Last Week on Reddit - September 19 2022

The recap of our last week of helping out home buyers and home sellers on Reddit, brimming with mortgage and real-estate advice from an experienced Realtor and loan officer.

Mortgage Broker is Suggesting a Smaller Down Payment?

Reddit User u/TheBirthdayAuthority asks:

"I always thought it's better to have 20% down but he ran through numbers with me and is it generally correct that putting less down and paying for PMI could actually save you money? I mean, if you don't plan on keeping it for the 30 year length of the mortgage? Or even if you refinance. Seems like in every situation it might be better to put less down, as long as the monthly payment isn't too much for you. Is that right?" Source Thread

u/TheBirthdayAuthority isn’t alone in their assumption, many home buyers mistake this industry standard for a best practice, which isn’t the case for every single buyer. While you do prevent Private Mortgage Insurance (PMI) from applying to your file with a 20% down payment, there’s certain cases where it’s worth taking the increase in monthly payment if you have a plan for the upfront money you’ll save.

As I mentioned in my response:

"It's not "ALWAYS" better to put 20% down. That's what the industry has set for a standard. Take these things into consideration when putting less money down (and in this order):

• Can you afford the payment both ways? 20% and 10% with PMI?

• What are you going to do with the extra 10%? Remodel, pay off debt, invest in the market, buy another home?

• Do you have reserves?

• Also you put less money down, and values drop by 10% you wont be able to refi, if a chance comes up.

• We are entering a dark period in the economic markets, so having some cash could be good for reserves, do you have reserves/rainy day fund?"

Let's break down what I'm talking about here

"Can you afford the payment both ways? 20% and 10% with PMI?"

Affordability is essential. The first thing to take into account is if you’ll be able to maintain your monthly payment in all circumstances.

At lower than 20% down you’ll be paying PMI which will raise your monthly payment until you reach 20% equity, really think and do an analysis of whether this additional cost is manageable and comfortable.

At 20% down your payment will be lower, but you’ll be spending a lot more upfront. Is this withdrawal from your savings leaving you in a precarious position if anything bad happens? Is it still large enough to rely on comfortably in case of emergency?

“What are you going to do with the extra 10%? Remodel, pay off debt, invest in the market, buy another home?”

Since you’ll be paying more every month to cover your PMI, you’ll want to be doing something smart with the money you saved on your down payment. Ideally you’ll be making some sort of investment that will yield more money than the total PMI you’ll be paying until you reach 20% equity.

Remodeling, paying off high interest debt, investing in the market and purchasing another home are all great things to do with the extra 10% this Redditor mentions. Buying a flashy new car or taking an expensive vacation are not recommended.

“Also you put less money down, and values drop by 10% you wont be able to refi, if a chance comes up.”

A pretty big risk when considering a low down payment is getting into negative equity. Negative equity, also known as an “upside-down loan” or an “underwater mortgage”, is what occurs when you owe more than what your home is worth.

How does this happen?

Let’s say you put 5% down on a $800,000 home. You’d have $40,000 in this home at 5% equity, and you’d owe $760,000.

Now let’s say there’s a sudden dip in the market, and your home’s value dropped 20%.

Even though your home’s value has dropped from $800,000 to $640,000 — you still owe the $760,000.

This negative equity situation isn’t necessarily a bad one if you plan on sticking with the home for the long run, and can still afford your monthly payments — the market always recovers and you’ll end up just fine. Although you won’t be able to leverage the equity in your home for some time, and opportunities for refinancing will be some time off as well.

For investors and house flippers this scenario is far more distressing. You’ll be taking a large loss upon sale of the property, and you’ll likely be forced to hold it until conditions improve, whenever that may be.

“We are entering a dark period in the economic markets, so having some cash could be good for reserves, do you have reserves/rainy day fund?”

It’s always a smart idea to have a rainy day fund, and despite how common that knowledge is, not enough people have them.

It might be a smart idea to take a lower down payment if you’re low on emergency savings.

If you can afford the increased monthly payment, and you decide that your reserves would be uncomfortably low after making a 20% down payment, then that’s a completely valid reason to buy less equity out the gate.

Buying Parent’s house

Reddit user u/triSARAtopps asks about buying a home from their parents, and how to handle the process between someone you already trust:

"Hello! My boyfriend and I will be purchasing his parents house in the very near future. His parents have found a house and it seems as if everything is going in their favor, so we were told to find a mortgage. We have money saved for a down payment and they want to sell us the house for well below the market value for our area. What do we need to know? Where should we start? When they started looking we got a pre approval from Better to get a ball park estimate of our budget but that has since expired. Should we talk to a real estate agent? TIA" Source Thread

A classic scenario. Plenty of families want to sell/buy between each other for prices lower than the market, and without having the trust issues surrounding dealing with strangers, the family members are often wondering how to handle the transaction. Here was my response:

Hi Young Couple! I have helped so many like you buy family members homes from either grandparents or parents and here is my advice:

You only need an escrow company and a lender to help you with the mortgage.

You need some agreement on price and stuff but the escrow agent will help you with the rest

Hire Real Estate Agent if you can't negiotiate a number with your parents lol. It will be a waste to spend the 1-6% on them

Tell the lender that you are going to do a Gift of Equity Down Payment instead of you having to actually put a down payment in real cash. Gift of Equity is in lieu of the cash down payment

Talk to a local lender instead of better because they are usually better at dealing with Non-Arms Length Sales. Yours would be considered Non-Arms Length because its a sale between family and value would be much cheaper.

There is probably a better way to gift you the property instead of selling it, but I would talk with estate planning attorney

If you need more advice. Im here to help!

Let's dig a bit deeper.

Since these people are all family they actually only need a minimum of two professionals to help you along: an escrow company, and a lender. Since the only essential To-Do’s are to obtain a loan, and trade the money and the title deed between the parties.

Some might consider getting a Realtor to help handle this transaction, and sometimes that’s beneficial, but if you think about it a lot of the work has already been done. There’s no need for home search, and no need for private showings, and negotiations with family sometimes don’t require the fierce negotiation usually necessary. Not to mention Realtors can be costly — taking up to 6% of the home’s purchase price in commission if both sides are represented.

This is of course assuming you can agree on a price for the home. If you’re unable to come to an agreement, a Realtor can be a great mediator for more complicated relationship dynamics.

It’s important to mention Gift of Equity Down Payment, considering u/triSARAtopps mentioned the parents selling the house to them below market value. Many lenders offer this, and it allows for the difference between the appraised value of the home, and the actual sale price, to be used as the down payment. This saves a ton of money of the part of the buyers, and doesn’t require any money to change hands.

“Non-Arms Length Sales” refer to the sale of a property between two individuals who are socially close, like in this example parents and their children. Non-Arms Length Sales are also often cheaper than conventional transactions, however they face a lot more scrutiny from underwriters and the IRS — due to the fact that many people have used it in the past to avoid taxes. It’s important to consider the risks however, some non-arms length sales end in tragedy. Not doing the full due diligence usually found in an arms length sale can result in strained relationships, due to one party getting taken advantage of through their trust. Just make sure you have a strong and trustworthy relationship if you’re going to pursue a transaction like this, and do as much due diligence as possible to ensure bad blood doesn’t emerge.

I also briefly mention how it might be possible to gift the property instead of selling it, but this involves some tax considerations that are in constant flux. I recommend speaking to an estate planning attorney if this option appeals to you, and to advise you on whether gifting the property is viable for your family.

What items can be written off tax when buying a house?

u/FollowYourHeart- asks on the subreddit First Time Home Buyer:

"I learned today that mortgage points can be written off as itemized deduction. Are there any other items? Thanks for the help." Source Thread

A fantastic question, a lot of first time buyers aren’t aware of all the tax incentives that come with home ownership:

"Hi, you can write off on your

Primary residence:

• Interest (Yearly)
• Property Taxes (Make sure you check your state cap)
• All other maintenance, remodeling expenses, closing costs etc etc will be added to your cost basis when you sell

Rental Properties:

• Interest, Property Taxes, Insurance, Maintenance, Depreciation, HOA, One time remodel costs - Refer to Schedule E on your 1040 for more items. - And you take this yearly

When you itemize deductions you are basically claiming that you have more write offs than the standard deduction the IRS gives you ($12,950 for single or married filing separately, $19,400 head of household, $25,900 married filing jointly for 2022)."

Going further into tax deductions for home owners

When considering what you are able to write off in terms of your home, it’s important to note that primary residences and secondary properties such as rental homes are treated differently.

When I say all these expenses like maintenance, remodeling, closing costs are added to your “cost basis”, it refers to the value of your home from the perspective of the tax man. If you make improvements to the property, the costs of those improvements will be taken into account in your cost basis. The IRS will consider your profit and loss based on the amount you bought the home for, plus the cost of improvements, compared to the sale price. This cost basis ratio will determine how much you owe the government in terms of capital gains tax.

Rental properties have some interesting opportunities to save on taxes, such as depreciation. The IRS considers rental properties to have a lifespan of about 27.5 years. This means year-over-year your property that you’re renting out is lowering in value by about 1/27th, with the exception of the first and last year of ownership. [source]

Repairs and maintenance for rental properties can also be reduced. For a more detailed look at the available tax deductions for landlords, check out this article.

Regarding maximum deductions: your interest payments, the property taxes and other reoccurring costs can be deducted even further than the IRS’ standard deductions, if you choose to itemize your filing.