Wealth Planning
Your guide to buying a home
Getting ready to buy a home can be both an exciting and a stressful time. Finding the right property for the right price, contract negotiations, mortgage considerations, and tax ramifications all require a thoughtful approach, which can be especially daunting if you are new to home-buying.
A home purchase can be one of your largest investments, so it’s important to arm yourself with the right information when navigating this process. Here are some things you may want to think about beforehand:
Cash is often king
In “hot” real estate markets, cash buyers often come out ahead. Even if you ultimately intend to put a mortgage on your new home, presenting a cash offer can be an important factor in determining whether the home becomes yours.
If you choose to offer cash and want to close quickly—and without disrupting your long-term investment plans or generating unnecessary capital gains—consider taking a loan against your portfolio.
A line of credit against your portfolio can be put in place in a matter of days—and you pay nothing to set it up. In fact, there are no fees; you only pay interest on amounts you draw against the line while those amounts are outstanding. You can repay the loan over time, or you can repay it fully if you decide to take a mortgage loan on your home.
Match your loan to your expected time in the home
Many people instinctively prefer a fixed-term loan, whether 15 or 30 years. But if you expect to be in a home for a shorter period of time, or if your income varies—and especially if you can afford to repay the loan at any time—consider an adjustable-rate mortgage. The annual percentage rates on adjustable-rate mortgages tend to be lower than on fixed-rate mortgages, and the payments on interest-only adjustable-rate mortgages are generally lower as well since they don’t include any principal payments. And during the period that you are only paying interest, many interest-only loans reset your monthly payment lower if you prepay principal (rather than reducing the number of payments you’ll eventually make, as is common with amortizing fixed-rate loans).
Look at all the terms, not just the rate
While the mortgage rate is the number on which we all tend to fixate, consider other elements of a mortgage loan when making your choice. Does your lender charge fees for closing, locking a rate, or extending a rate lock? A low headline rate can increase with the imposition of “stealth” fees. Will your lender hold the loan on its own balance sheet, or will it sell the loan to a servicer? If you want to modify the loan later, or if you run into an issue making payments, your original lender is likely to be easier to deal with than a servicer with whom you have no relationship.
If you have an adjustable rate loan, how high and how quickly can the rate increase? Some adjustable-rate loans allow for a five percentage point increase in the first adjustment—so your 3.25% adjustable-rate mortgage can increase to up to 8.25% at its first reset point if interest rates have increased significantly. Is that a risk you want to take? Other loans cap the first adjustment at a two percentage point increase (so that 3.25% rate could only rise to 5.25%). Even if you may be paying an eighth- or a quarter-point more today to cap the first adjustment or to fix the rate for the term of the loan, it might be worth it in the future.
Be thoughtful about taxes when borrowing
You can deduct the interest on up to $750,000 of debt used to acquire a home—typically this is mortgage debt but it can include other types of debt as well. For indebtedness incurred on or before December 15, 2017 (and certain refinancing of the indebtedness), this limit is $1 million.
If you want a new loan against your home of more than $750,000, consider using the proceeds of the loan to invest in securities rather than to “acquire” the home or to spend for other purposes. Under a different provision of the Internal Revenue Code, interest on money you borrow to invest can be deductible to the extent you have investment income.
So if you borrow money against your home and use the loan proceeds to purchase investments, interest on the entire amount of the loan can be deductible as an investment interest expense deduction and not as a home acquisition indebtedness deduction). Note that in order to qualify for this deduction, you can’t invest in tax-free bonds and you can’t offset the interest expense with qualified dividend income.
Selling a home
Don’t forget that if you are selling a primary residence—and you have lived in it for at least two of the past five years at the time of the sale—you can exclude up to $250,000 of gain from your income for the year of the sale (or up to $500,000 for married couples). So if you bought your home for $800,000 and are selling it for $1.1 million, you would only owe tax on the $50,000 of gain above this $250,000 exclusion. Note that if you don’t own your home in your name, you may forfeit this exclusion, so it is important to speak with a tax advisor when deciding how to own your home.
Make sure you coordinate with all of your professional advisors to ensure you have all the information you need to navigate your home-buying journey.
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