What Should I Consider When Buying a Home - Part II
In Part II of this series, I will cover things to think through regarding closing on your home, tax issues, estate planning, and other general issues to consider. Click here if you didn’t catch Part I!
Down Payment & Closing Costs
Do you need help determining closing costs?
There are quite a few people that help close on your loan and incur you some additional fees. Inspections, appraisals, loan origination fees, application fee, processing fees, title insurance, points, etc. Work with your realtor and bank to get a detailed list of expected fees that you’ll be expected to pay to make sure you have estimated the proper amounts. Lenders have to give you the details 3 days before closing, but that should not be the first time you estimate these costs!
Do you know how much of a down payment should be made?
Depending on your loan type (see part I of this post), it can range pretty wide. You should get a good understanding of your budget and understand how 5, 10, 20 percent, etc. can impact your savings vs your monthly payment (the larger the down payment, the lower your monthly mortgage payment). If you’re going the conventional loan route and put less than 20% down, you'll have to pay private mortgage insurance. Just because you want to put more money down, doesn’t necessarily mean you should. I encourage you to keep a 3-6 month emergency fund intact during this process. Something will likely go wrong after you buy the home (I’ve been the lucky purchaser of two AC units on the two different homes I’ve bought).
When you calculate this payment, just know that’s the principal and interest portion of your payment. If you escrow (pay your taxes and insurance as part of your payment to the bank for them to send out when they are due), then know your payment will very likely fluctuate year to year as taxes go up and insurance costs increase or decrease. Finally, don’t forget your HOA dues, if applicable!
Where should you pull the money for a down payment?
Savings Account - The best case scenario is that you’ve been a diligent saver and have the cash in an account to utilize. However, that’s not the case for everyone.
Roth IRA - Your contributions can be withdrawn without penalty and $10,000 of earnings can be removed without penalty or tax for first time home purchases (as long as the Roth account has been opened for at least five years). This is a per person limit. The IRS considers you a first time home buyer if you haven’t owned a home for the last two years.
Traditional IRA - you can withdraw up to $10,000 total without paying the normal 10% early withdrawal penalty, but you’ll still owe taxes on the withdrawal amount. This is a per person limit.
A note on IRA withdrawals - just because you can, doesn’t mean you should. A withdrawal of $10,000 early on in life can have you miss out on some significant growth potential. If you’re 25 years old and were able to make 7% over the next 40 years on average, you would wind up with roughly $150,000. Just some perspective if you decide to pull that lever.
401(k) Loan - Not all plans offer loans. Often, you will find a general loan and a home loan. Home loans can be taken for up to 10 years vs a general for 5 years. Interest rates may be a bit different as well. Ask your HR person for details or call your 401(k) provider to learn more about your specific plan. I also wrote an entire article on 401(k) loans that you should read first.
Assistance Programs - many states offer down payment assistance programs that often require a certain credit score and income situation to qualify. You can do a quick search online to learn more about this option.
Gifts - if you’re in a position where a parent or grandparent wants to gift you a down payment, congrats! Typically a bank will want to understand where the money came from, so the the person(s) giving it to you may need to sign a letter stating it’s a gift. In most situations, an individual can give $16,000 or a couple $32,000 to each person in 2022 without incurring gift taxes. (there is no tax to you for receiving a in this manner. Just know that’s not the case for all types of gifts, e.g. your granparents gift you their home while they are still alive. There is a whole mess of tax issues to consider on something like that!).
Tax Planning Issues
How much SALT do you have?
This stands for State And Local Taxes. Under the current tax code, you cannot deduct any amount over $10,000. This includes property taxes, sales tax, and state income taxes (if applicable). However, your specific tax situation needs to be considered here, especially if you’re not near the standard deduction limits. If you’re over the standard deduction, you may want to explore what’s called bunching your deductions. For example, you can pay next year’s real estate taxes in the current year to increase your deduction amount, if it makes sense.
Will your mortgage be larger than $750,000?
Under current tax law, you can only deduct mortgage interest on the first $750,000.
Will you use your home for your principal place of business?
If so, you can consider home office deductions for the office space that’s specifically used for business purposes. Talk with your CPA on this one to make sure you’re not going overboard!
Are you going to make any improvements?
If so, keep track of the cost of the improvements so you can add them back to the basis (what you bought the house for). This will reduce your capital gains if you eventually sell your home. This especially helps with secondary and rental properties, but also potentially with your primary home. Currently, an individual can receive $250,000 and couples $500,000 in tax free capital gains on the sale of the primary home, if you’ve lived in it more than 2 years out of the past 5 years. Search more on Section 121 exclusions for details.
Estate Planning Issues
Should the home be owned by one spouse or owned by a trust?
Trusts - Trusts can avoid probate, which can help for properties that you may own in a state other than your primary residence.
Transfer on Death - some states allow for a transfer on death deed. Check with your state for their options.
Remarried with kids from first marriage - depending on how you want your assets to be distributed after you pass, a qualified terminable interest trust (QTIP) may help to provide the surviving spouse while making sure your children from your first marriage benefit from the property. Discuss with your estate attorney to see if this scenario makes sense for you.
Do you need to update your estate plan?
Typically, the home is one of the largest assets someone has. When you purchase a new one, does that change your estate plan regarding how you want your heirs to receive your property. Are you buying a much larger home than before? Have other assets increased or decreased. Consider how this may affect the distribution of your assets and update your estate plan to reflect it.
Other issues
Should you buy the home warranty?
This sounds good in theory, but read the policy thoroughly and know what is covered. I bought one on our first home and canceled it after they refused to cover my air conditioner that went out in August when it was 105 degrees in Texas (reference back to having an emergency fund ready). I know other people who swear by it and claim it has paid for itself easily. Like any insurance policy, know what’s covered and how it’s covered.
Is this a second home or rental property?
This goes back to titling and how it should really be considered. A second home or rental property may come with liabilities that your primary home does not. Explore the use of an LLC for this scenario.
Will you need more life insurance?
If you’re taking out a larger debt that wasn’t considered in your life insurance analysis, you may need to increase your coverage. Your mortgage provider may offer you mortgage life insurance. Typically it’s cheaper to buy term life insurance, but if you’re uninsurable for some reason, you may want to consider this option.
Will you need to review your home and auto policy?
You’re not married to your insurance company. You should use this as an opportunity to shop rates on your home, auto, and umbrella policies.
Is the home purchase a result of an employment change?
Check with your company to see if they have any relocation assistance they can offer.
Hopefully this series of articles helps to show that buying a home is more than just a payment. It’s an exciting time that also brings in a lot of stress in a short amount of time. Uninformed or bad choices during this process can cost you in the long run. Often, a skilled financial planner can help you walk through these issues and make the best decision for your specific situation.
I’m happy to discuss being that kind of planner for you! Just click the Schedule Appointment button at the top of the page to set up time to talk.
