EXECUTIVE
SUMMARY | IN A HOT REAL ESTATE
MARKET, CPAs HAVE AN
opportunity to advise clients
buying homes on a wide range of issues
including financing and price
negotiations. Accountants also can help
clients refinancing existing mortgages
make the right decisions while interest
rates hover at historic lows.
LOW INTEREST RATES
MEAN CURRENT HOMEOWNERS can’t
resist tapping the equity they’ve built
to fund improvements or other purchases.
CPAs should advise clients to look
carefully at the fees they pay to
refinance and shop around to compare
them with what other lenders offer.
FIRST-TIME BUYERS
MAKE UP NEARLY HALF of the
market. CPAs can help these clients
figure out how much house they can
comfortably afford based on their
income, down payment and local market
conditions.
CPAs SHOULD ADVISE
ALL HOME-BUYING CLIENTS to
get preapproved for a mortgage before
they start shopping. Sellers
entertaining competing offers may want
to make sure all prospective buyers can
get the financing they need to complete
the purchase.
TO AVOID GETTING
CAUGHT UP IN A FRENZY of
multiple offers, clients should set a
maximum price they are willing to pay
for a particular home and stick to it.
It’s the best insurance against
overpaying. | MAUREEN NEVIN DUFFY is a New
Jersey-based freelance writer. She also is
the host of “Restore Radio,” a weekly
radio program that follows the ongoing
redevelopment and restoration of Asbury
Park, New Jersey. Visit her Web site at
www.restoreradio.com .
|
f the 1990s were noted for
irrational exuberance in the stock market,
certainly the early 2000s will be remembered for
hysteria in real estate. How hot is it? Sales of
existing homes in the western United States rose
5.1% to a record-breaking annual rate of 1.66
million units changing hands in January 2003—3.1%
stronger than January 2002—according to the
National Association of Realtors (NAR). With it
went the median existing-home price, which soared
to $219,600—an amazing 10.4% spike from the same
month a year earlier. In the Northeast the median
existing home price was $175,000, up 14.9% from a
year ago. With the stock market still in the
doldrums, it’s no wonder people are considering
home buying a better bet. But is it?
Whether the exuberance in today’s residential
real estate market is rational or not, only time
will tell. In the meantime, how should
CPA/financial planners advise their clients in
this volatile climate? Should clients buy houses
and “flip” them like so many poker chips? Can
houses be expected to yield returns like other
investments? This article answers those questions
and highlights some of the areas where CPAs can
guide home buyers and sellers to a smooth
transaction.
RECORD LOW INTEREST RATES
A home is a
place to live, not an investment. Randi
Grant, CPA/PFS, CFP, a partner with
Berkowitz Dick Pollack & Brant in
Miami, says, “Never look at your home as
an investment or source of future
income—only as a roof over your head.”
People can gain a false security
watching their home values increase,
reasons Grant, but they may have to use
all of that gain to find comparable
living space later. With today’s
low interest rates, many current
homeowners can’t resist tapping into the
equity they’ve built up in their homes
to make improvements or fund other
purchases. If clients want to realize
the financial gains their homes
represent —without moving—and take
advantage of the historically low
interest rates, Angelo Ciullo, CPA, a
partner with Trien Rosenberg Rosenberg
Weinberg Ciullo & Fazzari LLP in
Morristown, New Jersey, and New York
City, recommends refinancing.
“Homeowners should lock in the lowest
rates in 40 years,” says Ciullo.
|
Market
Snapshot
Some 42% of
buyers purchased a home for
the first time.
The typical buyers were a
married couple with household
income of $71,300
.
The search for a new home took
about seven weeks
, with buyers
visiting an average of 10
homes.
Repeat buyers needed only
four weeks
to sell their
previous home.
Some 41% of
purchasers used the Internet
as an information source.
Source: National
Association of Realtors,
Washington, D.C.,
www.realtor.org , 2002.
| |
“Generally, we CPAs don’t like debt,” notes Bob
Doyle, CPA/PFS, a partner in Spoor, Doyle &
Associates in St. Petersburg, Florida. “Now that
tax and interest rates are so low and itemized
deductions are limited, the tax benefits of debt
are not as attractive as they used to be.” Despite
the absence of these benefits, Doyle is having a
hard time telling his clients not to borrow for 30
years at 5%. “Even though the client pays much
more interest on a 30-year vs. a 15-year loan,
with rates as low as we’ve seen in a generation, I
feel compelled to support my client’s borrowing
plans.” However, there has been less
argument for recommending adjustable rate
mortgages (ARMs) in this market. Ciullo says the
interest rate on an ARM is fixed for a short
period, say three to five years. After that, the
rate floats based on an established index, such as
the one-year Treasury bill rate. “Mortgage bankers
love ARMs,” says Ciullo. “But adjustable rate
loans are wise only in the short term,” he says,
since rates could start heading up. That
possibility puts the borrower “constantly at risk”
unless he or she refinances, with all the
associated costs of doing so. Ciullo’s bottom-line
advice: An ARM is not a good choice unless you
know you will occupy the home only for a short
time. Doyle agrees: “I don’t think there’s
a lot more downside potential left in rates. The
trend seems to be more toward the upside. So why
use an ARM if you’re going to be in the home for a
long period of time?” Eventually, homeowners who
don’t pay off the debt quickly or sell their
houses have to refinance to a fixed-rate
loan—usually after rates have started to climb. At
that point, what had seemed like a cheap, quick
and cheerful way to grab low interest rates may
come back to bite them. Ciullo advises
consumers to shop carefully when picking a
lender. But sometimes it’s difficult to
compare apples with oranges. “There often
are additional fees on top of appraisals
and various other charges. Interest rates
are just part of the mortgage package.”
The lender may tell you you’re getting a
5% rate, “but with hidden costs that loan
may be the equivalent of 514% at another
bank that doesn’t charge those fees.”
Ciullo says whatever choices borrowers
make in selecting a mortgage, they should
know that “14 of a point on a 30-year loan
costs the homeowner a lot more money and
the bank has a much more valuable
investment. That’s why many banks will
absorb those fees—they make it up in the
resale value of the mortgage.” To help
clients make the right choice, CPAs should
volunteer to sit down and help them
determine the true cost of credit so they
can compare loan terms. Many clients
are refinancing or taking out home
equity loans to free up cash to fix up
their property—using the money to
improve the value of the house and
provide creature comforts or to
consolidate debts and possibly increase
their tax deductions since mortgage
interest is deductible and personal
interest is not. |
Home Warranties
H ome buyers
who do stretch the budget too
far may want to look at home
warranties to limit the
unexpected expenses that go
with buying a house, advises
Phyllis Bernstein. Numerous
companies, such as HMS
National Inc. and American
Home Shield, offer a variety
of plans that range from
coverage for appliances and
garage-door openers to leaky
roofs. For example, Ft.
Lauderdale, Florida-based HMS
offers a home warranty that
covers microwaves, wiring,
water heaters, refrigerators
and wall ovens for $275 for
one year, with a $100
deductible. Most real
estate Web sites have links to
warranty suppliers; Century
21, for example, has its own
Home Protection Plan. The
plans vary greatly, with some
charging minimum call-out
fees, while others may not
cover certain parts. CPAs
should help clients study
closely the fine print of
these plans. Says Jim
Shambo, “Knowing what could
happen allows you to be
prepared to deal with it if it
does.”
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The CPAs interviewed for this article agree
with this rationale, up to a point. “You don’t
want to be the most expensive home on the block,”
says Doyle, who also serves as chairperson of the
AICPA personal financial planning executive
committee. “People want to live next door to
better—not lesser—houses. When it’s time to sell,
the lower-priced houses in the neighborhood also
could compete against you.” Besides, says
Doyle, in this market “people already are
expecting to pay an arm and a leg for a
fixer-upper. Why put anything into it unless
you’re planning to stay for awhile?” CPAs should
advise clients to make large-scale improvements
only if they plan to stay in the home long enough
to enjoy them, perhaps 5 to 10 years. Since most
home improvements don’t translate dollar for
dollar to an increase in property value, remind
clients they are making the renovations for
themselves, not the next owner.
FIRST-TIME BUYERS
The low rates also
are tempting some younger clients to become
first-time home buyers: Some 42% of 2001 buyers
were in this category. Many CPAs have clients who
have decided that buying a house—despite the
sellers’ market—is the best decision for them. And
while this isn’t an entirely bad decision,
accountants may want to suggest a little caution.
NAR President Cathy Whatley, owner of Buck
& Buck Inc. in Jacksonville, Florida, says
even with the strong momentum the association
expects a temporary drop in home sales. “About a
fifth of the country was essentially shut down for
the better part of a week in February due to the
huge snow storm in the East, so we shouldn’t be
surprised to see a negative impact on home sales,”
she said. “However, the disruption will only
postpone transactions and we should see strong
housing activity throughout the rest of the year.”
While that’s encouraging, of course it’s not a
guarantee. For many first-time buyers,
affordability is a big issue. With interest rates
at record lows and banks eager to lend, clients
may qualify for a great deal of mortgage money,
perhaps even more than they can carry comfortably.
Should CPAs recommend clients borrow all they can
in this low-rate environment? Ciullo recalls
clients who were eyeing a luxurious $700,000
house, for which the bank recommended a 20% down
payment. With help from their parents, the couple
could have even gone to 40%. Or the couple could
have put down only 20% and borrowed over $500,000.
But the monthly mortgage payment on such a
loan would come to about $2,300 plus escrow for
taxes and insurance, and the utility costs of
maintaining a large home would be high. The
couple’s projected finances didn’t make it under
Ciullo’s general rule: one-third of pretax income
for house and mortgage, one-third to live on and
one-third for taxes. So he advised them to put 30%
down and reserve the balance for improvements.
How can CPA/financial planners ensure their
clients—first timers and repeat buyers—survive
today’s real estate market? The process can be
complicated and involve bidding wars,
affordability, financing, contract negotiation,
inspections and warranties. Here’s what some
advisers are telling their house-hunting clients.
COMPETING FOR WHAT YOU WANT
“Two things matter to
the seller—price and terms,” says Phyllis
Bernstein, CPA, of New York City-based Phyllis
Bernstein Consulting Inc. “He or she wants the
highest price possible and the best terms
available. Both of these areas leave room for
negotiation. Just because a seller is entertaining
multiple offers doesn’t mean the client will lose
the house. The offer just has to hit the right
note with the seller—the one the other contracts
don’t.” Bernstein says: “The seller will
accept only terms that meet his or her own needs,
so CPAs should advise a buyer to keep
contingencies to a minimum. The buyer should ask
his or her agent to find out from the seller’s
agent what terms the seller will view most
favorably. If a buyer can’t get there first, he or
she should be competitive and flexible.” Bernstein
says this includes offering to pay some of the
seller’s closing costs or being willing to
accommodate as many of the seller’s wishes as
possible, including move-out and closing dates.
For example, the buyer might be willing to
let the seller rent the property until her job
transfer is complete or agree to pay certain
closing costs. The reality in today’s real
estate market is that everything is linked, says
Doyle. “I’ll buy this, if I can sell that. If I’m
a seller and have a buyer who doesn’t have to
apply for a mortgage—who plans to pay cash—that
means the deal is not contingent on his or her
selling a house. Even if that buyer is offering
$3,000 less than someone else, I may take it.”
Conversely, a buyer may need a mortgage
contingency in the contract if he or she thinks
the appraisal may not come up to the purchase
price less the promised down payment. Let’s say
your client is buying a house as-is for a purchase
price of $200,000 and plans to put 20%, or
$40,000, down. The mortgage company wants
something done—a new roof, a new porch and some
masonry work on the driveway—and devalues the
appraisal by the estimated $15,000 cost of that
work. With a $185,000 appraisal, the bank will
lend 80% of that amount, or $148,000. If the
client was counting on borrowing $160,000, he or
she could be short of cash on closing day.
Depending on the contract, the buyer could also
risk losing his or her deposit due to default. A
contingency clause allows the buyer to back out if
the lender lets them down. (Most banks will lend
more than 80% of the home’s value if the purchaser
acquires costly mortgage insurance.)
Prospective buyers can get a leg up on the
competition by being preapproved for the mortgage
they will need to buy houses in their price range
before they start to shop. For example, buyers
looking in the $250,000 to $300,000 range may want
to get preapproved to borrow up to $275,000
depending on how much they plan to put down.
Getting preapproved is as easy as calling a
local lender and answering a few simple questions
about income and assets and agreeing to a credit
check. CPAs should recommend a client get the
approval in writing. Sellers entertaining
competing offers will frequently ask to see it and
may favor buyers who already have mortgage
financing lined up. The buyer is under no
obligation to use this lender for the final
mortgage and is free to shop around after signing
the contract.
BUYING AT THE RIGHT PRICE
Even though
the market is hot, CPAs should encourage
clients—both buyers and sellers—not to
overlook the traditional problem spots,
such as transitional markets, says
Bernstein. “Buyers should make the same
price checks a seller makes to price the
house right—get comparables, track sale
prices, use the local newspaper to keep
tabs on asking prices, visit open houses
and use a real estate agent schooled in
the history of market trends and
statistics in the neighborhood where they
want to live.” Clients should forget about
using their college roommate or
sister-in-law the real estate broker who
lives 50 miles away—he or she may not be
as familiar with the local market. If
they’re still not confident about how much
to offer, Bernstein urges clients to hire
a professional appraiser even before they
make a bid. “Spontaneous guesses of value
are not what you need.”
When to give up.
As in any poker game, it’s
good to know when to fold your hand. “In
a multiple-offer frenzy, some sellers
will simply make unreasonable demands,”
says Bernstein. While a buyer who wants
a house bad enough will do anything
necessary, Bernstein cautions that “some
sellers will even demand offers beyond
those justified by comparables or local
lender guidelines.” |
PRACTICAL
TIPS TO REMEMBER
|
Here are some tips
CPA/financial planners should
keep in mind when advising
home buyers and sellers on how
to survive in today’s
competitive real estate
market.
With interest
rates at historic lows,
clients interested in
purchasing new homes or
refinancing existing mortgages
should lock in rates before
they head up again.
Make sure clients
don’t buy more house than they
can comfortably afford.
Housing expenses generally
shouldn’t exceed one-third of
the client’s annual pretax
income.
Advise clients
shopping for a home to get
preapproved for the mortgage
they will need to buy a house
in their price range. This may
give them an advantage when a
seller is entertaining
competing offers.
For potential
sellers who are moving to get
more space, make sure they
have compared the cost of
remodeling with the expenses
they would incur selling their
existing home, buying a new
one and moving.
When clients are
negotiating to buy a
particular house, make sure
they don’t bid over their
heads. Recommend they set a
maximum price they are willing
to pay for the property before
they enter any negotiations
and stick to it.
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Lenders have a ceiling on what they will lend
on homes in a given area, broken down by square
footage, age, history and other factors. This
limit is based on an appraisal formulated from
current market analysis, tax-roll data and gut
instinct. Bernstein says that if the comparables
don’t justify the price, “the lender may refuse to
take a chance on being the first to raise the loan
limits on a certain neighborhood or home. If that
happens, you might as well throw in the towel. But
sometimes a lender’s refusal can be the kick in
the pants a seller needs and she or he may agree
to a lower price when confronted by the voice of
reality.” The bottom line for CPAs is to recommend
buyers set a maximum price they are willing and
able to pay for a particular house before they
enter any negotiations and stick to it. It’s the
best insurance against overpaying.
A SELLER’S MARKET?
Many experts say
sellers have most of the advantages in today’s hot
real estate market. But sometimes selling isn’t
the best option for clients who like their
neighborhood, schools and home but simply need
more space. According to Bernstein, many
homeowners decide that with a little remodeling,
their existing home will offer them most of what
they need. She says “expert remodeling work can
add comfort and space as well as enhance the value
of a home.” Bernstein cautions, “Given the cost of
relocating, remodeling is almost always more cost
effective than moving.” When clients ask
for advice on whether to sell or remodel, here are
some questions Bernstein recommends CPAs ask them
to consider:
How does the location of your present
home compare with areas to which you are
considering moving?
Try to imagine your present home
after you remodel it. How does it compare with the
home you might purchase?
How much will it cost to purchase
things such as furniture, appliances, landscaping
and window coverings for a new home?
What costs will you incur for things
such as real estate commissions and presale fix-up
to sell your present home?
How long have other houses in your
neighborhood stayed on the market before they
sold?
How much will you have to pay in
closing costs to buy a new home?
How do these expenses compare with
the cost of renovating your home so it meets your
needs? Bernstein says sometimes moving to
a new home in a new neighborhood is the best
decision. But for clients happy with the area
where they live, their commute and amenities such
as shopping and recreation, remodeling will be the
right choice—even considering the cost and
disruption associated with making large-scale
changes to an existing home. Bernstein
says CPAs should caution clients not to remodel if
they plan to move soon or because they believe
they will recoup their investment when they sell.
She cites a survey by Remodeling Magazine
which shows that while a minor kitchen
remodel will enable a homeowner to recoup 94% of
his or her investment, remodeling a bathroom will
only add 77% of the cost to the resale value and
replacing windows only 68%. The bottom line,
Bernstein says, is that “not all home improvements
are equal.”
FINANCING ISSUES
Today’s lending
market is so competitive that some qualified
buyers can even borrow the down payment—something
unheard of in the past. “Lenders are being much
more creative,” says Grant. “If the loan-to-value
ratio is not high enough, often the same lender
will give the client an equity loan for the
difference. The bank splits it into two loans.”
Even down payments are low today. “They’re
usually only 5% to 10%,” says Jack Mondel, owner
of American Mortgage Express Corp., a Cherry Hill,
New Jersey-based mortgage banker, which manages
more than $1 billion in mortgage money. (Mortgage
banks actually loan the money, whereas mortgage
brokers act as middlemen to get financing for
clients from other lenders. Most brokers are
compensated by the lender for bringing in a new
client.) The best way to ensure a good deal
for your money, says Mondel, is to pay points.
These are a percentage of the loan amount, usually
1% to 3%. This money goes directly to the lender,
lowering the risk of the loan. The lower risk is
reflected in a better interest rate for the life
of the loan. The more points the buyer pays, the
lower the rate. However, if the applicant
lacks adequate income or has poor credit, that
will increase the rate. Typically, on smaller
loans consumers also will pay higher points or a
higher interest rate. Since points are generally
tax-deductible, the buyer can apply the lump
payment to reduce his or her taxes in the year of
the purchase. Other typical borrowing costs
include an appraisal, a credit report, an
application fee as well as title insurance and
escrow deposits. In some states the buyer retains
a lawyer to advise on the transfer. Closing costs
can range from $3,000 to $5,000 depending on
location. With interest rates so low,
experts generally recommend fixed-rate loans.
However, balloon mortgages, which borrowers must
pay off with a single “balloon” payment after a
set number of years, are very tempting to some
consumers because of low rates that today start at
3% to 4%. Variety is definitely the name of the
game today, says Grant, who cites five- and
seven-year adjustable rate mortgages, as two
examples. They offer fixed low rates—right now 4%
guaranteed—for a short period followed by an
indexed rate tied to the London interbank offered
rate (Libor) or the 11th District Cost of Funds.
Since the average person stays in a home only
about seven years, Grant thinks these may be
preferable to long-term fixed-rate mortgages. For
those who plan to be in their homes for a long
time, conventional fixed-rate loans are the best
option. Web sites offered by banks and
other mortgage lenders can give prospective buyers
an idea of how much house they can afford based on
their income and available down payment. CPAs also
can direct clients to other sites that help
prospective buyers get an idea of what housing
prices are like in their target areas. See the exhibit for a list of some
of these resources. By analyzing three
factors—mortgage, down payment and home
prices—clients can make sure they don’t overextend
themselves by biting off more home and mortgage
than they can afford. In addition to
affordability there’s another reason why clients
shouldn’t go whole hog on a house. Some people
forget they still need to reserve some of their
income for the future—to save! “It could be the
main reason people fail to achieve their financial
goals—overallocating assets to their residence,”
says James Shambo, CPA/PFS and founder of Lifetime
Planning Concepts in Colorado Springs, Colorado,
which specializes in retirement and investment
planning. “The best question clients
should always ask themselves is: ‘What could go
wrong?’” Shambo says. Citing job security issues,
economic uncertainties and war, Shambo asks his
clients: “How secure are your income streams?
You’re only as secure as the largest employer in
your region.” Shambo has a rule for home
expenditures. “Never mortgage 40% of your income,”
he says. “Anything above 30% is a heavy burden.”
USE COMMON SENSE
For many Americans
the home of their dreams is just around the
corner. CPAs can help those dreams become a
reality by advising clients to use caution in
shopping for a home, staying within their budget
and selecting a loan and lender. While most of the
advice offered here may seem like just common
sense to some, clients buying homes too frequently
give in to the emotion of the moment and sacrifice
good judgment as a result. CPAs can help make sure
a new home purchase doesn’t become a nightmare
because the client overpaid, accepted unfavorable
terms or selected the wrong mortgage.
Internet
Resources |
www.americanhomeshield.com .
Provides warranty protection to home
buyers and sellers on covered mechanical
systems.
www.bankrate.com . Includes
easy-to-use mortgage calculators, access
to current rates and advice about
refinancing.
www.getsmart.com . Owned by San
Francisco-based Providian Financial
Corp., this site matches buyers with
lenders.
www.hmsnet.com . Company offers
homeowner warranties on appliances,
wiring and hot water heaters, for
example.
www.homestore.com . A site for
renter and homeowner needs, it offers
information on new construction,
preapprovals for mortgages, home
furnishings and advice on moving.
www.hsh.com/hbcalc.html .
Consumers can download free home buying
software to calculate mortgage payments,
compare loans and estimate closing
costs. |
www.lendingtree.com . Provides
access to mortgage calculators and also
matches consumers with mortgage lenders
and real estate agents. Offers advice on
the best loan for a particular
transaction.
www.monstermoving.com . Consumers
can calculate payments on a variety of
different mortgages, figure out how much
house they can afford and get estimates
of up-front loan costs.
www.mortgage101.com . Offers
consumers information on prequalifying
for a mortgage, how much house they can
afford, help with the buy vs. rent
decision as well as loan calculators and
access to lenders.
www.realtor.com . This site has a
large listing of homes for sale, with
pictures of houses, information on
neighborhoods, schools and more. Run by
the National Association of Realtors, it
supplies data on market conditions. | |