What You Should Know About Down Payment Gifts

With an extreme lack of inventory facing so many of my buyers right now, they need all the help they can get. The biggest obstacle for many is the lack of money for a down payment. Thankfully, one solution is to get some help in the form of a gift from a family member, close friend, or a charitable organization. 

As a mortgage professional, I have become very familiar with the IRS code on this topic because there is so much confusion regarding the tax implications of giving a cash gift to help a loved one buy a home. Before I delve deeper into this, a disclosure: I am not a licensed tax preparer and don’t ever want to be one – I have mad respect for tax professionals. This article is not to advise specific tax guidelines but instead give some useful, general information to help lead you in the right direction. Please seek a tax professional for more detail.

The 2021 annual gift exclusion will not change from its current $15,000 that you can give to as many individuals – your kids, grandkids, their spouses – as you’d like, without gift tax consequences. The person receiving the money does not have to report it to the IRS or pay gift or income tax on its value. However, if you give the gift and it’s more than $15,000 per individual, you will want to pay close attention to the following. 

Here is the good news for most of us. Unless you are gifting more than $11.7 million, you will pay no taxes on that gift. Yes, you heard me right. I am talking millions here – Thanks to the lifetime gift tax exemption, you can give away $11.7 million tax-free throughout your entire life and not pay one penny on gift taxes. Of course, this could change as new tax policies get enacted, so be sure to always check with Uncle Sam or your tax professional before writing that check.

When my clients learn about this little nugget, they realize worrying about gifting more than the yearly allotment of $15,000 is a moot point. Most will not pay any taxes on the gift as most of us cannot fathom having $11.7 million to give our loved ones when we pass. According to the Joint Committee on Taxation (2015), only 2 out of 1000 people who die – owe any estate tax. So gift away, my friends! Show your loved ones how much you care now that you have this critical information in your pocket!

Home values are up. Can you still afford to buy?

Home prices in California are going up and will probably continue to do so. Does that mean they are less affordable?

The news can be misleading and confusing as it recently touted the significant move higher in the median home price, currently up 15% nationally versus last year. And 14.3% in Sacramento County, says the Sacramento Association of Realtors. 15% sounds awfully high. But the median home price does not measure appreciation. Instead, it marks the middle price point of recent home sales. 

With a substantial lack of inventory for lower-priced homes, more transactions occur for higher-priced homes, which pushes the median home price higher.

The actual Sacramento home price appreciation rate was about 1.25% for the last quarter, or 5% annualized. And it is forecasted to increase by a similar margin next year. So have you been priced out of the market?

The short answer is no, or at least not yet. California’s affordability factor has improved year over year because mortgage rates are down by almost a full percent, and incomes have gone up (Avg. weekly net pay is up 5.7% year over year nationally). Also, remember, only a portion of your income goes towards paying your mortgage. A 5% rise in income can offset a much more significant percentage rise in housing expense.

Let’s assume your monthly earnings did not improve from last year. Consider a buyer’s max purchase price of a new home, based on his/her income and debt was $450,000 last year. Maybe this buyer decided to wait because they were nervous about the market. Now, that home is worth about $472,500.

As a mortgage professional, if I were to use the same income and debt structure I used last year, this buyer would now afford a home for $490,000. This tells us that homes are actually more affordable, even though they have appreciated.

Granted, I am using very simple math here, and this does not get into down payment or cash required to purchase this home but is purely to show you the media doesn’t’ always get it right. Take the time to work through these numbers with a mortgage professional you trust, and don’t give up your dream of homeownership!

Refinance Now or Wait?

Refinance now or wait? With rates coming down as they have, some borrowers may want to delay a refinance, hoping that rates will improve further. Unfortunately, there are no guarantees rates will go even lower, and more critical, borrowers forget about the savings they forgo while they are waiting for rates to move lower potentially.

To make sure I don’t get in trouble with my company marketing policy, I will not talk about specific rates and instead will talk about the difference between your current rate and a new rate. 

Say your current mortgage payment is $1,775 a month. And based on a new rate, you could lower your monthly payment by $350 a month. You are in no rush and think rates will stay where they are or possibly go lower! Let’s assume by waiting another six months, you can score a .25% lower rate than today. The incremental savings you would see from a slightly lower interest rate would take a significant period to recoup the savings you would have been guaranteed by locking in that new rate today.

If you waited six months and could get a 0.25% rate lower than the rate you could get today, you would save $58 a month. But based on the $2,130 in savings you would have guaranteed by refinancing today, it would take over 3.5 years to make up for the forgone savings. If the rate were only better by 0.125%, it would take more than seven years to breakeven. And again, remember there is no guarantee that rates will move lower.

SECRET WEAPON – You Pick the New Term!

Get a tailored mortgage if your lender offers it! If you are managing your monthly payment just fine and have a goal of paying off your mortgage earlier by aggressively paying down your principal balance, this may be your secret weapon. For example, I have a client who purchased their home four years ago and wants to take advantage of a lower rate but does not want to start over with a new 30-year term, which eats into their long term savings. 

We did the math and were able to lock them into a new 22-year mortgage while keeping their monthly mortgage payment roughly right where it is now. In essence, our client was able to shave-off four years of payments without increasing their monthly cash flow. Be creative and take the time to run these numbers with your lender.

Why Don’t I Have the Best Rate?

Without fail, the number one question I get from first-time callers looking to refinance or purchase a new home is “what’s your rate?” I used to stumble a bit when asked this question because there is so much involved in getting an accurate interest rate and one that I can’t answer in a 30-second conversation. I wish it were that easy.

After years of experience, now I don’t hesitate to answer – I respond with, “What rate do you want? “This tactic usually serves to disarm them a bit and allow me to detail the components that go into an interest rate. 

If you are not getting the rate you heard on the radio or the interest rate you read in the Real Estate Section of the newspaper, it’s typically not because of some elaborate bait-and-switch scheme. In all probability, your rate is different because of Loan-Level Pricing Adjustments. Loan-level Pricing Adjustments are not discretionary fees, nor are they a profit source for me or my bank. These are federally mandated fees per Fannie Mae and Freddie Mac to compensate for loans with greater risk.

They work just like auto insurance. With greater risk come higher premiums. It’s an add-on to the base rates set by Wall Street. Here are just a few triggers that will increase your rate or fees:

  • Having a second mortgage or line of credit that you would like to subordinate. (Keep in 2nd lien position)
  • Doing a “cash-out” refinance with less than 40% equity in your home.
  • Having a credit score of 740 will save you almost a full percent in rate relative to a 640 score.
  • Investment property can add up to a full percent or more compared to the primary residence.
  • If you like Macaroni and Cheese, it will cost you. Not really, just making sure you are paying attention.

You can research your scenario at Fannie’s site.

Why Getting the Lowest Rate Might Be a Bad Idea!

I know it feels good to tell your friends that you have a lower rate than them, but you might just be spending more money over time to get that rate because you are paying points (aka extra fees to buy the rate down). And since many first-time homebuyers sell within 6 to 8 years, having that low rate was just for show. I know this might sound counterintuitive, but you may be paying more because of that lower rate.

The one constant in life is that life is continually changing. Folks can’t envision what will happen in years to come because life just happens, and maybe down the road, they need to a cash-out refinance to pay for required maintenance or repairs, or to help with their kids education, a wedding, or help with a new car, the list goes on and on. 

The important thing is to work with a lender who will take a little bit of extra time to crunch some numbers and help you decide whether a buydown or lender credit is better for your long term and short term goals.

New Tax on Mortgage Refinances

I’ve got some good news, and I’ve got some bad news. Here’s the bad news first.

Last week, the Federal Housing Finance Agency (FHFA) announced a surprise fee on all new refinance transactions sold to Fannie Mae and Freddie Mac, making up approximately two-thirds of all loans. The cost was assessed regardless of the bank or mortgage company you choose to work with and will increase the interest rate that you had been expecting and had been available.  

This sudden move came as a surprise both in the imposition of the fee and in making the fee effective almost immediately. Historically, they allowed 60-90 days before the new pricing went into effect, to enable lenders reasonable time to close their rate lock pipelines.

Why are they introducing a new fee?

Two reasons. First, both Fannie and Freddie are concerned about the uncertainty surrounding future mortgage defaults and the increased costs they incur. Secondly, they are worried about how quickly their current mortgages are prepaying due to the unprecedented wave of refinances. When a loan refinances, the prior loan comes out of the security, which creates losses to the investor who owns that mortgage, so by raising the cost to refinance will slow down how past loans are paying off.

Although Fannie nor Freddie outwardly stated this, many in the industry think that a third reason drove this announcement. The “refinance tax” will allow both enterprises to build up a capital base for their future release from conservatorship and back to becoming private entities – This is pure capitalism ladies and gentleman. 

 What is the impact to borrowers?

  1. Across the country, lenders are adding these new refinance fees into rate sheets effective immediately for all conventional conforming refinances.
  2. These fees are on top of all other fees already charged by Fannie and Freddie.

What happens next?

The mortgage industry is united in its disappointment with the announcements, specifically with the break from all past precedent of providing a reasonable advance notice of the effective date. The probability of FHFA, Fannie Mae or Freddie Mac revising their announcements with a different effective date is probably low.  

Now for some good news… 

Interest Rates are still at extraordinarily low levels, and refinancing may be a smart financial move, which can save you money every month or reduce the number of years remaining on your mortgage. You may also be able to consolidate your debts to save even more money.