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Your Equity = You Largest Asset and Best Investment

The dynamics of home equity often make your home your largest asset and your best performing investment. Equity in a home is the amount that your home is worth minus what is still owed. Two dynamics, appreciation and the reduction of unpaid balance, work in concert to make homeowner’s equity grow.

The Power of Appreciation

Usually, your home is your best financial investment. It is the appreciation, the increase in value, is what causes it to be your best financial investment. In a one-year period, the increase in value divided by the beginning value will determine the rate of appreciation for the year. News stories and articles, report statistics on appreciation. However, using local appreciation rates are more reflective of an individual property.

The National Association of REALTORS® reports “The median existing-home price2 for all housing types in June was $363,300, up 23.4% from June 2020 ($294,400), as every region recorded price jumps. This marks 112 straight months of year-over-year gains.”

The low inventory experienced nationwide resulted in some significant appreciation. This in turn has increased homeowners’ equity. According to Black Knight, a mortgage technology and research firm, at the end of 2020, roughly 46 million homeowners held a total of $7.3 trillion in equity.

Monthly Mortgage Payments Increase Your Equity

If a homeowner has a mortgage on their home, while the home is appreciating, the unpaid balance is declining. An increasing portion of each payment is applied, when the payment is made, to the principal balance to retire the debt based on the term of the loan. Each month the equity in the home becomes larger because the home is worth more due to appreciation and the unpaid balance is less due to amortization.

Make the Dynamics of Home Equity Work for You!

Once a homeowner has sufficient equity in their home, they can borrow against it and take cash out of their home. Most lenders require that the homeowner maintain at least 20% equity position. You can then borrow up to 80% of the property’s appraised value, less the amount that is currently owed on the property.

The options include a cash-out refinance mortgage or a home equity line of credit, HELOC. While some institutions have stopped offering HELOCs, they are still available. (For more information about what a HELOC is Click Here.)

The HELOC is a line of credit. It usually has a term of 10 years. Once the HELOC is approved, you can draw out your mone as needed. Interest calculates daily. Like a credit card, when the balance is paid down, the unused portion of the available credit is available again. Check out this HELOC Calculator from Bank of America to get a sense of what payments would be like.

Contact Sound Investments and we will be able to offer some lender suggestions.

STEPPED-UP BASIS

Stepped-up basis is an incredible benefit to people who inherit property. You can recognize the basis or cost value of the property at fair market value at the time of the decedent’s death. That means you avoid recognizing the gain between the decedent’s cost and what it is worth when it is inherited.

For example, a person purchases a home for $100,000. 20-years later when they pass away, the property market value is $500,000. There potential gain in the property value is $400,000. However, because of a tax provision called step-up tax basis, the person inheriting the property will have a basis of the fair market value at the time of death.

The recipient could sell the property for $500,000 and have no taxable gain on the sale.

GET A FORMAL APPRAISAL

A formal appraisal is the most reliable and defensible estimate of fair market value when you inherit property. There will be a fee of several hundred dollars for the appraisal. Another alternative is to get a broker’s opinion of value in writing. It may be reasonable to get three opinions to see if they are similar. They should rely on comparable sales to justify their position. Either method is acceptable to IRS.

NOT ONLY FOR THE WEALTHY

The President has mentioned the possibility of eliminating this step-up in basis benefit. Some people consider it to be a tax loophole for the ultra-rich. However, it can impact ordinary people who inherit property and don’t want to sell it. It allows families to leave assets to their heirs without having to pay capital gains tax.

Take for example, a person inherits a farm from his parents. The heir may not be able to afford to pay the capital gains tax due at time of transfer. This could forced them to have to sell the property or borrow the money to pay the tax.

Federal estate tax is paid from the deceased’s remaining estate, not by the heir. If the decedent’s estate is approaching the limit before estate taxes are due, consider seeking professional tax. This is because there could be additional provisions in play. Find more information on property inheritance on IRS.gov.

PLUSSES AND MINUSES OF OWNING

Are you better off owning than renting in the long term? Due to today’s low mortgage rates, a total house payment could easily be less than what the rent would be on a comparable home.  But, once you assume ownership, you will have the responsibility of the repairs and possibly, a homeowner’s association fee. Renting a home has advantages.  It is usually a short-term commitment from year to year and the landlord is responsible for the repairs.

Additionally, an initial benefit of owing a home includes the ability to deduct property taxes and qualified interest on the mortgage.  With the increase of the standard deduction and a limit of $10,000 on state and local taxes, it is estimated that 90% of homeowners do not itemize their deductions to consider property tax and mortgage interest.  This comparison will not consider them.

There are two very significant benefits to consider if you want to know if you are better off owning property. First, a home is an excellent investment. Also, it is a principal reduction due to normal amortization of the mortgage and appreciation of the property.  While the property goes up in value and the unpaid balance decreases, the owner’s equity grows, increasing their net worth.

Renters do not benefit from either of these, but their landlords do.  That is the reason for the saying “whether you rent or buy, you pay for the house you occupy.”  Tenants pay for the home for their landlord.

COMPARING RENTAL PAYMENTS TO OWNING COSTS

Rent		Own
$2,500	Rent/Payment	$2,232
-0-	Principal Reduction	$504
-0-	Appreciation	$875
-0-	Estimated Monthly Maintenance	$300
-0-	Estimated Homeowners Association Fee	$25
$2,500	Net Monthly Cost of Housing	$1,178

With each payment made on a fully amortized loan, the principal balance is reduced.  Moreover, while appreciation is generally expressed in an annual rate, homes go up in value incrementally throughout the year so considering the monthly appreciation is appropriate in this comparison.

In this example, the payment is less than the rent proving the initial idea that it costs less to own a home.  After factoring in the effect of the principal reduction and the appreciation, even when you consider the maintenance and HOA fees, the net monthly cost of housing is considerably less than renting.

The largest part of the savings inures to the equity of the home which directly impacts a homeowner’s net worth.  Therefore, while the money may not be easily accessed, it has real value and available in a cash-out refinance or when the home is sold.

FIND OUT FOR YOURSELF

If you want to know about how your numbers would be reflected in a similar comparison, go to our Rent vs. Own calculator. This will help let you know if you are better off owning a property vs. renting.  Please let me know if you have any questions.

Your credit score plays a huge role in getting a mortgage. That is because it is a variable that helps the lender determine how likely you will pay off your loan on a timely basis.  Credit bureaus evaluate people’s credit worthiness using a FICO score.  The higher the score the better the borrower’s credit.

Impact of Credit Score on Mortgage

The mortgage rate charged to a borrower depends on their credit score.   There is an inverse relationship between credit score and interest rate changed.  The higher the score the lower the rate and the lower the score, the higher the rate. 

Therefore, it is not unusual to see two separate buyers approved by a lender, but charged different interest rates based on their credit scores. This is true even if they have the same income and purchase the same priced home.

You could save thousands of dollars over the life of a loan by improving your credit score by just a few points.  A $350,000 mortgage at 3.5% has a principal and interest payment of $1,571.66.  By improving your credit score to qualify for a 3% rate, it would save $96.04 a month. 

Over the life of the mortgage, that would save $34,575 in interest.  Improving your credit score to shave 0.25% off the rate would make it worthwhile.

Credit Score Components

The percentage of total credit used compared to the total credit available is your credit utilization.  If you have a $2,500 balance on a credit card with $10,000 available credit, your utilization rate is 25%.  Ideally, it should be 10% or below.  This ratio accounts for 30% of a person’s FICO score. 

You calculate credit utilization using the balance on the monthly statement. Therefore, paying it off in full every month could still result in a high CU score.  Some credit counselors suggest paying down the balance before the end of month statement comes out.  A trusted mortgage professional can make specific recommendations like how to improve your credit utilization. 

When you credit limits are lowered, your credit score suffers.  You may have the same monthly outstanding balance you have had for years. However, it now becomes a larger percentage of your available credit and your score goes down.  In the example used earlier, assume that the available credit is now $5,000 and your balance is $2,500, the credit utilization is now 50%.

Payment history is the largest contributor and counts for 35% of an individual’s FICO score.  It is an indication of your likelihood of paying on time and as agreed for your debt. This is especially true for mortgages, credit cards, student and car loans, among others.

A surprise to some borrowers is to find out that even if they never actually paid a late fee because of a grace period, their score was still dinged because it was not paid on time of the actual due date.

Foreclosures, deeds in lieu of foreclosure and bankruptcies will affect a borrowers payment history as long as they appear on the credit report.

Check Your Credit!

Americans are entitled to a free annual credit report by law from the major credit companies: Experian, TransUnion and Equifax.  Visit AnnualCreditReport.com for these federally authorized reports.   During the Covid-19 pandemic, they are offering free weekly reports.

Even if you are not buying a home or getting a mortgage currently, it is a good routine to check your credit report periodically. This will allow you to discover signs of identity theft early.

If you believe we’re on the brink of a “housing bubble” that will soon burst, you may have to rethink that. But there are many factors that suggest that isn’t the case. For example:

1. Housing supply is low.
   – 1.9 months current supply; 6 months supply is normal.
2. Housing demand is high.
   – The economy is improving.
   – Interest rates remain low.
3. Rampant foreclosures are not expected
   – Currently, a vast amount of homeowners have a large amount of equity.

Experts are expecting prices will continue to increase and rates will remain relatively stable through 2022.

Plenty of Home Buyers Continue to Enter the Market

According to the 2021 Realtors Confidence Index Survey, real estate agents across the country described their market based on how many buyers were looking and how many sellers were selling. The map below shows how hot the buyer traffic looks in your state.

But the Market Needs More Homes to Be Listed for Sale

Conversely, the survey showed that the number of homes actively listed for sale in March 2021 was down over 50% as compared to 2020. The next map shows how the majority of markets look slower when it comes to the number of homes available for sale. Buyers will have a harder to find their dream home.

How Fast Are Homes Selling in 2021?

In 2020, existing homes were typically on the market for 21 days. That’s over two weeks less than was the case in 1999. But in 2021, homes sell even faster than that. This year, homes stay on the market for an average of 18 days. This is great news for sellers… but buyers need to stay on their toes. Wait too long, and you may be a loser!

What About Foreclosures?

Early projections showed that up to 500,000 homeowners across the country might face foreclosure in 2021. Post-pandemic foreclosures are ticking up, but only on vacant and abandoned properties. What do more foreclosures mean for home buyers? Increases in foreclosures could mean a increase in available supply plus some discounts.

Is the Housing Market Going to Crash?

It’s unlikely that the housing market will crash in the next two years. Home prices have already seen a 16.2% increase in 2021 which is more than two times the original predictions. That reflects a strong economy. And, as long as new buyers keep entering the market and there aren’t enough homes for sale to meet demand, home sales and prices will continue to rise. This should keep the market healthy.

What Does This Mean for Home Buyers and Sellers?

Buyers will have to be smart and quick. With more buyers than sellers, you’ll be up against some heavy competition. But there are some bright points. Mortgage rates will likely still be low through 2021. Experts also anticipate that housing inventory will climb in the second half of 2021, which means less competition.

Sellers might want to put your house on the market sooner while inventory is still low. There are plenty of buyers out there. Also, it is a very good idea to work with an experienced agent to set the best home price and find the right buyer. With an expert by your side, you should have no problem selling your house at a great price this year.

Even with all the data available to us, the housing market is hard to predict. To buy or sell with confidence, it really pays to have a trusted professional on your side. Get an experienced Real Estate Agent on your team, leverage their expertise and you’ll be in the best position to have your interests protected.

There is a story of a real estate agent’s prayer. “Dear Lord, if I can’t be someone’s first love, or second wife, at least, please let me be their third REALTOR.”

In a normal market, the supply of sellers and buyers is balanced . This prayer describes the preference that it might be better to be the third listing agent to help the seller after they became more realistic about their list price.

Multiple Offers

In today’s market, it might have more to do with buyers. Increased competition means chances of having an offer accepted are greatly reduced . Therefore, it is only after they have lost several that they become more aggressive in the negotiations.

Over the last two years, competition for homes being sold increased. In April of 2021, there were nearly five offers for every home sold (REALTORS® Confidence Index Survey from NAR). This is an increase from two offers in 2019 and 2020.

Utah reported the highest number of offers per home sold with seven. Arizona, Georgia, New Hampshire, and Washington had six. California, Colorado, Tennessee, and Texas each had five offers per home sold.

Other Strategies

To make their offers appear more attractive, more buyers are making cash offers to eliminate financing contingencies. Cash offers represented 25% of offers in April and 21% in the first quarter of 2021. Compare this to 18% in 2020.

Buyers who are not able to make cash offers are increasing their down payment. Nearly half of homebuyers are putting 20% or more down during the first quarter of 2021. Even first-time buyers are using an 80% mortgage to make their offers more attractive to sellers.

The median days on the market for listings was 17, down from 21 days a year ago. first-time homebuyers accounted for 31% of residential sales . This is down from 32% in March 2021 and down from 36% one year ago.

Nearly ¾ of homes closed on time. 5% were terminated and 22% were delayed but eventually went into settlement. Appraisal and financing issues were the major contributors to the delayed transactions. The two major factors for the terminated transactions were also appraisals and inspections issues.

Today’s environment requires a strong, sensitive agent who understands your goals as well as the intricacies of the market. They will devise a plan to make it happen. Your agent are the boots on the ground you need whether you are a buyer or a seller.

If you are about to enter into a divorce, there are some advantages to how a home you own can be transferred to one of the parties of the divorce. No gain or loss is recognizable on the transfer of the residence if this transfer is related to the end of a marriage. Here is one option on how the property ownership can be moved as beneficially as possible. You may be able to:

• Treat the transfer as a gift
• There will be no Gift Tax due
• But the transfer must be within 2 years before or 1 year following divorce
• There should be no change in basis; carryover basis goes to the recipient

Of course it is best to check in with your attorney and your tax accountant before you finalize any transfer of your residence.

Risks Not Worth Taking

Today’s housing market’s extremely low supply. That means it is especially important “NOT” to rely on risky negotiation tactics. You don’t want to lose a property you truly want just because you relied on a weak tactic.

• Lowball offers that offend sellers
• Asking for the “Moon” in the way of personal property or concessions
• Using inspections to renegotiate AFTER the contract was accepted
• “Take it of Leave it” offers hoping to intimidate the sellers into a accepting your offer

Sellers in the current market know that demand is high. They will most likely receive multiple offers. Many of those offers may even be above asking price. Therefor, using intimidation or being obstinate about things that are not really important doesn’t help your bid get accepted.

So is it really worth losing the home of your dreams?

Our Advice

Instead of taking a negative approach and using risky negotiation tactics, you can take actions that can increase your chances of success. If you haven’t read our post about “Writing a Successful Offer in a Low Inventory Market,” Click here and learn some tricks to help your bid get selected.

Currently there are at least 40% fewer homes on the market now than there were a year ago. Many serious buyers have lost a property they wanted because of the increased competition. Today’s buyers should be looking for ways to improve the odds that their contract will win without needing to use purchase price as their only tool.

Buyers should reconsider, rethink, and re-evaluate their “must have” features and amenities. It’s unrealistic in a normal market to get your perfect home at the price you want. But in today’s market, it is even less possible. Start by listing the things you must have, and the things you would like to have, then prioritize them. Identify the critical from the convenient.

The next step is to put together your “home” team. You are the captain of this process, but it is essential to have a strong first officer and that is your real estate agent. This professional will oversee the process, advise you on current market conditions and normal procedures. Your agent will even help you assemble the rest of the assets you will need such as a mortgage officer, title, insurance, warranty, inspectors and service providers.

Your agent can advocate your cause personally to the listing agent by personally delivering the offer and pointing out your strengths to lobby your position. Obviously, your agent will not share anything that you do not expressly give them permission to.

Even before you write your offer, your agent can ask the listing agent about any preferences of the seller not mentioned in the listing agreement, as well as which contract forms and addendums to use.

The following list of suggestions are provided for your consideration realizing that some may not be appropriate for your individual financial situation or comfort level.

• Get pre-approved from a local lender and include documentation with offer to purchase.
• Have your lender phone and email the listing agent to verify that you are pre-approved.
• Increase the amount of earnest money.
• Acknowledge flexibility on closing and occupancy dates.
• Eliminate unnecessary contingencies.
• Waive the appraisal and have proof of funds to meet the difference in the purchase price.
• Avoid concessions like asking the seller to pay the buyer’s closing costs or points.
• Avoid including personal property to go with the sale unless specified in the listing agreement.
• Purchase “as is” with right of quick inspection to cancel contract if condition is unacceptable.
• Shorten time frames on necessary contingencies.
• Attach proof of funds for down payment or full purchase price if cash.
• Arrange bridge financing to be able to pay cash.
• Buyer should pay their own normal closing costs.
• Write a personal note to the seller explaining why you like and want their home. Some listing agents are advising sellers to not accept them due to potential discrimination liability.
• Escalation clause … offer to pay $X,000 more than highest acceptable offer up to a limit.
• If you physically sign the offer, use a contrasting color ink to add a personal touch. If using a digital contract, change the font and color to distinguish the signature.
• Make your best offer first because they may not make a counteroffer.

When a new listing hits the market, it is common for there to be a rush of interested buyers that result in multiple offers. Because of this, it’s prudent for you to research and consider which of these ideas you can implement before you find the home. It is much better to have more time to make these decisions, especially, if it involves a mortgage officer or an attorney.

Your real estate professional will be able to tell you which of these suggestions are viable and may be able to offer additional recommendations. If you do not have an agent, contact me at 510.244.0081 or rdwilson@soundnvest.com to discuss a plan to craft your offer in the most favorable way possible.