Fabulous Financials

I’ve been contemplating a big financial move.  Right now, it’s just an idea floating around in my head and I’m thinking out loud on the blog.  However, I need to make a final decision soon and take action (if any) by December 31st.

I’ve considered using my savings to pay off my second mortgage.  The current balance is just under $50k at a fixed rate of 7.875%.

This makes financial sense to me because:

1. If I pay off the second mortgage, my home value will be right side up again. With only the first mortgage remaining, my LTV will be less than 80%.

2. With an LTV less than 80%, I can refinance out of an ARM that will adjust in June 2011.

3. Although the ARM adjustment is more than 1.5 yrs away, current rates are low and it would be nice to lock in an equally low fixed rate now.

4. If I pay off the second mortgage, my monthly mortgage payment be around $1,000.  Maybe lower if I can refinance before rates begin to rise again.

5. If I continue renting the property after all is done, it will generate about $400-500/month profit.

6. If I make the property my home again after all is done (BG graduates HS in June, tenant’s lease is up in Oct), my fixed living expenses will decrease by more than 50%.

7. Mortgage is my only debt. It would be nice to tackle that elephant.

8. Dropping $50k on my debt will reduce my liquid assets, thereby reducing my expected family contribution that affects BG’s college financial aid package.

9. With reduced expenses (or extra profit) and my current income, I can rebuild my emergency fund back to $25k in less than a year – maybe 9 months.

10. I won’t be able to sell the house anytime soon without taking a significant loss, so I should make the best of the cards in my hand.

Any thoughts? Opposing views?

Before I make big decisions (financial or otherwise), I evaluate the benefits and risks.  I don’t think too long about it though.  When I make a final decision, it’s done and I don’t question myself.  I implement immediately and deal with the consequences (if any) later.

I completed my taxes, but I need to do a little more research (maybe even call the IRS hotline again: 1-877-777-4778) to confirm a few things before I submit the e-file button.  The good news is, I don’t owe this year!  Yay!  So far, it appears that I will receive a refund from federal and state, primarily due to this money pit my rental property.

When I hired an accountant last year, I learned quite a few things about the tax treatment of residential rental property. Now that I’m doing my own taxes again this year, I’m learning even more.  From IRS Publication 527 (Residential Rental Property), here are 4 basic tax tips for residential rentals that I thought were interesting:

1. Advance rent. Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use.

This was interesting to me because I remember when my tenants paid their December ’07, January ’08, and February ‘08 rent in December ‘07.  Collecting rent early should be a good thing, but I was concerned that the advanced payment would increase my taxable income for 2007.  When I blogged about it, a reader stated that the extra payments could be claimed as income for 2008 depending on my accounting method: accrual vs. cash.  However, I learned this is NOT true.  If you receive advanced rent, it as taxable income in the year you receive it, regardless of the accounting method used.

2. Security deposits. Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.

This was interesting to me because I used to think the security deposit was taxable income. But after familiarizing myself with state rental laws, I learned that I have to keep the security deposit in a separate account and return the deposit plus accrued interest when the tenants move out – assuming all lease terms were honored. In that case, it isn’t really MY money.  It’s more of an insurance or collateral for damages.  However, if I do not return the security deposit, then I have to report it as income.

3. Vacant rental property. If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. However, you cannot deduct any loss of rental income for the period the property is vacant.

This was interesting to me because I had a 2.5 month vacancy in 2008 – over $4k out of pocket and no rental income to offset it.  Man, that hurt!  But oh well, rules are rules.  When the rental is vacant, loss rent is not deductible.  On the same accord, if the rental is occupied, but the rent collected is less than the monthly mortgage payment, the difference is not deductible.

4. Local transportation expenses. You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property.

This was interesting to me because I live over 75 miles (one way) from my rental property.  Between multiple trips when the property was vacant this summer and quarterly inspections when it is occupied, I racked up hundreds of miles.  It’s also good to know that the 2008 standard mileage rate for business miles driven is 50.5 cents per mile.  With the rising cost of gas this past summer, every little bit helps.

There is so much more to learn about the tax treatment of residential rental property. It’s enough to drive you to drinking!  Between Sunday afternoon and Monday evening, I’ve emptied two bottles of Moscato. LOL!  I tell you what though.  I only plan to do this for one more tax year.  I’ve decided that being a landlord is simply not for me.

[image credit: frugal.families.com]

These are my FICO scores as of 1/18/2009 from the three major credit bureaus.  For the first time ever, I broke 800 on at least one of them.  But as you can see, there is a 38 point difference between EQ (768) and EX (806).  This is why it is so important to check all three credit reports: neither is ever exactly the same.

Let’s see what the problem could be.  I have (or have had) a mix of credit that covers the gamut of all possible scenarios: mortgage, credit cards (major and store), installment loans (personal, student, auto), etc.  I have no late payments, collections, or public records, a 2% revolving balance to limit ratio, one inquiry on EX, and 20+ accounts on each report.  Hmm…

So why is Equifax significantly lower than the other two?

Length of credit history.

Yep, that’s it.

From Fair Isaac:

Your FICO score measures the age of your oldest account and
the average age of your accounts. In your case, either your
oldest account was opened recently or the average age of your
accounts is relatively low. People that do not frequently open
new accounts and have longer credit histories generally pose
less risk to lenders. Therefore, as your credit history lengthens
and you pay your bills on time, this factor should have less of a
negative impact on your score.

Translation.  Length of credit history makes up about 15% of your credit score.  So even if you pay your credit card bills on time and handle credit responsibly, you must do it consistently for a long time to obtain the greatest effect.  For example, according to Equifax, my oldest account was opened only 6 years and 1 month ago and the average age of my accounts is only 3 years old.  On the other hand, Experian’s data is more than 2x as long because it is reporting three older accounts in good standing that somehow fell off Equifax’s radar.  Do you see why it is so important to maintain your oldest accounts?  The difference results in 38 points, which is a lot!  My EQ score (768) is still above average so it isn’t worth my energy to have them fix it.

Why did I pull my FICO scores?

Reason #1: pure curiosity.  I monitor my reports regularly, but I like to pull my credit scores at least once per year to know where I stand.  I never know when I will need to take out a loan.  I also like to play with the simulations to see how my scores will change over time based on various behavior.  At this point, the only thing I can do to improve my EQ score is to keep doing what I do: use my cards, pay in full, then rinse and repeat.  As my accounts age, my score will continue to increase.

Reason #2: I want to refinance my mortgage.  The 30 year fixed rate is at an historical low and I want to take advantage of it.  Currently, I have two mortgages (80/20).  One is a 5/1 ARM set to adjust in 2011 and the other is 15 year fixed.  The two loans together have a blended rate (i.e. weighted average) of 6.25%.  For my situation, there are four benefits to refinancing:

• Consolidate both loans into one
• Get rid of the ARM
• Lock in a lower, fixed rate
• Lower my monthly mortgage payments

What rates can I expect?

With a middle score of 782 (as used by most mortgage lenders), the lowest rate I can probably obtain is 4.469% (may be outdated by the time this publishes on the blog).  This rate is based on the national average, but the rates in my locale may be higher or lower.  Assuming I could refinance at 4.469%, the difference in my monthly mortgage payments will be over $100.  The thought of saving $100/month is great, but I also have to consider closing costs, points, and the break even point before making a final decision.

My Next Steps

Considering the three criteria that lenders look for when refinancing – credit score, income, and equity – I’m batting 2 for 3.  The economy isn’t doing me any favors, so the lack of 20% equity will be a thorn in my side.  With that in mind, I plan to call my current lender to see if they will refinance my loan at a competitive fixed rate.  Worst case scenario, I’ll ask them to “restructure” my loan with better terms.  If all else fails, I will shop around for a lender who values a customer with good credit and a steady income.  Recommendations (not advertising) are welcome.

Sources

• I used a 50% off code and paid $24 for all three reports and scores.
• Get all three credit reports (no score) for FREE, courtesy of the Federal Trade Commission.
• Read about what makes up your FICO score.

[image credit]

I have a question…

What is so catastrophic about a foreclosure?

I don’t “personally” know anyone who has experienced a foreclosure, so I’m trying to put it in perspective based on what I do know.  Growing up in Brick City, then living in a rural, clearly segregated, small town in NC, here are my thoughts:

Foreclosure.  Eviction.  Same thing.  I’ve seen the latter happen many times.  Life goes on.

Whether you’re renting an apartment or buying a house – in both situations – you make a deposit (maybe), sign a written agreement, move your family and all of your worldly possessions, enroll your children in school, and create family memories/traditions as you make the place “home.”

During the housing boom (or bust, whatever you want to call it now), many people who didn’t previously qualify to buy a home began buying them left and right.  Now reality has set in and they are at risk of losing the home they couldn’t afford in the first place.  Why is this bad?

By the time the bank comes to repossess, dude, you had a 2-3 month head start.  Pack ya shyt and bounce!  Go back to the living arrangements you had before you bought the house.  It was acceptable then, so why isn’t it acceptable now?  Why do you want to stress yourself out for 30 years to keep a home you can’t afford?

Help me out people.  This isn’t tongue in cheek, I’m really confused.

This makes year 3 and I can get used to this.  Same as last year, and the year before, I received a refund check from my mortgage company for a projected overpayment in my escrow account.  Based on my estimated taxes and insurance for the upcoming year, my mortgage company has estimated that I will pay them too much.  So they give it back!

• The 1st year (‘06), it was $500+
• The 2nd year (‘07), it was $300+
• This year, it is $500+ again

Woo wee!

But wait…

I can’t afford to make THIS mistake again, so I poked around a bit until I saw that my monthly mortgage payment will decrease by $16.  Not much, but I’ll take it!

Ok, celebrate now.

Woo wee!!

As usual, this refund will be used to pay for my annual HOA fees.  Great fun. [sarcasm]