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Monday Morning Coffee – California Tax Credit

Monday Morning Coffee

California Tax Credit

Good morning!

I hope you enjoyed the great weather this weekend and got out a bit. A couple of good things last week that will effect the real estate market (good in terms of real estate, you will have to decide for yourself if they are good long term). First of all, the Governator signed a California Home Buyers’ Tax Credit that will help offset the expiration of the Federal Tax Credit next month. The credit is $10k max spread over 3 years. More details on the blog. The second was that it appears Greece is going to get its own bailout. The reason this is good is that a default by Greece could have a ripple affect throughout the European Union and to all the bondholders of Greek debt – many of whom happen to also be the people and/or countries we need to buy mortgage debt. So, the fact they didn’t just los e a bunch of money is a good thing. The downside is that instead of a depression in Greece, the pain will be spread and diffused throughout Europe and while this brings a chance of a larger problem later, for today’s San Diego real estate market, it’s good you will be able to get a loan next month.

Ok, we have three new listings coming. Two will come on this week (photos Tuesday) and one next week. Here’s the best part – none are short sales!

This week we have a 2300+sf 4 bedroom home in Garden Gate @ 4S Ranch. There is a bedroom downstairs. We will be hitting the market in the low $600k range. It has a very private backyard and we sold the one next to it last month in about 8 seconds.
The second one for this week is on the picturesque 4S Ranch Pkwy and is a 1600+sf Summerwood home. Very nice 3 bedroom with beautiful hardwood floors. It will be priced in the low $500k range.
Next week we have another Garden Gate home at just over 1900sf. This is a 4 bedroom with a peek ocean view.

If you are interested in any of these, please give me a call.

That’s it, Enjoy the Coffee!

The Life We Choose

Here’s the premise: We are all, right now, living the life we choose.

This choice, of course, is not a single, monumental choice. No one decides, for example, “I’m going to move to L.A., and in five years I will be a waiter in a so-so restaurant, planning to get my 8-by-10’s done real soon so that I can find an agent and become a star,” or “I’m going to marry a dreadful person and we’ll live together in a loveless marriage, staying together only for the kids, who I don’t much like, either.”

No. The choices I’m talking about here are made daily, hourly, moment by moment.

Do we try something new, or stick to the tried-and-true? Do we take a risk, or eat what’s already on our dish? Do we ponder a thrilling adventure, or contemplate what’s on TV? Do we walk over and meet that interesting stranger, or do we play it safe? Do we indulge our heart, or cater to our fear?

The bottom-line question: Do we pursue what we want, or do we do what’s comfortable?

For the most part, most people most often choose comfort – the familiar, the time-honored, the well-worn but well-known. After a lifetime of choosing between comfort and risk, we are left with the life we currently have.

And it was all of our own choosing.

Peter McWilliams

Have a Great Week!

Scott Voak

858 688 0189

California Homebuyer Tax Credit – New

California Homebuyer Tax Credit

A Quick Overview of AB 183 Tax Credit

On March 25th, Gov. Schwarzenegger signed AB 183 Homebuyer Tax Credit into law. Here’s a quick look:

What Does the Tax Credit do?

Provides $200,000 000 statewide for a 5% (up to a max of $10,000) credit from the purchase of a home against your California Income Tax.
The law is a little confusing and I don’t have a complete explanation, but the way it reads:
- You must purchase a qualified PERSONAL residence between May 1 and December 31, 2010 OR
- You must purchase a qualified PRINCIPAL residence between December 31, 2010 and August 1, 2011 based on a binding contract signe prior to December 31, 2010.

Who is Eligible?

First time home buyers AND
Any buyer of a new home (never been lived in before). Most likely, this is “Principal” residence as builders sell new homes well in advance of move-in.

How is this different than the expiring Federal Tax Credit?

This credit is taken over 3 years rather than all at once like the Federal Credit.
People who have previously owned a home are not eligible unless they purchase a new home from a builder.

What is the reason for the new credit? What are they trying to do?

40% of first-time home buyers in the past year said they would not have purchased a home without the Federal Tax Credit.
That credit expires for homes put into escrow afterApril 30th.
This is an attempt by the state to offset the loss and keep demand strong.
By applying to two different types of homes, the state is trying to accomplish 2 things:
- Motivate people to buy new construction which will help support employment and help builders finish projects and avoid financial difficulties which would flow through to the banks which have loaned them money while the recovery is still fragile.
- Motivate first time buyers who might not otherwise afford a home to purchase a foreclosure and use the tax credit to make repairs – thereby employing people in the services fields (this one seems like a stretch to me as the credit isn’t really enough to fix up a home if it is in bad shape).
By driving people to action this year, but applying the credit over 3 years, the government gets the added stimulus to the economy now, but spreads the impact of lower tax revenues for the state over 3 years – you know, like when someone else is Gubernor and has to try and balance the budget.

So, is this good? I think overall it is a good idea as it will help support the real estate market when the federal credit ends. Since I think the recovery is very fragile, the support is a good idea. If all the homes purchased maximize the $10k credit, 20,000 buyers will benefit. I am concerned at the large number of vacant homes that are going through foreclosure. When these hit the market, I think the market will soften and if that does happen, my hope is the 20,000 buyers purchase those homes, because if we spur the building of a lot of new homes with this bill and then the vacant homes come on the market, we could end up with more homes than buyers again. However, I understand the goal, and think it is a good try.

Since the Fed Lowered Rates to 0%, Why Haven't Mortgage Rates Fallen Farther?

A friend was over on Sunday and asked this question. I tried to explain, but don’t think I did a very good job. But, it is a good question and one that I hear a lot, so I am going to try to explain it here (within the limits of my understanding).
First of all, let’s define a couple terms:

Fed Funds Rate – This is the rate set by the Fed. It is currently targeted to be between 0% and 0.25%. This is the rate that the Fed uses to provide short term loans to banks.
Prime Rate – This is the interest rate that commercial banks offer to their most valued and credit worthy customers. It has tracked at 3% over the Fed Funds Rate over the last several years. This 3% is the spread that banks make. Think about it this way; if the bank borrows at 1% from the Fed, they will loan to their best clients at 4% and to others at more than that. That difference is their profit and how banks typically make money. Note that their profit is a lot more than 3% because with $1,000 of assets, they can borrow $10,000 to loan out a total of $11,000. So, in that case, they pay your grandmother 2% for her deposit of $1,000 and the Fed 1% on their $10,000 for a total of $120 cost a year and earn $440 (4% on $11,000) for a profit of 367% (ok, they had operating costs, but who can’t cover operating costs on a 367% gross margin?)
US Treasury Bonds -Bonds issued by the US Government paying the buyer interest payments every 6 months. They usually have a maturity rate of 30 years. The payments are set by the government, but when the bonds are issued, they are done so in an auction and they are in $100 increments. The amount paid in the auction determines the Yield, or actual rate the holder will receive. For simplicity, lets say the bond is going to pay 5% a year for 30 years. If people think that is too low, they will bid less than $100. If they bid $90, they are still going to get $5 a year, plus their $100 back in 30 years, so the effective interest, or Yield, would be closer to 5.7%. Likewise, if they think 5% is a great rate, people may bid the bonds up over $100, lowering the yield. This is why when bonds go up, it is the same as saying the yield, or interest rate is coming down. Since US Treasury Bonds are guaranteed by the US Government, they have historically been considered the safest investment and offer the lowest yield.

It is important realize that your bank does not keep your loan. (Remember from above that every $1 your bank has in deposits allows it to borrow $10 to loan out. Once they loan out $11, they are done. To get around this, the bank sells your loan (hopefully for more than $11) takes the profit and loans it out again). Your bank sells these mortgages to investors such as insurance companies, foreign governments, pension funds, Bill Gates, etc. (from here on out, we will call this group Pwtom for People With Tons of Money). This buying and selling of mortgages is what is called the Secondary Mortgage Market. Here is the important part. Your bank does not set the price on the secondary market – the buyers do, by insisting on a yield. So, what determines the yield the investors want?

Treasury Bonds. Treasury Bonds are (historically) the safest 30 year investment because they are backed by the US Government and everybody knows the US Government is safe (isn’t it?). So, if Pwtom has a choice between buying Bonds from the government or a mortgage from your bank, what is going to determine which he buys? Basically, the difference in the yield, or interest rate, between Tresuries and mortgages. If the difference (or spread) is too small, Pwtom buys Treasuries and to get him to buy mortgages, the rate on mortgages needs to go up (remember that if Pwtom doesn’t buy mortgages, your bank has to hold onto them and can not lend out anymore money).

Let’s look at today. Treasury Bonds are currently trading at historically low rates. So, why aren’t mortgages falling as far as Treasuries? It’s the risk involved in mortgages.

Imagine that you are Pwtom and you are trying to decide where to put your money. You have always bought Treasuries and in the past several years have bought US backed mortgages. You were willing to buy the mortgages because they were guaranteed by Fannie Mae and Freddie Mac – basically by the US Government, not so different from Treasuries. However, now the administration is talking about requireing banks who are going to get government aid to “modify mortgages”. While mortgage modification sounds great to those of us with a mortgage, what about Pwtom? He basically bought a bond in the form of a mortgage that he thought was guaranteed by the United States Government and now he is being asked to accept a lower interest rate or less money at the end when the mortgage is paid back. Now, we don’t have to be smart like Pwtom to realize he is getting screwed in this deal.

The important thing to realize is that if Pwtom thinks that there is a chance the mortgage he is buying will be re-negotiated or go into foreclosure, he is going to require a much higher interest rate on all the mortgages he invests in to cover the ones that go bad. So, the exact thing we are hoping will help, mortgage modifications, is creating uncertainty for buyers of mortgages and causing mortgage rates to stay higher than they otherwise would.

Time to Buy?

Yes and no. I think there are two types of buyers who can make it in this market. The first is the investor with experience who is picking up cosmetic fixers from the bank and turning them quickly. The second may surprise those of you who know that I have not been counseling many people to purchase over the past three years. I think that now is a very good time for buyers who have some stability in their lives (you need to be thinking 5-7 year minimum hold) who are tired of renting. It’s not that I think we are at the bottom yet (I don’t), but I think that interest rates could be extremely volatile over the next 2-3 years. Let me explain.

First of all, I think that Southern California real estate is going to be no lower than it is today in 5-7 years. That is why I think that if you have that time horizon, you are not likely to get hurt (if I am wrong, odds are I’m doing something else in 7 years anyway so you won’t have a chance to tell me about it). So, let’s say you have been paying rent for a couple of years wishing you had purchased years ago when your friends did, although now you are glad you didn’t and are looking a lot smarter then they are. Let’s look at a hypothetical buyer:

Joe makes $60,000 a year and has a car payment of $500 a month. He has no credit card debt or student loans. To qualify Joe, a bank is going to say he can have roughly 40% of his income in debt (including housing). This means that after his car payment, Joe can spend $18,000 a year on his housing. If Joe uses an interest only loan at 6% (lenders, I am using 40% debt ratio and an interest only loan because the math is easier – it makes the same point as an absolutly accurate scenario) the bank would qualify him for a loan of about $250,000 (assuming $3k a year in property taxes, etc.)

Now, let’s say that we are at the low point now and prices go up. Joe is obviously going to wish he had purchased now. But what happens if the market keeps going down? Well, Joe’s $250k will buy him more house. Or will it? What about interest rates? Let’s say the price of Joe’s home falls 10%, how much would interest rates have to rise to offset the drop in prices? The answer is not much. If interest rates rose from 6.0 to 6.67% and the price of Joe’s home fell 10%, he would be able to buy the same home. However, if interest rates rose to 7.5%, Joe’s home would have to drop 20% for him to still afford it. Am I predicting rates will go up to 7.5%? No. But with the Fed pumping as much money into the economy as they are, inflation is bound to heat up and the Fed likes to raise rates to control inflation.

That is why, if you are planning on being in a home for 5-7 years, now might be a very good time to make a purchase and stop giving your paycheck to your landlord.

Conforming Increase On Its Way

According to about 5 of my mortgage friends (who emailed me within hours of each other), Congress is fast tracking a bill that will put California into the “high cost” category for housing which will raise the level for our conforming loans from $417k to $625k which is enjoyed by Alaska and Hawaii. Further, they are then going to increase that $625k to $725k for a period of one year. This is great news as loans that fall under the conforming level are easier to qualify for and there are more flexible programs available for buyers who would otherwise be viewed as borderline by banks.

Expect this bill to be on the President’s desk by the middle of February. The change will help homes in the lower and mid range of the market which is where our recovery is most likely to start.

Big Rate Drop Today

Ok, I promise I did not have the inside scoop on the rate drop when I wrote yesterday’s post. My initial reaction was that this is just what the market needs. My thoughts were that this will help keep people’s loans from adjusting to an overly high monthly payment which in turn would keep some people out of foreclosure.

In checking with several people involved in the foreclosure market, their thoughts are more along the lines that this will help a smaller number of people than I thought. Apparently (according to them), there are too many people in the negative amortization loans who are making only the minimum payment and will not be able to handle the interest only payment regardless of the rate. They see this rate drop as help to people with good credit who will get a break in their payment, and also as an aid to people purchasing – it will allow them to pay more which will hopefully prop up prices a bit.

So, it might not be “just what the market needs”, but I think it is a good step in the right direction. Now, let’s get the conforming loan limit up to $625k!