Good article on the new tax provisions in the housing bill

I finally found a good article about the new tax provisions in the big housing bill that was signed last week. Although each of the provisions targets a very select audience, I thought I would try to summarize:

1) If you are a first time home buyer (did not own a primary residence for 3 years prior to this purchase) between April 9, 2008 and July 1, 2009, you can get an interest free loan of 10% on the house up to $7,500. It comes in your next years taxes as a tax credit and must be repaid starting in the second year for 15 years. You can't make more than $95,000 for singles and $170,000 for couples and the credit is reduced for those above $75,000 and $150,000.

2) If you own a home but don't itemize your deductions and therefore take the standard deduction, you can property taxes on your home above the itemized deduction of up to $1000 for couples and $500 for individuals.

Those are the "helping" provisions. To pay for this, there is a third provision which is a tax hike. Here is a quote from the article describing that tax hike:

To pay for the new breaks, Congress adopted some revenue raisers, otherwise known as tax hikes, including one that affects homeowners. At present, taxpayers who own a vacation or rental property can begin using it as their principal residence and then sell it after two years, taking advantage of the break that excludes from income capital gains from the sale of a principal residence. The excluded amount is up to $500,000 for a couple or $250,000 for a single.

But thanks to the new law, after January 1, any time a house isn't used as a principal residence it reduces the gains eligible for exclusion on a pro rata basis. So, if a couple uses a house as a vacation or rental home for five years and then as a principal residence for five years, only half their gain will qualify for the exclusion.

If the couple has a $100,000 gain, they can only exclude $50,000 of that gain from their income. But if the same couple owns a mansion and sells at a $1 million gain, they can still claim the maximum $500,000 exclusion, because it's just half of their gain.

An odd result from a law that was supposed to help struggling, ordinary homeowners.

Well, it looks like that hurts people also that maybe haven't been able to sell their home because of the bad market. For example, if they moved from a house they lived in for 4 years and established another primary residence, and didn't sell their home for 1 year after that, they would only be able to exclude 80% of their gains regardless of the fact the last year of house taxes have been dismal. That's how I read it, but I am no tax professional. I think this is going to hurt a lot of people who already were hurt by the housing market.

Amortization schedules show the real problem

Financial Advisors love to flaunt the power of compound interest, that is the amount of interest money can earn over time when you earn interest on the principal and interest that exists. If you look at an amortization schedule, you will see the opposite, almost a negative compound interest thing happening.

First, an example. Using an Amortization calculator and Freddie Mac's current weekly average mortgage rate of 5.85% on a 30 yr loan starting in April of let's say $150k, you will find I would pay off the first half of principal in February of 2029 making the minimum monthly payment. Thats almost 21 years to pay off $75,000 at almost $900 per month! By the end of 30 years, the total interest paid is over $168k!

While changing the principal doesn't change when you pay off half, your interest rate does. If you have a higher mortgage rate, lets say 7%...you pay off half in December of 2029. So, when you pay off your first half of your mortgage varies from about 20-22 years based on the current interest rates.

Now, in the past people have paid little to no attention to these schedules. Its because paying off principal wasn't an issue when houses were growing at 4% compounded annually. But, with the recent housing market growth slowdown, I hope that more people pay attention to it. If someone gets a 100% financed $150k house now and prices only go up 1% per year for the next 3 years and then they try to sell it, they will have paid off roughly $6.5k in principal and gained about $4.5k in value on their home. So, if they sell it at that $154,500 with a standard Realtor fee of 6%, they will pay $9,270 in Realtor fees. This will leave them with a whopping $1,730 check for paying $32,400 in mortgage payments not including PMI, homeowners, and taxes. Sure, they will also have got a small tax deduction during that time...but I think they might have been able to rent and save more money.

Just as a matter of opinion, look at your amortization schedule and consider dropping some more money into your mortgage monthly. Maybe you can pay off the first half a bit quicker than in 20 years then :-)