For the past 3-4 months there has been a form of moratorium on foreclosures set up by the present administration. Most institutions with delinquent mortgages have not foreclosed and your tax money has been used to cover the bank losses during this period (dumb move). There are only a few foreclosure signs in the neighborhoods, but, the rest of the banks are rushing to get their properties onto the market.

From December 2008 until March 2009 the number of bank asset managers inquiring about foreclosures dropped by 80%. Recently, the number of inquiries has skyrocketed as they see the inventory coming to market. Expect a flood of new properties in June.

Many investors entered the market too early and are now unable to “flip” the properties. They will now have these same homes foreclosed on them.

All of the administration’s efforts to revive the housing markets have failed. Those who are losing their jobs cannot buy homes, interest rates are rising, crowding out buyers and prices are continuing to fall.

Rental properties now have negative cash flows and will also come onto the market. In addition, builders are being supported in states like California. The state is providing a $10,000 credit to buyers of new houses bought directly from builders on top of the $8,000 Federal Credit. This encourages builders to build more houses that are not needed. It is estimated that more than 500,000 new homes will be built this year.

Lastly, many second homes were bought from the equity in people’s primary residence. Many of these homeowners need cash so they are selling the vacation homes which adds more inventory.

So with the end to the foreclosure moratorium and unemployment increasing it shows that more foreclosures are on the way. Keep you powder dry as there will be GREAT opportunities for you to make “buys” as prices continue to erode.

Here are Ric’s top ten reasons for keeping a mortgage along with my thoughts. There is a link at the end of the article so you can read the whole article. I welcome your questions at any time.

Reason #1: Your mortgage doesn’t affect your home’s value.

True, your home value goes up or down whether or not you have a mortgage. Your home does not know it has a mortgage. Go ahead…stand in front of your home and ask your home if it has a mortgage or not.

Reason #2: You’re going to build equity anyway.

True, equity is built in two ways
• Through increases in the value of your home
• Through principal paid monthly. (which is very small in the opening years) Any cash put into your home earns a zero (0) rate of return. Stay with the home values increases to build your equity.

Reason #3: A mortgage is cheap money.

Also true, as long as interest rates are low. When inflation is high this leads to higher interest rate. Thus, your future mortgage payments in an inflated environment mean you are paying back in cheaper dollars. Thus, rates are cheap in most situations on a relative basis.

Reason #4: Mortgage interest is tax-deductible.

True again, as long as you can itemize deductions. If your income is too high, then these deductions are not available. To circumvent this, you can run the mortgage interest expense through your side business LLC, so it is deductable.

Reason #5: Mortgage interest is tax-favorable.

This is tied into #4 but holds true in that our government looks favorably on a mortgage deduction in order for that most people to participate in home ownership.

Reason #6: Mortgage payments get easier over time.

If you have held a mortgage for a long time then this is understandable. In the opening years of paying a mortgage most people are strapped with the payments. As years go by a person’s income goes up while the mortgage payment is a constant. Thus, as a percentage of the higher income the mortgage is a smaller percentage.

Reason #7: Mortgages let you sell without selling.

As your equity increases in your home do not sell the home to get out the equity. Instead refinance, take out the equity, invest those monies rather than leaving them in the home earning a zero (0) return.

Reason #8: Large mortgages let you invest more money more quickly.

The strategy is to place a small down payment and invest the remainder since any cash in the house earns zero return.
Reason #9: Long-term mortgages let you create more wealth.

Consider the after tax cost of your mortgage and invest the difference in a higher tax free return investment.

Reason #10: Mortgages give you greater liquidity and greater flexibility.

A 30 year mortgage gives you more flexibility than a 15 year mortgage. You can always pay off a 30 year mortgage earlier, but, you cannot stretch a 15 year mortgage into a 30 year plan.

See the whole article: http://www.ricedelman.com/cs/education/article?articleId=232

Usually when you ask clients whether they plan to buy a second home for pleasure or investment, the response is “pleasure.” The follow-up questions should then be: “How long do you anticipate owning it?’ Then, “What, if any, growth rate do you expect on the value of the home?” Very rarely are there “rational” responses like “20-plus years” and a “5% or so return” (which is the approximate national residential 20-year average rate of return for a home).

Many buyers anticipate that the value of their second home will double, even though they say it is not an investment.

Often clients will buy on emotional and perhaps irrational factors. They will also base their decisions on some misguided information or misinterpreted facts. The following are some of the more common misconceptions:

A vacation home is a vacation home. A vacation home can be categorized in three different ways: personal, rental, and dual purpose. The one that pertains to your individual circumstance will depend on the days used and the days rented.

I always can deduct my mortgage interest on my second home. With so many affluent clients purchasing McMansions these days, it is not uncommon to see a large mortgage on their primary residence. Remember that you can generally deduct qualified residence interest on up to $1.1 million of home mortgage debt ($1 million worth of acquisition debt on up to two homes plus $100,000 of home equity debt on up to two homes). Any excess interest on home mortgage debt is generally nondeductible. Furthermore, the owner’s overall interest deduction may be lessened due to the itemized deduction phase-out rule for higher-income taxpayers (for 2007 the AGI level is $156,400). This rule is expected to sunset by 2010. As such, if nothing is done, in 2011 it will revert back to full phaseout. (Now there are legal methods that we use with our clients that allow them to deduct interest on well above the $1.1 mm limit).

I always have to report rental income. Rental income is completely tax-free for property that meets the rules for personal-use property, but has a very limited opportunity to generate rental income (generally 14 days or less). From a tax perspective, this can be quite a boon for clients with properties that can be rented at an exorbitant rate for a short time (e.g., properties located near a major golf event, Olympics, or Super Bowl location).

Vacation home donations are always a good idea. Unfortunately, the IRS considers vacation home donation days as personal use days, not rental days, since the owner did not receive a fair market rental for the use if the home. In addition to not qualifying for additional rentals expenses, the owner receives no charitable deduction for donating the use of the home to charity.

I can use the capital-gains tax exclusion ($500,000) upon sale. The exclusion applies only to principal residences.

A 1031 (tax-deferred) exchange can be done on a vacation home. A recent Tax Court ruling (Moore, T.C. Memo 2007-134) disallowed tax-deferred treatment for a personal vacation home. The court held that a couple’s exchange of vacation homes did not qualify for like kind exchange treatment because the homes were not held for investment purposes (as required by § 1031(a)).

Rental income will be offset by cost. With property prices still high, some clients may believe they will offset the cost of a second home by renting it. Unfortunately, clients forget that in order to cover their costs they often will have to rent it out at peak season, coincidently the weeks they want to use it the most.

This is a “business.” Many people say they manage their property and thus “materially participate.” In other words, they are in the business of renting real estate and are able to take losses against other taxable income.

You can go home again. And, finally, do not “impulse buy” while enjoying a vacation. If you have an interest in purchasing real estate at a great place where you vacationed last month, I suggest that you hold off until you have “felt out the neighborhood” for a while, meaning you should visit the location a few more times. You should focus on the commute to work, the community, people, activities, and amenities, and, very important, talk to as many locals as possible, particularly those who have owned vacation homes there for some time. Do you have a similar feeling of happiness each time you visit the location? Are your experiences consistent over time?

The financial ramifications as well as the emotional toll of purchasing vacation homes can be complicated. But understanding these rules and your expectations will open the door to some great discussions with your advisors.

These cyclical actions in the world economy have happened many times before. For most people the 1930’s depression, bank failures and a 30% unemployment rate (after the depression) is something you read about. Yet, you have lived through your own chaos with the dot.com (actually dot bomb) meltdown and the tech wreck bubbles of the late 1990’s. Real estate and stock markets go through classic meltdowns every 25 years.

Those that have foresight, strong stomachs and are contrarians make their wealth by buying near the bottom (Hmmm… seems I heard that before… buy low, sell high).

The Missed Fortune Principles of Wealth Building have been written about many times in this blog. I suggest you review these articles found in the Missed Fortune subheading.

Are the ideas of building your wealth by properly using equity management still valid? Can you still profit by “being your own banker”? Answer… yes, yes and yes again. Who better to learn about banking than the Federal Reserve. I encourage you to read this short excerpt of “The Feds” recent white paper abstract report.
Federal Reserve Abstract Report, Dated March 2007:

Many households face the trade-off between paying an extra dollar off the remaining mortgage on their house and saving that extra dollar in tax-deferred accounts (TDAs) used for retirement. We show that, under certain conditions, it becomes a tax arbitrage to reduce mortgage prepayments and to increase TDA contributions because of the tax- deductibility of mortgage interest and tax-exemption of qualified retirement savings. Using data from the Survey of Consumer Finances, we document that a significant number of households that are accelerating their mortgage payments instead of saving in a TDA forgo a profitable tax arbitrage opportunity. Finally, we show empirically that this inefficient behavior is unlikely to be driven by liquidity or other financial constraints. Rather, the observed behavior can be attributed to a certain extent to the reluctance of many households to participate in financial markets as either lenders or borrowers.

So what am I saying? … Stick with the Discipline of professional investing, or, suffer the Regret later in life.

Simply put…how much interest does your bank pay you on the down payment on your home? (zero, correct). What is the largest down payment anyone could make on an home purchase (100%, or pay cash for it) Therefore, all the money tied up in your home gets a zero rate of return, it is not liquid and it is not safe. Read on.

You’ve got better things to do with your money, like saving for retirement, building an emergency fund or even living it up a little.

You normally don’t think of people who prepay their mortgages as being wasteful or careless.

But a recent study suggests these households blow more than $1.5 billion a year, or $400 per household, by accelerating their mortgage payments instead of contributing more to their non qualified retirement accounts.

The research found that at least 38% of those who were making extra payments on their mortgage were “making the wrong choice.” Instead, these households would get back 11 to 17 cents more on the dollar by putting the money into a non qualified retirement plan.

The study, titled “The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings,” was conducted by Clemens Sialm of the University of Michigan’s Ross School of Business, Gene Amromin of the Federal Reserve Bank of Chicago and Jennifer Huang of the University of Texas at Austin using Federal Reserve data.

If anything, I think the study underestimates how many people make a mistake by prepaying their mortgages. It didn’t look at folks who were accelerating their mortgages while carrying higher-rate debt, or who failed to have an emergency fund, or who didn’t have adequate life, health or disability insurance.

Most people, in short, have much better things to do with their money than to pay off a low-rate, tax-deductible loan.

The urge to be free of debt

It’s not that I don’t understand the impulse to speed up the day that you own your home free and clear. There’s something psychologically satisfying about knowing the bank can’t take your castle.

Besides, the numbers can seem pretty impressive. Let’s say you have a 30-year, $250,000 mortgage at 6% interest. Your monthly payments are $1,498.88. By paying an extra:$100 a month, you could save nearly $52,000 in future interest and pay the loan off 4½ years early.

$250 a month, you could save nearly $100,000 in future interest and pay the loan off nine years early.

$500 a month, you could save nearly $144,000 in future interest and pay the loan off almost 14 years early.

So who wouldn’t go for that, right? Indeed, the study estimated that almost one in six U.S. households (16%) pay extra on mortgages each year.

But anyone who really understands money would realize that the savings aren’t all they’re cracked up to be.

For one thing, mortgages tend to be some of the cheapest money you can get, and, as mentioned earlier, the interest is often deductible. If you’re in the 25% federal tax bracket, that 6% interest rate may be costing you as little as 4.5% if you itemize. (Your tax break depends on the amount of interest you pay and the total of your other itemized deductions.) Even if you don’t get any tax break at all on your mortgage, though, the rate is still dirt cheap compared with that on most other loans.

Furthermore, those seemingly impressive interest savings are way in the future, where their value will be substantially eroded by inflation. For example, $50,000 in 25 years would be worth less than $24,000 in today’s dollars, even at a moderate 3.1% inflation rate.

Contributions to a liquid tax free accumulation and, tax free withdrawal plan will get you a lot further ahead.

Even if you’re contributing the max to your retirement accounts, though, your next step shouldn’t be making another mortgage payment.

Establish priorities

You need to look first at all your other debt. Chances are if you have any, it’s accruing at a higher interest rate than what you’re paying on your home loan. That’s especially true for credit card debt: It makes no sense to save less than 6% by prepaying a mortgage when you’re paying 15%, 20% or even more on your plastic.

What if you’re free of other debt, you can start to tackle that mortgage, right?
Not quite. There are other threats to your financial security you need to address, especially:

Financial inflexibility

Fewer than three in 10 households have enough savings to withstand even three months of unemployment. Half say they live paycheck to paycheck at least some of the time, according to a survey commissioned by the Consumer Federation of America. Having an emergency fund equal to at least three months’ expenses (plus access to a home equity line of credit) can make the difference between a rough patch and financial disaster; that should be your priority after saving for retirement and retiring high-rate debt. But remember if you lose your job and try to tap into an equity line of credit the banker will say “Fat chance”. Your loan repayment is based on your income. Since you do not have a job…No line of credit. Then there’s the issue of:

Inadequate insurance

If you have people financially dependent on you — a spouse who needs your paycheck to pay the mortgage, or minor children — you need life insurance, and usually plenty of it. In addition, you need adequate health insurance, since medical bills are a factor in half of all bankruptcies.

Also crucial: long-term disability insurance, which most Americans don’t have. Fewer than 30% of all workers have long-term coverage, according to the U.S. Bureau of Labor Statistics. Yet our chances of a disabling accident or injury are pretty high: At age 30, for example, you have more than a 50% chance of being disabled for three months or longer before you turn 65, according to the Council for Disability Awareness. One in seven U.S. workers are disabled for five years or more, and disabilities cause 50% of all mortgage foreclosures. Wouldn’t it be ironic if you skipped disability coverage to prepay your mortgage, then wound up losing your house? The bottom line: If you have access to long-term disability coverage at work, buy it.

OK, so what if you’re maxing out your 401(k) and Roth IRAs, sitting on a pile of emergency cash and insured up the ying yang? I still wouldn’t necessarily attack that mortgage. If you have kids, for instance, you might want to be tucking more away into a 529 college savings plan to make sure they aren’t saddled with students loans, as too many young graduates are today. Also, if your home is paid off most financial aid officers are telling parents to pull the equity out of their home before they get any financial aid.

Again, assuming the money is invested prudently in a mix of stocks, bonds and cash, you should make a much better return than what you can get prepaying your mortgage, and the money is tax-free when used for college.

You’ve got to live a little

There’s a final, much more subjective issue to address. Some of the folks I’ve run into who are determined to pay off their mortgages early are what I’ve come to consider “oversavers.” They’re putting aside prodigious amounts for all kinds of future goals, but spending precious little today. Sometimes they’re even straining family relationships by their single-minded focus on being debt-free as early as possible.

That might be OK if any of us were guaranteed long, healthy lives. The reality is that no one is, and we need to strike a balance between saving for tomorrow and living today. The person who’s set on paying off a mortgage in as few years as possible, even if that means skipping vacations and the occasional dinner out with the spouse, is just as out of balance as the person living on credit cards. Remember homes were made to house families not to store cash.

Would you like to learn more? Are you interested in participating in one of our study programs? Drop us an e-mail at founders@foundersgroupinc.net with your name, phone number and one of our team members will contact you to see if you qualify. No obligation.