Is a Home Equity Loan an Option?

Here's the scenario: you have a project and need to borrow some money, but you want to do it in the most economic manner.  You've got a low rate on your existing first mortgage and don't want to do a cash-out refinance and pay a higher rate.  Is a home equity loan an option?

Prior to 2018, homeowners could have up to $100,000 of home equity debt and deduct the interest on their personal tax return.  The Tax Cuts and Jobs Act of 2017 eliminated the home equity deduction unless the money is used for capital improvements.

Regardless of the deductibility, lenders will still loan money to owners who have equity in their home and good credit.  The most common reasons people borrow against their home equity are:

• Consolidate debt with higher interest rates
• Make improvements on their home
• Refinance an existing home equity line of credit
• Down payment for another home or rental investment
• Creating reserves or available access for potential needs

One available loan is a fixed-rate home equity loan, commonly referred to as a second mortgage.  It is usually funded at one time, with amortized payments for terms that could range from five to fifteen years.

Another option is a home equity line of credit or HELOC, where a homeowner is approved for up to a certain amount at a floating-rate over a ten-year period.  The borrower can draw against the amount as needed and would pay interest every month and eventually, pay down the principal.

The amount of money that can be borrowed is determined by the equity.  Lenders generally will not exceed 80% of the value of the home.  If a home was worth $400,000, the 80% ceiling would be $320,000.  If the homeowner had an unpaid balance on their first loan of $240,000, an amount up to $80,000 would be possible.

The next variable is the borrowers' credit score which will determine the rate of interest that will be charged.  The higher the score, the lower the rate the borrower will pay.  And the converse is true, the lower the score, the higher the rate.

Another common variable considered is the borrowers' total debt to income ratio.  Ideally, the combination of regular monthly debt payments should not exceed 43% of their monthly gross income.

If you have good credit and an adequate amount of equity, your home could be the source of the funds you need.  There is a lot of competition among lenders and shopping around can make a difference.

Call us at (215) 641-2500 for a recommendation of a trusted mortgage professional.  If you have questions about whether the interest on the loan will be deductible, talk to your tax professional.

Home Inventory

Generally speaking, when you need an inventory of your personal belongings, it is too late to make one.  Sure, you can reconstruct it but undoubtedly, you'll forget things and that can cost you money when filing your insurance claim.

Most homeowner's policies have a certain amount of coverage for personal items that can be 40-60% of the value of the home.

Homeowners who have a loss are usually asked by the insurance company for proof of purchase which can come in the form of a receipt or current inventory of their personal belongings.

The most organized people might find it difficult, if not impossible, to find receipts for the valuable things in their home.  Think about when you're rummaging around a drawer or closet looking for something else and you discover something that you had totally forgotten that you had.

An inventory is like insurance for your insurance policy to be certain that you list everything possible if you need to make a claim.  Systematically, make a list of the items by going through the rooms, along with the drawers and closets.  In a clothes closet, you can list the number of shirts, pants, dresses and pairs of shoes but higher cost items should be listed separately.

Photographs and videos can be adequate proof that the items belonged to the insured.  A series of pictures of the different rooms, closets, cabinets and drawers can be very helpful.  When video is used, consider narrating as it is shot and be sure to go slow enough and close enough to see the things clearly.

For more suggestions and an easy to use, interactive form, download a Home Inventory, complete it, and save a copy off premise, either in a safety deposit box or digitally in the cloud if you have server-based storage available like Dropbox.

Standard or Itemized Deductions

The Tax Cuts and Jobs Act of 2017 increased the standard deduction to $24,000 for married couples.  There will be some instances that homeowners may be better off taking the standard deduction than itemizing their deductions.  In the past, homeowners would most likely be better off itemizing but the $10,000 limit of state and local taxes (SALT) adds one more issue to consider.

Let's look at a hypothetical homeowner to see how a strategy that has been around for years could benefit them now even though they haven't used it in the past.  The strategy is called bunching; by timing the payments in a tax year so that they can be combined to make a larger deduction.

Let's say that the married couple filing jointly has a $285,000 mortgage at 5% for 30 years that has about $14,000 in interest being paid.  The property taxes are $6,000 and they have $4,000 a year in charitable contributions for a total of $24,000 of allowable itemized deductions on Schedule A.

Since that deduction amount is the same as the Standard Deduction, there is no monetary advantage one way or the other.  However, if the taxpayers were to pay their interest because they must make timely house payments but only pay $2,000 of the 2018 property taxes in December of 2018 and the balance of the $4,000 in January, they transfer part of the deduction into 2019.

Additionally, if they make their intended charitable contribution for 2018 in January of 2019, it makes that deductible on the 2019 return.

Since the total deductible amounts paid out in 2018 was $16,000, the taxpayers would have an $8,000 benefit that year from taking the Standard Deduction. 

Assuming they made the same $4,000 charitable contribution in 2019 during the year and paid the house payment and property taxes on time, their total deductions for 2019 would be $32,000 which is $8,000 more than the Standard Deduction.

In this example, the taxpayers in 2018 and 2019, would benefit a total of $16,000 in tax deductions by bunching and electing to take the standard deduction one year and itemizing the next. 

This is only an example but if your situation is similar, it might benefit you to consider an alternative when to take the standard deduction and when to itemize.  This is a conversation you need to have with your tax professional to see if it would work for you.

Eliminate FHA Mortgage Insurance

Mortgage insurance premium can add almost $200 to the payment on a $265,000 FHA mortgage.  The decision to get an FHA loan may have been the lower down payment requirement or the lower credit score levels, but now that you have the loan, is it possible to eliminate it?

Mortgage Insurance Premium protects lenders in case of a borrower's default and is required on FHA loans.  The Up-Front MIP is currently 1.75% of the base loan amount and paid at the time of closing.  Annual MIP for loans with greater than 95% loan-to-value is .85% per year. 

For loans with FHA case numbers assigned before June 3, 2013, when the loan is paid down to 78% of the original loan amount, the MIP can be cancelled.  The borrower may need to contact the current servicer.

However, for loans greater than 90% with FHA case numbers assigned on or after that date, the MIP is required for the term of the loan.

Most homeowners with FHA mortgages are not eligible to cancel the MIP because they either originated their loan after June 3, 2013, put less than 10% down payment and/or got a 30-year loan.  If they have at least 20% equity in the home, they can refinance the home with an 80% conventional loan which in most cases, does not require mortgage insurance.

With normal amortization on a 30-year loan, it takes approximately 11-years to reduce the original loan to the 78-80% requirement based on normal amortization.  There is another dynamic involved which is the appreciation on the home.  As the home goes up in value and the unpaid balance goes down, the equity increases.

If the homeowners believe that they have enough equity that would eliminate the need for mortgage insurance, they can investigate refinancing with a conventional loan.  Borrowers refinancing will incur expenses in starting a new mortgage and the interest rate may be higher than the existing rate.  Analysis will determine how long it will take to recapture the cost of refinancing.

Call me as (215) 641-2500 for a recommendation of a trusted mortgage professional.