Property Taxes...Should I Escrow or Not?

Many first time homeowners have questions about taxes + insurance and how they will impact a monthly mortgage payment. When you set up your mortgage, you may have some choices in regards to how often you pay toward your property taxes and insurance, but first it’s important to see what category you fit in to better understand your options:

Category One: If you are putting less than 20% down on your home OR if you have an FHA loan, you will likely be required to set up an escrow account with your lender. An escrow account is part of your loan paperwork and agreed upon at closing. Each month, your lender collects the required insurance and tax payments from you along with your mortgage amount. The money then gets held in an escrow account and used to pay off the insurance and property taxes either annually or semi-annually, whenever they are due. The lender takes care of these payments for you out of your escrow account and pays directly into the insurance company and county tax office for you. While these payments are collected at the same time as your monthly mortgage payment, they are technically separate. The convenience of an escrow account is that it forces you to save for these big annual or semi-annual bills every month along the way. However, many times the lender does not grant any interest on the money sitting in an escrow account whereas if it were sitting in your own private account, the same money could have some interest earning potential.

Category Two: If you are putting more than 20% down on your home or have your home paid off, you have some different options when it comes to property taxes and insurance. Instead of setting up a required escrow account, you can accumulate the money you need for insurances and taxes on your own, earning interest on that money all the way up until the time it is due. When the bill comes, you are in charge of paying the taxes directly to your county tax collector and the insurance payment directly to your insurance company. In Austin, the tax bill always arrives around Christmas and is due at the end of January. The disadvantage to this method is that it requires discipline to make monthly payments to yourself in your savings account and earmark that money for insurance and taxes. You do not want to be surprised by a hefty annual bill (right at Christmastime) and have no accumulated savings to pay it. However, avoiding escrow does ensure that your mortgage payments are consistent from month to month throughout the year. If you have an escrow account and your property tax bill or your insurance premiums suddenly jump, you might not be made aware of the change until the end of the year when you see the breakdown from the lending company.

Whatever your decision when it comes to paying insurance and property taxes, it is important to discuss your options with your realtor and financial lender to make the most financially sound decision for you!

Conventional 30 Yr Fixed Interest Rates Are Going Up

The overnight rate is the interest rate the central bank sets to target monetary policy.  Since the Federal Reserve decides when to increase the overnight rate, it can be a good predictor for the movement of short-term interest rates for consumers in the broader economy.  When the Fed increases its interest rate to the banks, the banks then tend to pass on some, if not all, of that increase to the consumer.  Therefore, the higher the overnight rate, the more expensive it can be to borrow money.

After an extremely low interest rate in the recession of 2008, the overnight lending rate has been increasing slowly over the past 10 years and is expecting another rate hike in December, three more hikes in 2019 and another increase in 2020. 

source: https://tradingeconomics.com/united-states/interest-rate

As mentioned previously, many predict that this overnight rate hike will result in increased interest rates being passed on to the consumer. 

30 YEAR FIXED RATE MORTGAGE INTEREST RATE FORECAST 2018, 2019, 2020

https://longforecast.com/mortgage-interest-rates-forecast-2017-2018-2019-2020-2021-30-year-15-year

Since the Fed has continued to announce project rate hikes until 2020, here are some suggestions for you, the consumer, to think about now:

1.      Pay close attention to variable interest rates.  These will continue to rise as the federal rate rises.  Credit cards interest, home equity lines of credit and adjustable rate mortgages will continue to climb. Student loans with variable interest rates may also be impacted.

2.     If you are a borrower with an adjustable rate mortgage, consider refinancing if your interest rate is set to change in the next 1-2 years.

3.     The sooner you can lock in a fixed rate mortgage, the better.  Even if you are in the process of searching for a home, many lenders will let you lock in a fixed rate once you have been pre-approved for a loan.

How to Eliminate Capital Gains Tax

Today, a friend and I had a conversation about his real estate investment. He has owned the property for three years now, and we discussed his options if and when he sells his property. So I brought up a "1031 Exchange." To my surprise, he was unaware of the 1031 Exchange and its helpfulness. This is an important topic for those who own investment properties.

Section 1031 of the Internal Revenue Code is one of the most underutilized sections of the tax code. When an investor sells an investment property and subsequently buys a new investment property, the investor can defer the capital gains taxes on the sale of the original investment property. The gain is “rolled over” into the new property.

Step by step overview: To begin, an investor would meet with a qualified intermediary to discuss a potential 1031 Exchange. The investor sells the investment property #1. After the close on property #1, the funds go to an escrow account, controlled by the qualified intermediary, to be held until property #2 is purchased. The qualified intermediary then transfers the funds for the purchase of Property #2.

Through a 1031 Exchange, an Investor saves the capital gains tax and can invest that money into another investment property. This is a government incentive for investors to continuously invest in real estate.

6 points to understanding the 1031 exchange requirements.

1: Like-Kind Property
The first requirement for a 1031 exchange is that the old property to be sold and the new property to be bought are like-kind. "Like-kind" relates to the use of properties. As a result, the old property as well as the new property, must be held for investment or utilized in a trade or business. Vacant land will always qualify for 1031 treatment whether it is leased or not. Furthermore commercial property may be used to purchase a rental home or a lot may be sold to buy a condo.

Additional factors to consider:
• Primary residences can never be utilized in an exchange.
• Properties to an exchange must be within the United States border. Properties located outside the United States may not be involved in the exchange.

2: 45 Day Identification Period
The Internal Revenue Code requires that the new property be identified within 45 days of the closing of the sale of the old property. The 45 days commence the day after closing and are calendar days. No extensions are allowed under any circumstances. If you have not entered into a contract by midnight of the 45th day, a list of properties must be furnished and must be specific. It must show the property address, the legal description or other means of specific identification.

Up to three potential new properties can be identified without regard to cost. If you wish to identify more than three potential replacements, the IRS limits the total value of all of the properties that you are identifying to be less than double the value of the property that you sold. This is known as the 200% rule. Accordingly, more than three properties may be identified as replacements. However, if the taxpayer exceeds the 200% limit the whole exchange may be disallowed.

It is the responsibility of the qualified intermediary to accept the list on behalf of the IRS and document the date it was received. However, no formal filing is required to be made with the IRS.

3: 180 Days To Purchase
Section 1031 requires that the purchase and closing of one or more of the new properties occur by the 180th day of the closing of the old property. The property being purchased must be one or more of the properties listed on the 45 day identification list. These time frames run concurrently, therefore when the 45 days are up the taxpayer only has 135 days remaining to close. Again there are no extensions due to title defects or otherwise. Closed means title is required to pass before the 180th day.

4: Use of a Qualified Intermediary
Sellers cannot touch the money in between the sale of their old property and the purchase of their new property. By law, the taxpayer must use an independent third party commonly known as an exchange partner and/or intermediary to handle the change. The party who serves in this role cannot be someone with whom the taxpayer has had a family relationship or alternatively a business relationship during the preceding two years. The function of the exchange partner/intermediary is to prepare the documents required by the IRS at the time of the sale of the old property and at the time of the purchase of the new property. The intermediary must hold the proceeds of the sale in a separate account until the purchase of the new property is completed. The taxpayer is entitled to the interest of these funds and must treat the interest as ordinary income during the period of escrow.

5: Title Must be Mirror Image
Section 1031 requires that the taxpayer listed on the old property be the same taxpayer listed on the new property. If you and your wife are married and sell the old property than you and your wife must also be on the title to the new property. If a trust or corporation is in title to the old property that same trust or corporation must be on title to the new property.

6: Reinvest Equal or Greater Amount
In order to defer 100% of the tax on the gain of the sale of old property, the new property must be of equal or greater value. There are actually two requirements within this rule. First, the new property has to be of greater or equal value of the one which is sold. Secondly, all of the cash profits must be reinvested.

In reality, you may deduct closing expenses and commissions from the sale of the property being sold. If the property is being sold for $500,000.00 and the actual net amount after closing expenses is $465,000.00, the $465,000.00 is required to be spent for the replacement property.

A party who elects to do an exchange and take cash out may do so. However, any cash received will be taxed at the corresponding rate of ordinary income if held for less than one year or the capital gains tax if held for more than one year.

Want a 2nd Home in Austin? 5 Helpful Tips

Whether you're thinking about buying an investment property for steady cash flow, a vacation home for your family or a temporary home for your college-bound son or daughter, there are a few things you should consider before making the investment:

Local Market -- Both the local resale and rental markets are important factors. Are home prices on the rise, increasing the possibility of a profitable sale in the future? Is the rental market tight, causing average rent prices to go up? You'll want your rental income to be able to cover mortgage costs, taxes and expenses.

Maintenance -- When calculating costs, include routine maintenance and potential repairs. If purchasing a property to rent out, note any requirements and safety obligations for your area. If you're not the handy type or your desired property is far from your primary residence, consider hiring a property management company to handle ongoing maintenance concerns.

Insurance Costs -- Find out if you need additional disaster coverage such as flood or earthquake insurance. In general expect to pay higher insurance costs, especially if you plan on renting out the property.

Financing -- Plan on being subjected to more scrutiny than you were on your primary residence. Banks often require a higher down payment on second homes, and interest rates may be higher as well.

Tax Implications -- Make sure you understand the tax implications of owning a second property. If you plan on renting it out, you'll need to report the rental payments as income. On the other hand, operating expenses, such as insurance, utilities and repairs, may be considered deductions.