by older Americans to convert the equity in their homes into cash. The money from a reverse mortgage can provide seniors with the financial security they need to fully enjoy their retirement years.”

Just like a traditional mortgage it is a loan against your house, but unlike a traditional mortgage, it is not used to purchase the property, but to extract the equity in either the form of a line of credit or a monthly payout.

How does a Reverse Mortgage Work?

The concept of a reverse mortgage is surprisingly simple.  It is the opposite of a traditional mortgage (forward mortgage).  In a traditional mortgage a loan is issued to the homeowner, generally for the purchase of property, and payments begin immediately, allowing the homeowner to pay the principal down over a period of time.  Assuming we are talking about fully amortizing loans, the homeowner will be able to pay the mortgage off in full at some point in the future, commonly 30 years.

A reverse mortgage also issues a loan to the homeowner, however the homeowner does not make payments on this loan.  Ever.  Instead a first position lien is placed on the property, and the homeowner may receive either a line of credit for some portion of the equity or annuity like payments that will be guaranteed for life.  Interest accrues on the loan and is never paid off.  Rather the balance continues to grow every month.  Upon the death of the homeowner, the mortgage company takes possession of the house unless the heirs make arrangements for repayment of the debt.

What are the benefits to a Reverse Mortgage?

1. If the homeowner is at or near retirement age and continues to struggle to make end meet due to the burden of a mortgage payment, this will relieve them of the monthly payment.  This is a big relief to many retirement age homeowners wanting to retire, but worried about their mortgage payment.
2. This allows the homeowner to use the equity in their house as a retirement fund without having to sell and move.  Many older homeowners have spent the greater part of their lives in their final house.  Many have seen their children grow up there, and have deep roots in the neighborhood.  Selling the house would be a painful option.

What are the drawbacks to a Reverse Mortgage?

1. The interest rate is typically 1.5-2% higher than traditional mortgage rates.  Anyone thinking about using a reverse mortgage should consider comparing the cost and benefits of using a cash out refinance traditional mortgage.
2. The other costs are fairly high.  There is an origination fee which will be the greater of $2000 or 2% of the maximum qualifying amount.  There is typically a mortgage insurance premium equal to 2% of the lesser of the value of the house or the maximum qualifying amount in the first year and 0.5% of the loan balance annual after that.  There are also appraisal fees and a litany of closing costs.
3. The likelihood of keeping the house in the family after the death of the homeowners is unlikely.  However, for anyone considering a reverse mortgage, the likelihood is low under any other option as well.

Is a Reverse Mortgage a good solution?

As an absolute last resort if you are completely desperate.  The high closing costs mean you will lose out on large chunks of equity so you are better off selling and moving into a smaller house or apartment if possible.  There are also various government programs for seniors that want to keep their houses (aside from SS, there are property credits, etc).

Matt:

Real estate is not an investment, it is a liability. Getting rich through real estate is completely based on your ability to distinguish between “good” and “bad.” That, Jesse my friend, is called speculation. But even taken a step further: your home is real estate, real estate is not an investment…you get the picture.

When you buy real estate at the market price, what exactly makes you think you will make a profit at some point? Is it because you think the home will appreciate in value? What makes you think that? The common answer of “because it always appreciates” is the sort of soft logical fallacy a lot of the banker lemmings used to decide to loan money to anyone with a pulse (and some without pulses). What makes you think that with any improvements you make your outcome will be greater than your investment (time + money) put in? Ah, whats the word for that again? Oh yeah, speculation my friend. A mutual fund is an investment, your home is not. And yes, this line of reasoning works…I know you are going to say “but mutual fund increasing over time is based on historical data” but one particular piece of real estate is akin to one particular stock: may or may not increase.

All of that aside, the definition of an investment is something that puts more cash in your pocket than it takes out on a consistent basis. So something that you put money into every month, including interest that goes directly down the drain, is not only not an investment but the antithesis of an investment.

Lets get back to that speculation thing. When you go to sell your house in ten years there are three outcomes: you sell your house for less than you bought/built it for, you sell your house for comparable to what you bought it/built it for, or you sell it for less than you bought it/built it for. When you factor in transaction costs, that means you are throwing away thousands no matter WHAT you sell it for.

Another thing we can’t forget is that you don’t even REALLY get to own your own land/house. Don’t pay your property tax? Now your stuff is the government’s stuff. Even worse news, you can pay your property tax on time for 100 years and the government wants to build a road through the middle of your house? Now your stuff is the government’s stuff (This is called eminent domain).

Jesse:

Well Matt, I know you’re pretty clever for an economics major (just kidding all you eco majors out there) but really, if pessimism was a sport you would be Babe Ruth. Just to set the record straight the definition of investment is actually “the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value.”

I understand your line of thinking about appreciation, but lets use some common sense here: when was the last time the average house depreciated over the course of say, 10 years. Your argument may work on flipping real estate but when applied to your HOME it disintegrates faster than a UN resolution in Iran.

The thing is, I can’t remember the last time I lived in my mutual fund. I’m pretty sure I won’t be able to convince my girlfriend that my well diversified portfolio is a great place to come lounge around and I don’t think my friends will like it much either. This alone should be enough to put the argument to rest but lets look a little deeper anyway. Over the course of time you can either be building equity for yourself, or for someone else. So basically you either have some degree of speculation while building equity (buying) or you have a guaranteed negative return (renting). Which one of those two sounds better? Not only that but lets say you have other people living in your home (as I do) that pay you rent. Now they are building you equity too.

Then there is that little tax thing. Ah yes, taxes. Turns out, you can deduct a whole ton of things (you do read my articles, right Matt? ) if you own a home.

What shall we talk about next? How about capital gains. I love talking about how much I hate capital gains. Every bit we make on our mutual funds we get to pay out a piece in capital gains taxes. Guess what, gains made on your home sale are capital gains free. Thats right, 15% bonus my friend.

Finally lets take a worst case scenario, lets say there is a massive economic collapse. Which is more likely to hold up, your stocks or your land/home? Thought so.

It should be noted both Jesse and Matt own homes and understand there are pros and cons on each side.

Having finished my taxes I was thinking about just how nice it is to own a home. If I did not own one I would have owed the government money, as it is I got a refund. So what exactly are my favorite tax deductions for home ownership? Glad you asked:

1. Mortgage Interest

You can deduct all your interest payments for your home (up to a certain amount which I have not reached). This is the biggest deduction and the one that makes the biggest dent in my taxable income.

2. Property Taxes aka real estate taxes

Property taxes are fully deductible from your income. You can’t deduct escrow money held for property taxes until the money is actually used to pay your property taxes. A city or state property tax refund reduces your federal deduction by the same amount.

3. No Capital Gains

Ok so this isn’t really a deduction, but its even better. As most of you know by now I love capital gains like I like a swift kick to the face. Thanks to the Taxpayer Relief Act of 1997, buying a home can be a tax shelter. Married taxpayers who file jointly now get to keep, tax free, up to $500,000 in profit on the sale of a home used as a principal residence for two of the last five years. Single people get to keep up to $250,000 tax free. Since I won’t be making $250,000 profit on any home sales anytime soon, I think I can forget about that cap for the time being.

4. Points

Your mortgage lender will charge you a variety of fees, one of which is called “points.” A point is calculated at 1% of the loan principal. At least one point is fairly common and it adds up. One point on a 200k loan is 4 grand. You can fully deduct points associated with a home purchase mortgage. You cannot deduct a mortgage broker’s commission. Refinanced mortgage points are also deductible, provided they are amortized over the life of the loan. Homeowners who refinance can immediately write off the balance of the old points and begin to amortize the new.

5. Home Improvement Loan Interest

If you take out a loan to make substantial home improvements, you can deduct the interest on this loan. There isn’t a dollar limit on this deduction you have to actually be adding something to your house. A good example would be finishing the basement - not just repairing broken things.

How much house can you afford? I recently set out to figure how exactly how much house I can afford and found out its a more interest question than you might think.

First piece for how much house you can afford: Income
The most general rule about how much house you can afford is to multiply your annual gross income by two and a half traditionally. I personally think multiply your income by 3 is a little more realistic for most people. Theres factors that raise or lower this but its a great baseline to see what your general range is. For example if you make 60k a year, you can, in general afford a house around 150-180k. If you are a couple and make say 100k combined you could afford 250-300k.

Second piece for how much house you can afford: DTI and HER
To determine how much house the bank thinks you can afford they use guidelines called debt-to-income ratios and housing expense ratios. Thats a fancy way of saying “how much you make vs how much you have to pay out every month on. Its the percentage of your month gross income before taxes that is used to pay your monthly debts. Because there are two different ratios they are written in a slash format. Front ratio vs back ratio. The front ratio is the % monthly gross income that is used on housing costs. The back ratio is the same thing except that it includes all of your debts. Thats great and all but the truth is that it is flexible and doesn’t necessarily the best indicator of how much you really can afford- one way or the other.

Third piece for how much house you can afford: Credit score
This might seem obvious but it makes a huge difference in price range. If you have great credit, you can get the best rates. If you have poor credit you cannot get near as good of rates if you can get a loan at all. Fort example taking the best rate today on my credit unions website for a 30 year fixed loan: 5.75%

Lets say you have perfect credit and get 5.75% rate on a $250,000.00 30 year fixed loan. Your monthly payment aka how much house you can afford would be about $1458.00 per month. Lets say you have a credit score a little lower, say 689. Still good, but not perfect…your rate would be more like 6.3% which would give you a monthly payment of $1547. Thats right, almost $90/month more per month for 30 years!

Some other factors to consider:

Mortgage type - If you can only afford it using an ARM, this is more house than you can afford.

Utilities - How much do you anticipate spending on utilities? Remember, the bigger the house, the more utilities are going to cost.

Maintenance - HOA fees can have a large impact on how much house you can afford

Closing Costs - how much house you can afford is actually a little less than you think simple because there are closing costs that include taxes, title insurance, financing costs, realtor costs etc.

Repairs/Remodeling - Does the house require changes once you DO buy it

Furniture etc - Filling out the house can be VERY expensive

Property Tax - There are taxes levied by city county etc that you will have to pay.

PMI - Private mortgage insurance. If you can’t come up with 20% of the purchase price you will generally have to pay PMI which can be 50-200 bucks a month.

Something for couples to consider:

Should you use both salaries in your “how much house can I afford calculations” and mortgage qualifications?

Only if you’re sure both of you will continue to be employed. If one of you becomes disabled or decides to stay home with the children, you’ve cut your income significantly. When it happens, you’ll be happy if you qualified for a mortgage using only one of your incomes. On the other hand if you are both working good jobs and are planning on building your careers then yes absolutely especially if it gives you the quality of life that you are looking for.

So how much house can you afford Jesse? 
Well I am not going to tell you that :)  But I will say that the house I like is right on the border and depends on a bunch of other factors.

The Case Shiller Index released its monthly/yearly review:

WASHINGTON (Thomson Financial) - The collapse of US home prices was spread across the whole country according to the S&P/Case-Shiller Home Price Indexes released today, while the price index compiled by federal housing regulators showed a much less dramatic decline.

The January S&P/Case-Shiller 20-city price index was down 10.7 pct from the year before, in line with expectations of a 10.5 pct decline. The January-to-December decline was 2.4 pct.

Case Shiller index? What the hell is that?
The Case Shiller index is an index based on 20 cities that follows the residential real estate market in 20 large cities in the US.  Case Shiller uses repeat sales pricing to evaluate the housing market.  It was developed by Karl Case, Robert Shiller and Allan Weiss.  Weiss obviously got the short end of the naming stick.

Why is Case Shiller Index not even close to the Fed index?
The reason it is a far cry from the fed numbers released earlier this week is that the fed OFHEO stats are adjusted based on the season and the Case Shiller Index is not.

What does the Case Shiller Index release mean for me?
Probably nothing - we already knew prices would go down as foreclosures add up.  The long short of it is, if you are looking to buy, its going to be a good time.  If you are looking to sell, you are going to be selling a good amount lower than you would have in the past few years.

I am writing this in response to this article entitled “Why Dont more Americans give a damn about the environment.”  Actually I should have titled this article “Why I dont give a damn about people telling me to give more of a damn about the environment” but then, thats not nearly as hooky is it?

Now, the truth is I love The Dough Roller, so before anyone gets too upset Ill preface with that….but now it is time to be a hardass devil’s advocate.

I hate to interrupt the touchy feely America hating, green loving fest but I have some news, America is headed in the right direction, and most of the world is not.  Many American businesses are voluntarily doing things to help …I remember when working at HP the amount of time and money that went into computer recycling.

Whoa wait, America consumes <numbers about what we consume> and pollutes <numbers about polluting>! but the truth is Americans as a whole are actually becoming greener and greener.

In 2006, total U.S. greenhouse gas emissions were 7,201.9 Tg CO2 Eq. Overall, total U.S. emissions have risen by 14.1 percent from 1990 to 2006, while the U.S. gross domestic product has increased by 59 percent over the same period (BEA 2007). Emissions fell from 2005 to 2006, decreasing by 1.5 percent (111.8 Tg CO2 Eq.).  All of this while global warming is suddenly in question again because it is now cooling, and the polar ice caps that had melted regrew this year.

China on the other hand is rapidly increasing its CO2 emissions as well as other pollutants.  India is doing the same.  I have been a couple hands worth of European countries and guess what: a lot of them are a lot less concerned about doing environmentally sound things than we are here, the difference is often overlooked:

America is a big space with less people and we have the ability to spend more resources than anywhere else in the world.  It boils down to that.  A lot of individuals in places in Europe, if they could drive SUVs and live in 5000 SQ foot houses, would.  For trucks to bring food to Colorado from the coasts, they have to drive a LONG way.

The truth of it is, many Americans are trying very hard to be green but still enjoy a nice standard of living.

Its true there are problems.  I do believe the oil industry has stifled alternative technologies for many years now and I do believe many people are much too wasteful. My family owned a solar business and my dad went out of business due to oil companies lobbying against the solar industry.  I have no love for them, nor our dependence on oil, nor our production of CO2 or pollution.

On the other hand, all of the talk about Americans being the least caring, etc…  Much of it has been used to advance political agendas from George Bush hopping on the bandwagon to Al Gore who, despite his famous movie and prize he got lives in two properties: a 10,000-square-foot, 20-room, eight-bathroom home in Nashville, and a 4,000-square-foot home in Arlington, Va. (He also has a third home in Carthage, Tenn.) while flying around in a private jet. AND according to public records, there is no evidence that Gore has signed up to use green energy in either of his large residences.

Here is what it boils down to: I have faith in all of you that you are being green, while remaining economically sound.  Do not do things that will put your finances in jeopardy if you cannot afford it.  While putting up solar panels would be great, if it will damage you financially, wait until you can afford it.

For those who are steaming angry right now, I have some bad news if you are wanting to flame me about my selfish environment killing self: I live in 1400 sq foot house, and my water is heated by two large water drainback solar collectors (designed by my father who owned a solar business).  My bulbs are all CFLs, I ride a 60 mpg motorcycle in the summer, and my yard is filled with four 75 foot trees, as well as 3 pines, 1 crab apple, 2 maples, 1 green apple and a bunch of bushes and I recycle.  I will even include a google maps picture below:

It may have seemed like a good idea at the time, but it you will pay for it long term.

Ah yes, the cancer that is Interest only ARMs. So for those of you who aren’t quite sure what it is:

An interest only ARM is an ARM (Adjustable Rate Mortgage) where for a set amount of time the borrower pays only the interest on the principal balance, with the principal not being paid down at all.

Several years ago banks went kind of crazy lending and started handing out ARMs like they were on a mission. Well, they were on a mission - lend to as many people as possible, regardless of whether those people could afford it or not. That in and of itself means big trouble but at least homeowners could build some equity in that time.

This is where the interest only ARM came in. Interest only ARMs are the same concept except that homeowners (and I use that word loosely) only pay interest on the principal - basically banking on their home appreciating. There is one major problem, housing prices were very inflated and so now we have people with houses they couldn’t afford in the first place with their interest rates resetting to high rates while they have effectively LOST equity in their houses.

I heard one guy call into talk radio and say he has three houses with interest only ARMs that he bought assuming he could flip them but now he cant even sell them below market value…and he is about to foreclose on all three.

Here is the lesson, I want all of you readers to make me this promise: “I reader hereby do solemnly swear that I will not get an interest only ARM or an ARM of any kind for that matter and I will tell my kids to never get an ARM too.”