Owning a Home Archives

Why Paying Down Your Mortgage Might be Bad

Paydown The HousePaying down your mortgage can be a great way to build equity, but how exactly do you benefit from paying down your mortgage? Well to answer that question we first have to have a basic understanding of the tax benefits associated with home ownership.

As an taxpayer you are entitled to the GREATER of EITHER the standard deduction or the itemized deduction for tax purposes. Well the standard deductions for a single individual like myself is $5,800 for 2011, but my itemized deduction was much larger for 2011, therefore I will deduct only my itemized deduction.

What goes into your itemized deduction? Well you might want to take a look at a Schedule A for the complete list and instructions, but the ones to discuss now are:

  • Interest you paid
  • Taxes you Paid

So let’s say you paid $3000 in taxes and $7000 in interest on your home. As a single individual you would take the greater of $5,800 (standard) or $10,000 (3000 + 7000, itemized) and deduct it from your income before multiplying it against your margin rate. So if you had a marginal rate of 25%, your itemized deductions saves you: [ $4,200 (how much larger your itemized is from standard) * 25% (marginal rate) ] = $1050 net savings per year.

Standard or itemizedNow back to paying down your mortgage. As your pay down your mortgage, the amount of interest you paid a year is lower, and this reduces the amount of itemized deduction you receive.

If your mortgage gets small enough, the standard deduction could even be larger than the itemized. For example you pay off 75% of your entire mortgage and only have $1750 of interest now instead of $7000. You now get a deduction of the greater of: $5,800 (standard) or $4,750 (taxes + interest, itemized deduction).

So what does this all mean?

If you paying down your mortgage and you are currently itemizing you only save:
Interest Saved * (1 – Marginal Tax Rate)

If your standard deduction is larger than the itemized deduction, you save:
Interest Saved

So if you have $10,000 to put towards the mortgage principle on a 4% mortgage and you currently are taking an itemized deduction and you are in a 25% marginal tax bracket, you save will:

$10,000 * .04 * (1 – .25) = $300 net year. Which is an effective rate of return of 3%

Why is this important? Well if you think 3% return is the best bet, then maybe paying down your mortgage is the best option, but I can promise you this – if you think 3% return is good enough – It’s going to be hard for you to accumulate wealth unless you have a lot of money to invest. Just to illustrate, if inflation is 2% on average for the next 30 years and you invest $10,000 in a 3% return for the next 30 years – Your investment after removing inflation is: $13,478 (+$3,478). Where will you be in 30 years to spend your extra $3,478?

Did I also mention your payment is still the exactly the same before and after when you prepay your mortgage? The take home message is: The only benefit you are getting from paying down your mortgage if you’re itemizing is:

Amount Paid Down * (1 – Marginal Tax Rate)

Disclaimer: Always consult a tax professional for assistance for tax preparation. EpicFinances.com is not to be used as a source for your personal tax preparation

My fascination with small housing knows no bounds. The idea of buying a small cheap house to save money is exciting to me. In Cincinnati we have dozens of neighborhoods, but sadly not all of them are created equally. There is about 6-8 neighborhoods that would make the “I could own a house here” rankings. I am not going to list them all, but Oakley, Hyde Park, Mount Washington, and Anderson Township (schools are good) are a few.

That last one sparked my interest in particular when I came across a house during my obsessive search through the real estate listings – a cheap house. Now when I say cheap, I’m thinking “live mortgage free cheap.” A house listed for about 180 days currently listed at $29,900 in a good school district.  Here is a public picture of the property.

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Not exactly like what I live in now, but I am completely fascinated with this property. I want to first state that to obtain goals such as living without a mortgage – usually sacrifice is needed.


Let me start by saying there are so many con’s to this house.

  • The house is very close to a road that I believe is 45 or 55mph speed limit, which would be noisy
  • There is no garage just a driveway for 2 cars
  • You are extremely close to your neighbors
  • The house needs some work, I would guess $15k would make it to my standards, flooring being the largest part of the rehab budget. You could probably get by after tossing $8k in the home.
  • It appears one of the houses directly next to you is a rental
  • Would lose itemized deduction, but I would argue that is good since that means you aren’t paying taxes and/or high interest
  • The lowest level in this house is jerry-rigged
  • It has oil heating which I cannot stand, it’s a hassle to refill.
  • It’s 2 bedroom / 1 bathroom – I’m currently in 3 bedroom / 2.5 bathroom but it is completely excessive.

But let’s also not forget the pro’s

  • Taxes are about $700 a year – that’s right…. a year. I pay about 4.5 times that for my home now
  • It’s smaller, but you have to buy less stuff to fill that space
  • If you financed 20k and put down 4k (assuming you could get it for 24k) your payment would be roughly: $221
  • $122  for interest / principle a month
  • $40 for insurance a month
  • $59 for taxes
  • After the home is paid off (which is very do-able) your payment would be right around $99 a month.

  • Now that the new taxes from the previous election for my city have been assessed, I pay roughly $900 for my mortgage, insurance, and taxes. Assuming that everything else is relatively constant – the difference between what I pay and what I would pay if I financed the majority of the home would be ($900 – $221 = $679 a month maybe more if insurance is less on the smaller home). If I applied that $679 extra to the mortgage – the home would be paid off in roughly 28 months (2 years and 4 months). If I saved the money instead of applying it towards the mortgage, it could also be said I would have about $20,000 of cash in 2 years and 4 months.

    Now let’s go back to my current home. I recently refinanced and my pay-off date is Nov 1st, 2041. If I added an additional $300 a month towards principle my payoff date is Mar 01, 2027. That’s 16 years from now. Furthermore if I applied that extra $300 and the savings towards this cheap little home it would be roughly 20 months to pay it off – think about it, 20 months to live mortgage free.

    If I cashed out my currently home and walked with $20-25k – the dream of living mortgage free might be almost within my grasp, but would I be happy with the quality of the area and home – that’s the real question.  The thought of paying about $100 a month for your own home has such a strong grasp on me that it is important to not become completely blinded with the price tag.

    Flipping Houses is Dead in 2012, For Most People

    How to Make Money Flipping Houses_InsertAh the glorious days of flipping real estate and climbing the property ladder. Buy a cheap home, toss some in some new paint, carpet, cabinets and maybe an air conditioner and furnace and pocket a quick $20,000 – $50,000.

    I for one think flipping is dead for the foresee-able future, but let me make my case before you condemn me entirely. I want to first acknowledge that there are ways for professionals to make a small margin on flipping, and that I am directing this post towards “normal everyday” people. 

    There are some good sides to having a downward economy when it comes to real estate of course. The biggest benefits that I can think of would be pricing, interest rates, and cheaper labor. After reading that last sentence you might think – cheap houses, lots of inventory to choose from, and easy to find labor – Sounds perfect for flipping…but not so fast.


    Pricing: The reason why prices are so cheap is because there are no buyers and there is an excess of inventory, which is perfect for you as a buyer – but terrible for you as a seller. You will have to complete for the few buyers that are out there with quality, location, and price. That means no cutting corners and maybe cutting into your margin to persuade buyers.

    Interest Rates: Low interest rates can be good, but they also can be a double edged sword. If interest rates turn around, it can hurt how much people can justify financing as a purchase price for your property. If you get stuck with a property for a substantial period of time and interest rates spike, you stand to get destroyed.

    Cheap Labor: Cheap labor is pretty hard to argue against, except for the argument before – which is that there is excess for reasons that don’t hint towards strength in the housing market.


    So let’s talk about hypotheticals.

    You find a house in a neighborhood listed for 180k, where a similar house in good condition is listed for $250k . The house only needs approximately 30k in work if you do some of the work yourself. You purchase the house for $180k and somehow manage to stick to your budget (which is rarely the case). Maybe you replace the kitchen and install new paint and carpet (which is 30k alone). Okay – now’s lets talk about your break even scenario.

    You have $180k in the purchase price + 30k in Work = $210k in the home

    You carried the home for lets say 2 months which cost you $3k and you had closing costs of $3k = $216k in the home.

    You opt into using a local broker and you list the home at 250k, assuming your broker takes the standard 6%, your break even is 216k = .94x, $229,787 assuming you sell it within the 2 months.

    Now’s talk about reality. Most likely you are not going to sell it in 2 months and most likely you are not going to get full asking price since there are other homes in your neighborhood listed as well. Probably you are going to have to shave off $10-15k off the sale price and it is going to take 6-12 months to sell at that reduced price.

    Factoring in $240k as the sale price and you hold the property for a more realistic 6 months (until time of closing) the numbers become: $240k – $210 (PP + rehab) – $9k (Carry Cost) – $14.4k (realtor fee) – $3k (closing) = $3,600 profit.  I would view that as almost a “best case scenario” as well, and would warn that its very easy for this situation to produce a loss. 

    The point of this is that people commonly do not take conservative estimates in how long it will take to sell, what they will actually get for a sales price, and how much money it will cost to get ready and to actually sell the house. Now let’s step back and think about this though. You are tying up a lot of cash (20% down-payment, 30k in repairs, closing costs, etc.) for an optimistic $3,600 profit. I think I could make a good argument that this attempt to earn this $3,600 profit is probably just as risky or even risker than going to Vegas and putting $3,600 on black.


    I eluded that *some* people would be able to flip still, so who can still flip? People who are able to find unbelievable prices through questionable means and people who can avoid fees on closing and selling.

    When I say “unbelievable prices” – I’m talking not listed on the MLS prices. Let me give you an example, you see those billboards and benches for “we buy ugly houses.” Those are people who can flip because they lowball people with cash offers, but you can argue where they are making the money isn’t on the flipping process – their services as a  real estate pawn shop are where the margins are generated.

    Avoiding fees, maybe you are a realtor yourself or have connections – if you have the ability to find ways to sneak in and out of real estate market without taking a 6-8% hit, you may have a competitive advantage.

    Sadly I must once again warn though that the real estate market has a lot of moving parts and a lot of variables and once you “put a pencil to it” – it rarely seems worth the risk. The stress, the labor, the idea of tying up such a large sum of money – no thanks. If the market does turn against you, be prepared to take a GIANT hit or become a landlord.

    Heating Your Home With Corn To Save Money?

    Heating your home with corn can be a way to save money this year. You have to buy a corn burning stove, have it installed, and load the hopper – Then it’s go to go, right? Not so fast. Corn burning can save you money, BUT it is not without its hassle.

    I am all about saving money, but you have to assess ALL of the costs. First, let’s take a look at some another common alternative:


    Wood Burning

    Colonial_Wood-_Burning-_Fireplace-Insert-_TR004250px-Cord_of_wood


    Pro’s

    • Cheaper than gas
    • Generally can provide a “home-y” ambience

    Con’s

    • For higher efficiency burning you are going to need an insert or wood burning stove
    • Fire Hazard (Creosote build-up)
    • Have to store large quantities of wood (Fire rack’s aren’t cheap)
    • Have to buy wood
    • Have to transport (or pay to transport)
    • Have to clean out ash from insert (which can easily travel in your air)
    • Can dry the air in your house
    • Chimney’s need cleaning ($$$)
    • Have to carry wood through house
    • Have to maintain and watch the fire
    • Chimney replacement (I’ve read 10’s of blogs where someone has claimed they had to completely replace their chimney after 10-15 of *HEAVY* use. Even if the chimney lasts 30 years – it can be costly to replace
    • You have a VERY hot stove in your home which can be a danger to you and your children

    Corn Burning
    fp-06-35PC45Cornstovehopperlg

    pelletdemoLet’s break it down. You buy a corn burning stove (which cost roughly the same as wood burning stove, $2000 – $3000) and have it installed, you find a local farmer with corn for sale and you get a stockpile for the season. You load the corn as needed into your system and perform regular maintenance on the stove. Corn costs roughly $4.00 a bushel give or take. 2.2 bushels is claimed to product around one million BTU’s. That 2.2 bushels at the cost of roughly $8.80 would produce the same amount of heat as an estimate $22.00 worth of wood. That is 60% less cost than wood! Now all of these numbers are completely subjective to who is telling you and vary on lots of factors, but compared to natural gas heating – it’s less than half the cost, but is it really worth it? What about overhead?

    Time to break down the Pro’s and Con’s

    Pro’s

    • Much cheaper than gas and even cheaper than wood
    • Also can provide ambience of fire
    • Virtually no smoke
    • Automatically loads corn into burner
    • No odor (or so they claim)
    • No radiant heat (so the burner itself isn’t going to burn you if you fall on it)
    • Cost no more than a wood burning insert
    • Much more green than gas and even more green than wood. Corn is completely renewable in about 3 months.
    • Don’t really need much of a chimney, an out vent is similar to a dryer vent. 
    • Can buy corn from local sellers

    Con’s

    • Have to find large quantities of corn
    • Have to store large quantities of corn which can be costly
    • Requires you to reload hopper
    • The system requires regular cleaning (The system makes a sort of burn “cake” that falls into a bin that you have to empty)
    • Need electricity (for the hopper and blower that automatically loads), batteries can be installed that last approximately 1-2 days, but they are a costly addition
    • The corn must be dry enough (10-16% moisture is optimal)
    • Keep animals out of your stockpile of corn (I can see a squirrel finding your 400lb bin and thinking he found El Dorado)

     

    imagesConclusion: Seems like a lot of overhead and hassle to me, but if you had the equipment and a supplier and enjoyed cleaning your stove out and making an effort to be green, corn burning might be up your alley. Sadly, if go to ten different sites you will get ten completely different break downs of the costs. It’s cheaper, but getting a firm grasp on the cost might be hard. Do you have to buy a gravity storage container for your 2,200lbs of corn? How much does corn cost today? How much will corn go up if corn burning becomes more popular? How much electricity does the system use? (One sites states $2.50 a month while another states $9.00 a month) There are a lot of questions. Also this system maybe less work than wood, but its still a lot of hassle. Let’s say hypothetically you save $500 – $1000 a year – that’s a lot of effort and commitment for that savings in my opinion.

    Also on youtube.com there was a video of a guy who was completely unsatisfied – it showed him sitting in a 46 degree room and all of the water in his house frozen (probably including his pipes). It’s important to note that apparently this person went to court and lost – Maybe he wasn’t operating it as intended? Whether the case I find it interesting that this is a viable alternative.

    Time to invest in corn commodities?

     

    Videos:
    http://www.youtube.com/watch?v=arUEQ1q4sIk&feature=related
    http://www.youtube.com/watch?v=fmroiK96nzg
    http://www.youtube.com/watch?v=YHuacwmGrDk&feature=related

    Resource:
    http://www.hrt.msu.edu/energy/Notebook/pdf/Sec4/Check_Off_Report_and_Newsletter_by_Michigan_Corn_Marketing.pdf
    http://www.increa.com/homeheat/index.htm

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