Mortgage rates are at their lowest levels in years. Now is an excellent opportunity for many people buying homes to lock in a low interest rate. Homebuyers can do a few things to maximize their dollars and get the most for their money.
To start, a homebuyer should make a down payment of 20% or more of the price of the home to avoid Private Mortgage Insurance (PMI). PMI is insurance that protects the lender against a buyer’s default and can cost up to 1% of the cost of your loan, annually. Homebuyers unable to put down 20% or more should verify with their lender that the PMI will drop off once a 20% equity position is obtained.
Secondly, homebuyers who have a large amount of savings for a down payment must decide whether or not to make a down payment in excess of 20%. In this case, a comparison should be made of the effective (actual) borrowing rate and the rate of return on an investment portfolio.
The stated interest rate on a mortgage is not always the effective borrowing rate because the interest paid on a mortgage is generally a tax-deductible expense. Homebuyers can calculate an effective borrowing rate by considering their federal and state marginal tax rates. Keep in mind that itemized deductions may be reduced when Adjusted Gross Income (AGI) is over $250,000 (in 2011) for a married couple filing jointly. In this case, a C.P.A. would need to calculate the effective borrowing rate. The following example illustrates how to calculate the effective borrowing rate, if the homebuyer’s AGI does not exceed the annually adjustable limit.
For example:
|
Mortgage Rate
|
Federal Tax Rate
|
GA Tax Rate
|
|
6.12%
|
28%
|
6%
|
Calculation:
|
Federal Tax Rate
|
+
|
GA Tax Rate
|
=
|
Total Tax Rate
|
|
.28
|
+
|
.06
|
=
|
.34
|
|
(1.00 – Total Tax Rate)
|
x
|
Mortgage Rate
|
=
|
Effective Borrowing Rate
|
|
(1.00 – .34)
|
x
|
.0612
|
=
|
.0404 or 4.04%
|
The effective borrowing rate should be compared to the projected return on a portfolio. This is based on the homebuyer’s investment risk tolerance. If the expected return of the portfolio is greater than the effective borrowing rate, the homebuyer may want to limit the down payment to 20% of the price of the home and invest the additional funds. Consider that historically the stock market has an annualized return of 12%. If we assume taxes lower the after-tax return to 9%, it still makes sense for our homebuyer to make a 20% down payment and to invest remaining savings in the stock market.
|
Projected After-Tax Return
|
–
|
Effective Borrowing Rate
|
=
|
Difference in Returns
|
|
9%
|
–
|
4.04%
|
=
|
4.96%
|
One exception: If the homeowner finds it difficult to resist spending the cash rather than investing, a larger down payment may be preferred.
For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
