WaPost: What You Earn is Key to Where You Live

Published by peter | Filed under Real Estate

A must-read from Ilyce R. Glink, author and nationally syndicated columnist. Her latest book is “100 Questions Every First-Time Home Buyer Should Ask.” Samuel J. Tamkin is a real estate lawyer in Chicago.

Here’s how the economists look at the world: If you have a job, you’ll pay your mortgage, credit card debt, student loans and auto loan payments each month. If you’re unemployed, you’ll pay until you run out of money, and then you won’t.

Job stability and the wages you receive in each paycheck are central to the concept of a housing market that works and a functioning credit market.

If you don’t think your job is stable, you’re not going to spend money on anything except the barest of essentials: food, gas for your car, mortgage or rent, and utilities. If you’re not earning enough to pay for food, rent and your credit card monthly payment, you’ll be forced into some tough choices.

But even if you have a stable job that provides a good wage, your ability to afford housing in your neighborhood of choice may be somewhat limited due to skyrocketing home prices in the early 2000s.

The Center for Housing Policy, a research affiliate of the National Housing Conference, recently released a new study called “Paycheck to Paycheck: Wages and the Cost of Housing in America.” The study, funded by Freddie Mac, looks at fundamental changes in the homeownership and rental markets from 2007 to 2008.

It turns out that even with home prices on the decline and the soaring number of foreclosures, there remains a gap between what workers earn and the cost of owning or renting a home, said Maya Brennan, a research associate for the Center for Housing Policy.

Some areas are more unaffordable than others, particularly those that enjoyed the fastest run-up in housing values.

For example, although Florida has been one of the hardest-hit states in terms of foreclosures, the rental market has become “substantially less affordable since 2007,” Brennan said. “Florida was the only state in which all the metro areas became less affordable. That indicates to us that former homeowners in Florida aren’t able to move into homes, and it’s putting some pressure on the rental market there.”

And thanks to the massive wave of foreclosures sweeping across the country, Brennan added, “places that have been ownership units aren’t converting into rentals fast enough to make up for increased demand in rental housing.”

It’s Economics 101 all over again: Low supply translates into higher prices — ones that people squeezed by a contracting economy and shrinking wages cannot easily afford.

“Paycheck to Paycheck” compares the income earned by people in 65 different occupations. It also looks at home prices in metro areas across the country.

The good news is that home affordability is better now than it has been in the past decade or longer. But the study found that while nearly all housing markets experienced a decrease in the income it takes to own a home, “it’s not quite enough for a lot of people to get into homeownership yet,” according to Brennan.

For families that include a working police officer, Brennan said, nine rental markets were unaffordable and 123 homeownership markets were unaffordable on just one household income. Construction workers also have a tough time owning or even renting a house, even if they work year-round at full-time construction jobs.

As housing values continue to decline, more areas will become affordable to more types of workers in different occupations. Then all we’ll have to worry about is whether lenders will loosen their purses to make the loans.

Q: I’ve been in this house for 10 years of a 30-year mortgage. If I refinance with another 30 years, then I will be paying for a total of 40 years — which seems forever. But I would save $309 in monthly payments, which I could in turn put toward retirement. I’m 53, single and don’t have a good retirement plan in place.

If I refinance for 20 years, then my payment is lowered $130 per month, which will not add much to the retirement fund. If I refinance my loan for 15 years, my payment goes up $51 per month with nothing extra saved for retirement.

Which seems to be the better option? The interest rate for the 30- and 20-year terms is 4.875 percent and for the 15-year term is 4.75 percent.

A: You’ve presented an interesting issue: balancing the need for retirement money versus a monthly mortgage payment. The answer depends on the answers to these questions: How much have you already saved for retirement? What income streams will you have other than Social Security? When do you plan to retire? Do you plan to continue to work, perhaps part time? Obviously, I don’t have those answers, so let me try to frame out the issue for you so you can think it through yourself.

Let’s look at Option 1: If you save $309 per month, that’s about $3,700 per year. Over the length of a 30-year mortgage, you’d save (assuming you still work) $111,240. If your cash compounds at 4 percent, you’ll have $182,600, which is about $73,000 in today’s dollars. That sounds great, but you’ll be 83 and probably already several years into retirement.

Will you have enough cash in retirement to continue paying your mortgage until the loan term ends? If you retire at 67, that’s 15 years of payments you’ll have to make. Not a great picture. However, if you’ve paid down enough of your loan, you might be able to take out a reverse mortgage, which would wipe out your monthly payments. But you won’t have anything like $182,000 in 15 years.

You might do a lot better by refinancing into a 20-year loan, and save $130 per month, or $1,560 per year, especially since you’ll get more of a break in the interest rate.

With Option 2, over 20 years you’ll amass almost $43,000 (which will feel like $28,000 in today’s dollars). But your mortgage will be paid off, and you’ll be 73. You’ll still owe property taxes and insurance, but you’ll free up $600 or so each month in mortgage payments.

Also, if you decide to do a reverse mortgage at age 67, you’ll have virtually the entire loan paid off and would be able not only to pay off the loan but tap into your home’s equity for additional cash or a monthly stream of income.

I don’t see much benefit in refinancing for a 15-year loan, which is Option 3. I’d rather see you save some cash.

We haven’t talked about closing costs, but you have to weigh just how much you’re saving and how long it will take to pay off your closing costs. If it takes you two to three years to pay off your closing costs, and you’re adding 10 years onto your payments, I don’t see how this really works for you. But if you can pay off your closing costs (with your monthly savings) in 18 months or so, and you’re refinancing for the same term length and are still saving money, that seems like a solid financial move.

Tax-wise, you may get to deduct the interest on your mortgage payments on your federal income tax return. But you may also have tax savings if you’re able to sock money into an employer-sponsored retirement account. It’s a small issue to consider, but run the numbers to see what happens tax-wise if you put the money into a retirement account rather than into interest payments.

One last issue: You indicated that your options were for three types of loans with different maturity dates but two of the loans have the same interest rate. You might want to shop that around. Twenty-year loans are typically getting the same rate as 15-year mortgages, not 30-year loans.

Q: I have a home equity line of credit for $50,000. I have had it for five years and owe nothing on it. As I recently lost my job, that line of credit is a means to survive. My question is, do I try to grab all of it at once as a financial cushion, or would that send up red flags for my credit score? Is it less obvious to grab $45,000 or another amount? My equity in the house is conservatively $190,000.

A: Your question is particularly timely, since so many lenders and creditors are clamping down on lines of credit that they deem too risky — which these days is apparently everyone.

I have heard the federal government is requiring lenders and creditors to have cash on hand equal to, in some cases, 40 to 50 percent of the credit that has been extended. So, if you have a $50,000 line of credit, the federal government might require your lender to have $10,000 to $20,000 in cash on hand, just in case you borrow against your line of credit and then default.

I’m hearing from creditors that these requirements for cash on hand are unsustainable, given how much credit everyone has been extended over the past two decades. So everyone’s credit is going to be clamped down.

For example, if you have a credit card that you haven’t used in 12 months, the lender may close it or reduce the amount of total available credit. We’re hearing from thousands of Americans who have had their home equity lines of credit reduced or closed. Not only does this make it difficult to access the credit you’ve so carefully preserved, but having less credit available will take some points off your credit score.

To your question: You have to tread delicately. If you don’t take money out of your credit line, you may have the credit limit cut and regret that you didn’t take the money out when you could. But taking a sizable amount of money without the means to pay back the funds can put you in a precarious situation.

If you tap 80 to 90 percent of your line of credit, you will hurt your credit score at least a little. But if your credit line is cut substantially, that too might hurt your credit score.

Optimally, you’d never tap more than 25 to 30 percent of a line of credit — in your case, $12,500 to $15,000. Anything more than that could lower your score a little. But since you might actually need the cash, it’s better to take it now rather than want it later and not be able to get it.

Just remember, this isn’t play money. It has to last until you find a new job, and then you have to pay it back, with interest. So spend it carefully, and with luck you’ll find a new job soon. Make sure you understand the risks of taking the money out if you decide you have to. Remember, your home equity line of credit is tied to your house, so if you stop making the payments, you will put your house at risk of foreclosure.

Q: My sister passed away in January. I am the beneficiary on some of her financial accounts, and I have also inherited her house and other property. Is there any difference between the two when it comes to taxes? Aren’t there rules on certain amounts that can be taxed on an inheritance?

A: When your sister placed you as the beneficiary on some financial accounts, you should have inherited those accounts automatically. With the proper documentation given to the financial institution holding your sister’s accounts, you would be entitled to use those funds as you see fit.

If your sister owned her house in a trust, the trust could convey title of the home to you and you would become the new owner of the home. If the home was held in your sister’s name, you might need to have a probate court authorize the transfer of ownership from your sister’s estate to you.

The federal tax implication of each of those transactions is another. Let’s start with the value of your sister’s estate as a whole. If your sister’s entire estate, including life insurance policies she may have owned, is less than $3.5 million, your sister will not have to pay any federal estate taxes.

When your sister’s estate settles up with the IRS for any taxes, your sister would owe only federal income taxes on her earned income from the year before she died through the date of her death. Those would be the same federal income tax returns that your sister would have filed for those years had she still been alive.

Most people’s estates are well below the $3.5 million threshold and are not affected by the federal estate tax. Each state treats estates somewhat differently, so there may be a state estate tax that is owed.

What some people forget is that retirement accounts will generally be taxed at some point or another. If you are named as the beneficiary on any of your sister’s retirement accounts, you will pay federal income taxes on that money as you take it out. In some cases you can defer taking the money out over time to minimize the effect of any taxes, but if you don’t follow the rules, you may have to pay federal income taxes on the whole amount you inherit, plus penalties.

If the accounts you inherited aren’t qualified retirement accounts (such as a 401(k), 403(b) or a 457 account), you shouldn’t have to pay taxes on the money you receive as an inheritance. If the account has mutual funds and stocks that are not held in a retirement account, the value of those funds and stocks shouldn’t be taxed if you cash them out and sell them.

As far as the home is concerned, if you decide to sell it, you shouldn’t have to pay federal income taxes on that sale provided you sell it within a year of the date you inherited the home.