There are a number of important tax law changes that take effect this year, including three changes that will affect some homeowners. There are also changes that impact business owners.

While you won’t see the impact of these changes until you file your returns early in 2009, it helps to know about them now so you can keep proper records and make the smartest decisions for your money.

Take a few minutes to review the changes so you can keep them in mind as you devise your 2008 tax strategies.

Changes for Homeowners

Homeowner’s Exemption: In the past, taxpayers have taken the opportunity to convert a rental property or vacation home into their primary residence and then later sell the property. This allowed them to take advantage of the Homeowner’s Exemption which allows a taxpayer to exclude up to $250K ($500K for married couples) of gain realized on the sale of a primary residence. An example of a common strategy has been:

• Taxpayer acquires rental property in 2000 for $100K.
• Taxpayer rents the property out for three years.
• In 2003, taxpayer moves into the property as his/her primary residence.
• In 2005, taxpayer sells the property for $600K.
• Taxpayer (married couple) avoids paying taxes on the entire gain ($500K).

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Following is an excerpt from John Mauldin’s “Thoughts from the Front Line” and a link to the entire piece. It’s lengthy but a great articulation of the current financial situation and proposed government intervention. It is in the form of a letter to Congressman Joe Barton, TX, a top Republican House leader. John Mauldin is a multiple NYT Best Selling author and recognized financial expert. He has been heard on CNBC, Bloomberg and many radio shows across the country. He is the editor of the highly acclaimed, free weekly economic and investment e-letter that goes to over 1 million subscribers each week.

It’s the End of the World As We Know It

Dear Joe,

I understand your reluctance to vote for a bill that 90% of the people who voted for you are against. That is generally not good politics. They don’t understand why taxpayers should spend $700 billion to bail out rich guys on Wall Street who are now in trouble. And if I only got my information from local papers and news sources, I would probably agree. But the media (apart from CNBC) has simply not gotten this story right. It is not just a crisis on Wall Street. Left unchecked, this will morph within a few weeks to a crisis on Main Street. What I want to do is describe the nature of the crisis, how this problem will come home to your district, and what has to be done to avert a true, full-blown depression, where the ultimate cost will be far higher to the taxpayers than $700 billion. And let me say that my mail is not running at 10 to 1 against, but it is really high. I am probably going to make a lot of my regular readers mad, but they need to hear what is really happening on the front lines of the financial world.

MORE

NPR had an interesting podcast on the current economic crisis and the government bailout. If you want to give it a listen the link is below. It is interesting to note that the crux of the bailout is entangled in an assessment of value. It is coming down to what price will the government, and ultimately all of us taxpaying citizens, will pay for the bad debt that is currently on the balance sheets of those who created it in the first place.

Listen to the NPR podcast here.

One of the costs of living in the Bay Area, and California for that matter, is that you are much more likely to owe AMT (Alternative Minimum Tax) when you file your personal Federal Tax Returns. Other than an act of congress to change the tax law, there’s not much you can do about it. The silver lining on this cloud has to do with… your mortgage.

The original AMT established in 1970 targeted tax shelters used by a few wealthy households and was greatly expanded in 1986 to aim at a different set of deductions that most Americans receive. The AMT sets a minimum tax rate of either 26% or 28% on some taxpayers so that they cannot use certain types of deductions to lower their income tax obligation. Sounds reasonable, right? I mean, why should people who are making millions of dollars be able escape paying their fair share of income tax!? Well, because of the way the AMT is structured, welcome to the life of the rich and famous!

According to the Congressional Budget Office, “Over the coming decade, a growing number of taxpayers will become liable for the AMT. In 2010, if nothing is changed, one in five taxpayers will have AMT liability and nearly every married taxpayer with income between $100,000 and $500,000 will owe the alternative tax.” That will be over 30 million household.

But why are we Californians affected more than the rest of the population? First, incomes in the Bay Area are statistically higher than the rest of the country. But here is the more specific reason: two of the disallowed deductions through the AMT schedule are state income tax and real estate tax.

As of 2007, the highest rate of state income tax is that of California, with a maximum rate of 10.3%. Under the standard 1040 tax schedule, if you itemize your deductions, you are allowed to deduct what you pay in state income tax. Not so under the AMT schedule. Despite the real estate downturn over the past year, values in many places in the Bay Area have remained stable and are still one of the highest priced areas in the US. Property taxes are often a significant part of one’s housing expense, to the tune of 1.25% per year of the assessed value of your home. This too is excluded under the AMT. So what’s a newly rich & famous person to do?

Generally speaking, the interest that you pay on your mortgage for your home remains deductable under AMT. That’s a bit of a blanket statement, so don’t take it as gospel. I’ve discussed this with the brightest of CPAs and they still will say “well… there may be some other issues”. The point being talk with your CPA or Tax Advisor. Nonetheless, let’s go through an example of how this can remain a tax benefit of having deductable mortgage interest on the AMT.

Let’s say you have a $500,000 qualified mortgage and pay 6% interest (and for simplicity let’s say your mortgage payment is interest only). You would have paid $30,000 of interest over the course of the year. If you are subject to the 26% AMT rate and approximately 10% California tax rate, that $30,000 would give you an approximate $10,800 reduction in your tax liability. This basically means that because of the deduction (even under the AMT), that 6% interest rate is costing you about 3.8% on an after-tax basis. Not bad.

What the moral of the story? Tax Efficiency. In the words of Ben Franklin… “In this world nothing can be said to be certain, except death and taxes.” If you accept that premise, then it would be wise structure your mortgage and money to be tax efficient. It’s not too complicated but it can be complex. For the do-it-yourselfers, run through pro formas on your Turbo Tax or other income tax preparation programs. For the rest of us, get good help from a skilled CPA or tax advisor. You need to do this whenever you are buying, refinancing or messing with your mortgage. You could inadvertently make a move that would eliminate your tax benefits.

Fannie Mae and Freddie Mac were taken over by the US government on September 7th, 2008. This is result of the unprecedented changes that are occurring in the US financial and real estate markets. And there is no doubt at this point that the effects of our liquidity crisis will be felt worldwide. Yet, what does it mean for top 1% income earners that are also consumers of US mortgages? (If you’re wondering, you are in the 90th percentile of income earners if your annual household income is over $150,000; top 1% is above $250,000.) It has been almost two decades since the recession and real estate downturn of the early 1990s brought on by, among other things, the Savings & Loan crises. As we learned back then, top 1% income earners are not immune. I’d like to offer my speculation about the risks and opportunities available in the current volatile marketplace.

In the short term, I believe we will see falling interest rates as the US government touts increased liquidity and the international markets cheer the savior of their large investments in the US mortgage markets. This drop has already occurred as rates fell more than 1/2% in the last couple of days in treasury yields and certain conforming and so-called conforming-jumbo mortgages. This could be positive for a large group people currently holding US properties encumbered with interim fixed period ARM loans that are due to reset in 2009. I believe we are going to see a massive refinancing movement while these rates are low and this may act to lessen the blow of the second wave of foreclosures due to hit the US next year. Rates on many 30 year mortgage products are now at or below 6% which is extremely low in terms of historical averages at 9%. Note that many property owners will still not be able to refinance due to the drop in property values and the lack of their ability to get a satisfactory appraisal, as well as stricter underwriting guidelines. Yet, I think it is safe to say that this second wave of foreclosures is going to be less dramatic than the first wave that was primarily attributed to defaults of sub-prime mortgages. The first crippling wave of foreclosures during 2007 and 2008 was a product of highly risky sub-prime loans done in mass and then abruptly stopped as the markets collapsed.

Yet, it is my belief that unabashed glee is short sided. The takeover will shift Fannie Mae and Freddie Mac’s losses to US tax payers. If you are a taxpaying US citizen who does not own real property, then you are exposed to the financial burden without any of the benefits of owning real estate. Someone will eventually have to pay the piper for these losses and it now appears that this burden will be heaped on top of the US’s national debt that is already staggeringly high. Just like individuals cannot expect to heavily leverage themselves without consequence, neither can governments. Thus I speculate that in order for our government to strengthen its position in the global economy we will need to drastically cut debt and this translates into increased taxes and slashed government programs. We are already experiencing this issue of increasing taxes and reducing government programs at the state level as California once again struggles to pass a balanced budget. An increase in taxes means additional financial pressure that will have to be levied on US citizens at some point in time. This will be a destructive consequence to the US economy.

Now more than ever top 1% income earners who endeavor to capitalize on their existing assets and/or enter the real property markets need superior help. Questions such as whether or not to refinance existing debt, if to sell and/or buy now, trade up, what financial structures are most tax efficient, and so forth, are vital to answer in order to preserve and increase their wealth. The answers to these questions will significantly impact the profitability or loss in your real property transactions, whether for investment or for your personal residence. It is critical that your financial, real estate and tax advisors are able to make powerful interpretations of your current and future situation. When there is a disruption in the marketplace, such as our current economic situation, there is heightened risk and also amplified opportunity. Make sure that your advisors are capable of handling all of your concerns during this turbulent time. If you are looking for financial, mortgage or real estate assistance feel free to contact us for a free initial consultation so we can adequately assess your needs.

For those that thought the mortgage markets and the liquidity crisis was over, think again. Indy Mac Bank Corporation just posted a blog entry saying they will cease all wholesale mortgage operations and slash more than half of its approximately 7,200 employees. Below is an excerpt from their corporate blog.

As a result of the above, we have made the difficult decision, effective July 7, 2008, that we will no longer accept any new loan submissions or rate locks in our retail and wholesale forward mortgage lending channels, except for our servicing retention channel. We plan to honor all of our existing rate-locked loans and will continue to fund these loans in the coming weeks. While the managers and employees in these units have worked incredibly hard, these units are not currently profitable due to the continuing erosion of the housing and mortgage markets. At the same time, these operations take up significant balance sheet capacity and “feed” growth in the servicing asset, an asset we need to shrink given its size relative to our existing capital.

It is interesting to see that Wachovia just tightened its guidelines on its, “pick a payment” loans. This is especially interesting to me, because at the beginning of the year we had a presentation at our office from a World Savings executive that touted the flexibility of this loan. My opinion is well reverberated in Mike Mueller’s recent post on the Lenderama blog.

“Seriously, The Neg Am loan has a very valuable place in the finance world when properly used.  I believe Wachovia (world Savings) had the highest performing Neg Am Portfolio in the biz.”

These mortgage products do have there place in the financial world. I also agree with the executive that visited our office at the beginning of the year. These products are useful and powerful for the right individual situation. Maybe, the changes in Wachovia’s policy have more to do with their own business concerns and buying Golden West mortgage, then with the validity of the product that was successful for Word Savings for so many years. Just check out this CNN Money story that illustrates how 3.8% of Golden West’s pool of pick a payment mortgages went belly up after Wachovia purchased them in 2006.

The answer is that there are no bad loans in the marketplace. Loans are not people thus they can’t act good or evil. Mortgages are either placed by a person with the strategic knowledge to effectively care for an individual’s entire financial situation or they are not. I have many clients who have taken World Savings pick a payment loans and they have met their financial strategies without causing any despair or foreclosures.

I think the conversation in the marketplace needs to change from the loan product, to who is doing your loan. Are they competent to take care of your mortgage concerns with out betraying the other financial concerns that you have? Many banks and brokers have done mortgages with a blind eye to the customers financial situations and concerns. Often, you can’t even blame the person doing the loan, because they are not even competent to take care of their own financial concerns, let alone yours. Maybe contracting guidelines is not the answer for banks. Maybe, they should start to think about how they operate in regards to the knowledge of the people they have doing the loans. Maybe if they observed, assessed and acted to care for a clients mortgage in the context of their total financial situation they would have a huge stack of loans that could sell on Wall Street as mortgage backed securities. Warren Buffet eloquently explained the breakdown in the mortgage markets when he said, “In extreme cases, mark-to-market degenerates into what I would call mark-to-myth.”

Thanks Ocean Flynn for this flicker Photo.

Thanks to Todd Derick for this flicker photo.

I just read an article on the Blown Mortgage blog. It had a graph showing new and existing home sales. Of course in this market both are down. In fact, the Blown Mortgage blog is claiming that the volume of existing home sales is down 15% from last year.

First, it is important to note that just because the volume of sales are down, it does not mean that values of homes are dropping. In fact this can be quite the contrary in certain areas. This is the case certain segments of the Berkeley California market where many listings are still transacting with multiple offers. Just a month ago I saw a home get 15 offers and sell at a price way above the average median price for a home of this size and location.

Second, I found it interesting that the existing home sales have begun to diverge from new home sales. In this graph since January of 1994 existing and new home sales tracked each other fairly steadily. Yet, we can see in January of 2008 that the curves are fairly far apart with the number of existing home sales beginning to level off while new home sales volume is still plummeting.

I speculate this is because many developers have stopped projects that were in the pipeline if they could. We have seen this effect in the drop in new home permits as well. We are seeing that the average homeowner in an existing home is still transacting while the investor/speculator is not. This makes sense for many home owners must sell and buy in any market. For instance, life ensues in any market and homeowners are relocated to new jobs all the time.

Does this indicate the bottom of the market? I am not sure, but it does indicate what we can expect from our market without a large volume of speculated dollars being spent to drive up prices. The air was let out of the real estate bubble for more then one reason. The constriction of financial liquidity in the mortgage markets started the deflation. Once the mood was set, the exit of speculators and investors, drove the market down further. Now we are seeing buyers who were over leveraged get caught in the falling values and go into foreclosure. I suspect that when we see the developers begin to return to the market and banks begin to loosen their guidelines, we will see a more robust market again. I also speculate that we should see a return in existing home sales before we see it in new home sales, for the mechanics of the entitlement and permitting processes means that it takes time for developers to ramp back up into production.

Interesting news on he mortgage front in California is that FHA is now offering 3% down on loans up to $729,750. FHA also allows for a 3% credit towards buyers non-reoccurring closing costs. This means that buyers can be 0% down once again. I view this as a drastic loosening of the mortgage guidelines. One blockade down… So, where are those speculators?

Divorce, or variations on that theme, is starting to look almost as certain as death and taxes… the national average seems to be holding with about 1 out of 2 marriages ending in divorce. Among my friends, family and clients, it seems the number of couples around me calling it quits has escalated over the past few years. I suppose it could simply be my age, the circles I travel in and living in California. With splitting couples, very often their home will be their single largest asset. They may even fight tooth-and-nail to keep the home and send their “ex” packing. Here’s the thing: this could be a huge financial mistake. Often the consequences are not realized until long after signing the settlement agreement. Generally there are three issues around real estate that come up that are often overlooked in a divorce.

The first issue has to do with the property as an asset class and liquidity. Let’s say a couple (Popeye and Olive Oyl) owns a home worth $1,000,000 free & clear, i.e. no mortgage. And in addition, they have $1,000,000 of cash and invested assets. They agree to split everything 50/50. But Olive Oyl wants the home. So she will give Popeye her half of the cash in trade for his half of the house. Though Olive now has a place to live, she has 100% of her assets invested in real estate with no liquidity (unless she sells or finances some of the equity out of the property). This is equivalent to having all of your money tied up in one single, privately held investment… not real consistent with Modern Portfolio Theory.

The next issue has to do with affordability and qualifying. Let’s say Popeye and Olive have a $500,000 mortgage. The payment on the house with property taxes and insurance is $4000 per month. Olive only has to give Popeye $250,000 of her cash to buy him out. So she has $250,000 left in cash plus the house with the mortgage. The first question is can she afford the payment? That’s a much bigger question than I can address here, so let’s say she thinks she can handle the payment. But Popeye doesn’t let her get off the hook so easy. Since both signed the mortgage obligation when they were married, Popeye will remain liable from the lender’s point of view even though he may not be on the title as an owner of the property. If Olive can’t qualify on her own either for a new mortgage or in assuming the current one, Popeye may be very reluctant to go along with this.

Last, and probably one of the most overlooked issues with taking the home, has to do with . . . taxes. Popeye and Olive bought their home for $500,000 a while back. Since the value has doubled, they would have a $500,000 gain if they sold the home today. Because it was their principal residence for two out of the last five years, they would be able to exclude all $500,000 of the gain from being taxed as a married couple (see IRS Publication 936 at www.opesadvisors.com/resource/links.html). But if Olive buys out Popeye and at some point in the future she sells the home, she will only be able to exclude $250,000 of the gain as a single person. This means she will take on about a $62,000 tax burden that she will realize when she sells the home (assuming the tax laws don’t change… so could be more!). Additionally, if Olive sells the property and pays a real estate commission, she will incur 100% of that expense, as opposed to splitting it with Popeye. This could easily be another $25,000 she would have otherwise not paid (50% of a $50,000 commission). Olive has now blown about $90,000, or 12% of the assets she received out of the divorce settlement, without even knowing it.

For those of you that are able, consider working to have your marriage not be the one-out-of-two that divorce. For the other half, seek out financial, tax and legal advice prior to settling the terms of your agreement. Your attorney may be very skilled in representing you legally, but unlikely to know all of the finance and real estate consequences to your decisions.

Copyright © Jeffrey T. Smith • (415) 464-9500 • jtsmith@opesadvisors.com Jeffrey T. Smith is a financial advisor and the Marin Manager for Opes Advisors, a Wealth Management Firm specializing in Mortgage Banking and Investment Management.

This link is to a terrific Newsweek article discussing one benefit coming out of the mortgage crash & crunch – financial literacy. I think this commentary points to the necessity of each of us acting financially responsible and seeking help where needed. I thought you would enjoy reading the piece:

Clues for the Clueless - The mortgage crisis may create momentum for improving our financial literacy. It’s about time.

The Federal Reserve Bank of New York has put together a great National interactive heat map that overlays the residential loan data of sub-prime mortgage holders. I am bringing this to the attention of our readers as I just witnessed a home in inner Berkeley that received 14 offers. I also just read a post on 3 Oceans Real Estate that concurred that homes on the peninsula are also receiving multiple offers and counter intuitive to what is going on Nationally, selling for over the asking price.

Since the beginning of the liquidity crisis I have been posting that many Bay Area cities were not experiencing as severe a decline as the national news media had indicated. I also stated that if we were to see a rise in interest rates coupled with a stagnation or rise in median home prices (instead of falling median home values as the media had speculated), then many home buyers would get caught waiting for the sky to fall. Having watched the Bay Area real estate markets closely over the past year I have begun to see interest rates rise due to the lack of liquidity in the banking industry. Yet, in many popular Bay Area markets the median home values have not fallen significantly as many have projected. Of course this is not true for all cities, zip codes and houses. Thus, getting the advice of a local competent real estate adviser is of the utmost importance when considering purchasing a home. Through transacting in this market I have seen for both my buyers and sellers that in volatile times there is great opportunity for both.

The interesting thing about these heat maps is that they show the strength of the Bay Area’s home owners to wait out a real estate storm. Thus, the most desirable Bay Area houses have been very resilient to the housing down turn, while in the less desirable areas I have seen sharper drops in values. In Berkeley we are seeing a lack of desirable housing inventory. This has meant the desirable housing stock is receiving lots of buyer activity and often receiving multiple offers. I believe that this is because as these heat maps illustrate the East Bay and Most of the Bay Area is not inundated by as many short sales and foreclosures as many other parts of the Nation. The maps also indicate that the East Bay has home owners who have steady jobs, strong FICO scores and lower loan to values then say California’s Central Valley.

Susan McHan, CEO & President of Opes Advisors, a Bay Area wealth management company specializing in mortgage banking and investment advising, was recently interviewed on ABC7’s The View From The Bay on the current mortgage & real estate environment.

This is a great take on where we are in the real estate and mortgage markets (locally, state and nation), where it may go from here and what actions to consider. You can watch the approximate 5 minute interview here. Be informed by someone with an historical and personal experience perspective (bio).

I know, alphabet soup… Welcome to the world of government acronyms and abbreviation. In lay terms, the 2008 Economic Stimulus Bill has cleared the way for three channels of mortgages (FHA, Fannie Mae & Freddie Mac) to increase their loan limits. Good news for most of California because these three types of loans generally have lower interest rates and/or easier qualifying criteria and/or higher loan-to-value limitations (the amount of a mortgage relative to the value of the home).

Earlier this week, HUD (Housing and Urban Development) released the new FHA (Federal Housing Administration) loan limits for California, with the remainder of the country soon to follow. (You can read more about the FHA limits at this link.) And today, the OFHEO (Office of Federal Housing Enterprise Oversight) that oversees Fannie Mae and Freddie Mac announced the loan limits for those counties and Metropolitan Statistical Areas (MSAs) that are affected by the new loan limits. Data for all areas are available on the HUD Web site at this link.

Ten counties in the greater Bay Area will have their limits raised to the new maximum loan limit of $729,750 for all three types of loans (FHA, Fannie Mae, Freddie Mac). Those 10 counties are: Alameda, Contra Costa, Marin, San Francisco, San Mateo, San Benito, Santa Clara, Santa Cruz, Napa and Monterey.It will still take time before anyone can act on the new, higher, loan limits. How long? We don’t know yet, but our speculation is in the next 4-8 weeks. And we still don’t know how these loans will be priced (i.e. interest rate you can get). Although most lenders can do conventional (Fannie Mae & Freddie Mac) loans, not all lenders can do FHA loans. So don’t assume your friendly mortgage broker necessarily can. This is good news for the CA real estate and mortgage markets. It won’t solve all California issues, but it certainly will help.

As part of the now-signed-into-law Stimulus Package, the raising of conforming loan limits is a welcome change for many home owners, buyers and sellers in the San Francisco Bay Area. But there are clearly some limitations of what the benefit will be, who will benefit and if/how/when it will all come together.

Tuck Reed, Executive VP of SunTrust Mortgage, released a memorandum earlier this week that I think best articulates and speculates about the impact of the increase in conforming loan limits. The ramifications and benefits will come to fruition over the next few months and throughout 2008.

At the conclusion of their meeting this week, the Federal Open Market Committee (FOMC) reduced the overnight borrowing rate for US banks by another ½%. This was on the heals of a similar move the Fed last week with a reduction of ¾%. For most consumers they will benefit with a reduction to the prime rate to 6.0%. Most Home Equity Lines of Credit (HELOCs) are tied to the prime rate.

But for traditional mortgages, this will not have a direct or immediate impact. There may be other events, trends and opportunities for considering refinancing. But the Fed’s move is not the trigger or reason those opportunities and choices will occur.
To understand why, read Chris Kissell’s article: Smart Mortgage Strategies After the Fed Cut.

“As you listen to news reports about the Federal Reserve’s latest rate cut, Bob Walters would like you to keep one thing in mind…. ‘Ninety percent of the media is getting this dead wrong,’ says Walters, chief economist at Quicken Loans”

It means easier mortgage qualifying, lower interest rates relative to current jumbo rates and more buyers able to qualify for larger loans. Although the White House and congress appear to have agreed upon the economic stimulus package that includes the increase in conforming loan limits through the end of 2008, it still has to be voted into law. For the Bay Area, this should be a unique opportunity for many homeowners to lower their current interest rate, and/or lower their mortgage payment and/or stabilize their mortgage.
“This will have a big, immediate impact, especially in California where sales have been down most significantly,” said Lawrence Yun, chief economist for the National Association of Realtors.

Read More At: CNN Money

Dan Green, a mortgage broker in Illinois, recently posted this interesting video about how changing mortgage guidelines are affecting the real estate markets. I found it to be a nice simple explanation.

As interest rates move lower, on the heels of yesterdays global stock market sell off, many are wondering if the real estate markets will begin to bounce upward. This video shows that more than just interest rates are affecting the US real estate markets. The liquidity of money is an important mechanic of our market.

This video also illustrates why our current market is such a tremendous buying opportunity for qualified long term Bay Area buyers. With the contraction of the mortgage guidelines we have seen less qualified buyers in the market. As we are seeing in the Bay Area this has led to less competition for homes. This is an unusual shift in the moods of Bay Area home owners. The Bay Area typically has a robust history and a diverse stable economic base. Thus, those who can meet the guidelines have an entrance into an exclusive group of buyers that are seeing real purchasing power. Now, if you are also a buyer who is looking to stay in your next home for, lets say 5-10 years, then you have a solid base for riding out future fluctuations in the real estate markets. It is my assessment, that we are currently experiencing a rare buying opportunity in the Bay Area real estate markets, where rates are low and the competition for homes has slimmed.

The Wall Street Journal today reports on what is happening in the home equity line market that may affect you.  If you have an equity line and you have questions about accessing the balance on the line, call your mortgage advisor asap.

See the full Wall Street Journal article here.

There have been a handful of incidents where lenders are “freezing” existing Home Equity Lines of Credit (HELOC). This means that if you have an available balance to draw on from your HELOC, your lender will not let you do so. This is happening in California and the Bay Area. Who would have guessed a year ago that Countrywide Home Loans, the largest independent home lender in the U.S., would be on the verge of bankruptcy (presumably saved by Bank of America’s purchase of the mortgage monolith)? Countrywide is freezing some HELOCs. So are Chase and other major lenders.

Why is this happening and what options may you have? I’ll do my best to address these issues here.

First, it is important to understand that HELOCs, although secured by your real estate, are treated by lenders as consumer credit. So just as a lender will unilaterally revise the terms of your credit cards, or even cancel them, they’ll do the same with your HELOC. Prior to the national mortgage meltdown and real estate slump, the typical things that would trigger a freezing of your HELOC were problems with your payments, declining credit scores, bankruptcy, etc. And on some occasions after a natural disaster (fires, earthquakes, flooding, etc.) a lender would freeze credit lines until they could verify that their collateral (your home) was still standing. These still hold true today.

Currently the issue has been two-fold. One is the concern of the value of your real estate. Lenders are proactively assessing the value of the properties they have used for collateral on HELOCs. If they have reason to believe that the value has declined to the point of being a risk, they will likely freeze your credit line. The other issue is the significant cash reserves a lender needs to maintain for each HELOC that has a potential future draw. That is, if you have $100,000 available on your credit line, your lender needs to make sure they have access to enough cash should you draw on your line. In this current “credit crunch” environment, this has become a difficult and costly situation to maintain.

What to do? First, decide if it is important or critical to your financial stability and well-being to have any remaining available credit on your HELOC over the next 12-18 months. If it is not important to you, then there is probably nothing to do. If it is important, then try to assess if you are in any jeopardy of having your HELOC frozen. Specifically get a current assessment of value on your property. Although Zillow (and other on-line real estate valuation tools) can appear like a reliable source for establishing values on real estate, it can be wildly off, especially in the current market. So having your Realtor provide comparable sales may be a good starting place. Having the appraiser who completed your last appraisal give you an update of the current value is another possibility (but may cost money). See if the current value is consistent with the value that was used when you had your HELOC established. If it does support the value when you first set up the HELOC, and you are confident that you can use the evidence should you need to provide it to your lender (if they freeze your account on the grounds of the property value dropping), then again probably not an issue for you now. But if the value has declined (at least from what would be used as comparable sales in the current market), then consider drawing on the HELOC now so that you have the cash available. You will incur the cost of the additional interest, but you should be able to off-set that cost by getting a nominal return from savings accounts and CD’s.

I do want to make a point about value. What you can sell your property for and what the empirical evidence of an appraisal (or other valuation processes and tools) support can differ. We are in a very unique market for real estate and financing, which makes this potential discrepancy even greater. There are great opportunities as well as risks because of this turmoil. The best advice I can give in this environment is to seek out and use expert advice from your Realtor and financial & mortgage advisor.

Thanks blmurch for the above photo.

There is a fantastic tax break for homeowners. You know the one – where you can deduct the interest and property taxes before calculating your income tax obligation. Here’s the thing: there are limits on how much and what you can deduct. We haven’t heard much about people getting into trouble, but the word on the street is the IRS is cracking down. If you’re not sure of the rules and limitations, read on so that you don’t end up sitting across the table from your friendly IRS auditor.With the disclaimer that you must seek tax advice from your CPA or tax preparer, let’s review generally what you are allowed to deduct. Simply put, if you own your principal residence or second home, and meet all of the conditions, you can deduct the interest and property taxes that you pay over the course of the year. Here’s an example: If a married couple had a 2006 adjusted gross income of $125,000, and spent $36,000 on qualified mortgage interest and real estate taxes, they calculated their income tax obligation based on $89,000 ($125,000 - $36,000). With a combined Federal & California marginal tax rate of about 34%, this couple received more than a $12,000 tax break.

So what’s the problem? Well, it’s not quite as simple as it may appear to meet all of the conditions for deducting the interest and property tax. Here are some of the hot topics and where we’re likely to see the crack down:

Qualifying Mortgage – You are generally allowed to deduct interest for your primary residence and second home if the mortgages (a) were used for the acquisition and/or substantial improvement of your home, (b) you are legally liable for the debt, (c) they are secured against your residence, and (d) they do not total more that $1 million. You are also allowed to deduct the interest on an additional debt of up to $100,000.

Let’s say that someone bought their home for $500,000 with $100,000 down and a 1^st loan for $400,000. After a few years, they took out an equity line for $100,000 to pay for things like a car, children’s college expense and some other things, using up the whole $100,000. Then more recently they decided to refinance for $600,000 (since their home was now worth closer to $1 million) and roll both loans into a new 1^st loan and pay off some other debts. They also have a new equity line for $200,000. Are they allowed to deduct all of the interest on the new $600,000 1^st loan and interest on the equity line? NO. And the IRS has made it a priority to investigate cases where they believe homeowners are taking mortgage interest deductions that are for loans greater than their acquisition debts.

Points – (a.k.a origination fee, discount points, etc.) This is considered pre-paid interest and is treated as such. One point equals 1% of the loan amount. If you pay points when you are purchasing your primary residence, you can usually deduct the full amount of the points in the year that you paid them. If you pay points on a refinance, you have to spread the deduction over the term of the loan (or typically 1/30^th each year on a 30-year loan).

I recently had a client who said that a lender offered to pay all of their closing costs (title insurance, escrow fee, appraisal, etc.). The lender required that they pay more points to get an equivalent interest rate (since the lender was going to pay for the closing costs). The loan officer suggested that they would be able to deduct the points. But the IRS states that in order to take the deduction, the points cannot be paid in place amounts that ordinarily are stated separately on the settlement statement, such as the “appraisal fees, inspection fees, title fees, attorney fees, and property taxes.”We’re just touching the metaphorical tip of the iceberg. There are a variety of things that will impact your ability to take home ownership deductions (Alternative Minimum Tax, 2^nd homes, businesses at home, etc.). For the down-and-dirty, read through IRS Publication 936 (available at www.opesadvisors.com/resource/links.html). Additionally, talk with your CPA and Financial & Mortgage Advisor. It’s a lot of money. Be wise.

Copyright © Jeffrey T. Smith