Three Ways to Create Value Through Mortgage Planning. How to help clients make smarter financial choices

Transcription

1 Three Ways to Create Value Through Mortgage Planning How to help clients make smarter financial choices

2 Objectives Cash vs. Mortgage: how to help clients evaluate whether to pay cash for a property vs. using a mortgage To Consolidate or Not: How to help clients evaluate the before and after-tax impact of debt consolidation Gift or Loan: How to evaluate the tax and cash flow impact of gifts of equity and cash gifts used for a down payment

3 Cash vs. Mortgage

4 Jane is 64 years old She is in a 25% income tax bracket Case Study #1 (with mortgage interest tax deduction) She wishes to purchase a $400,000 home What s the impact of paying cash vs. using a $200, year mortgage? * Assume that Jane is able to deduct the mortgage interest on her tax returns

5 1 st Acquisition Lien or Subordinate Lien vs. HE Indebtedness HELOC or Closed-end Mortgage Buy. Build. Improve. Acquisition Indebtedness ($1,000,000) AMT = Still Deductible Funds used for any purpose Home Equity Indebtedness ($100,000) AMT = No Longer Deductible

6 Option #1 Option #2 Case Study #1 (with mortgage interest tax deduction) $400,000 Cash on Hand - $400,000 Down Payment = $0 Remaining to Invest $400,000 Cash on Hand - $200,000 Down Payment = $200,000 Remaining to Invest

7 Tax Benefit, $188 $1,013 Mortgage Payment After-Tax Payment, $826

8 Option #1 Option #2 Case Study #1 (with mortgage interest tax deduction) $0 Mortgage $0 Monthly Payment $0 Invested $200,000 Mortgage $826 After-tax Monthly Payment $200,000 Invested

9 $537,567 $537,567 $400,000 $377,388 $200,000 $160, % 3.00% $0 Invested Equity Future Home Value Future Mortgage Balance Future Equity Position Rate of Return on Equity Option 1: Cash Option 2: Mortgage 10 Year Holding 3% Annual Appreciation

10 Option #2: $200, % Present Value of Invested Funds After-Tax Monthly Payment Future Value of Invested Funds $826 $200,000 $214,483

11 Case Study #1: Conclusion Future Home Equity Position Total Future Net Worth Future Value of Invested Funds $537,567 $537,567 $591,870 $377,388 $214,483 $0 Option 1: Cash Option 2: Mortgage

12 Extra Wealth Accumulation $54,304 Case Study #1: Conclusion $0 Option 1: Cash Option 2: Mortgage

13 What if you remove the tax deduction?

14 Tax Benefit, $0 $1,013 Mortgage Payment After-Tax Payment, $1,013

15 Option #2: $200, % Present Value of Invested Funds After-Tax Monthly Payment $1,013 $200,000 Future Value of Invested Funds $184,575

16 Case Study #1: Conclusion Future Home Equity Position Total Future Net Worth $537,567 $537,567 Future Value of Invested Funds $561,963 $377,388 $184,575 $0 Option 1: Cash Option 2: Mortgage

17 Extra Wealth Accumulation $24,396 Case Study #1: Conclusion $0 Option 1: Cash Option 2: Mortgage

18 What if the client has already paid cash?

19 90-Day Rule

20 Debt Consolidation: What s the Impact?

21 Three Factors 1. Blended Interest Rate 2. Monthly Cash Flow 3. Long-term Impact

22 Current Debt Structure Debts Balance* Interest Rate Before Tax Interest Cost Tax Benefit % Tax Benefit $ After Tax Interest Cost $ After Tax Interest Rate % Mortgage #1 $200, % $10, % $2,625 $7, % Mortgage #2 $75, % $5, % $1,406 $4, % Car Loan #1 $15, % $ % $0 $ % Car Loan #2 $20, % $ % $0 $ % Credit Card #1 $5, % $ % $0 $ % Credit Card #2 $13, % $ % $0 $ % Credit Card #3 $7, % $ % $0 $ % TOTAL BALANCES: $335,502 - $19,565 - $4,031 $15,533 - BLENDED INTEREST RATES: % %

23 Proposed Debt Structure Debts Balance* Interest Rate Before Tax Interest Cost Tax Benefit % Tax Benefit $ After Tax Interest Cost $ After Tax Interest Rate % Mortgage #1 $335, % $17, % $4,403 $13, %

24 $2,500 $2,000 $1,500 $1,000 $500 $0 $2,500 Current $1,853 Proposed Total Monthly Payments

25 $800 $647 $600 $400 $200 $0 $0 Current Proposed Extra Monthly Cash Flow

26 $45,141 $50,000 $40,000 $30,000 $20,000 $10,000 $0 $0 Current Proposed Extra Future Value In 5 6% ROI

27 7.00% 6.00% 5.00% 4.00% 5.83% 5.25% 4.63% 3.94% 3.00% 2.00% 1.00% 0.00% Before-Tax Interest Rate Current Proposed After-Tax Interest Rate

28 $25,000 $20,000 $15,000 $19,565 $17,614 $15,533 $13,210 $10,000 $5,000 $0 Before-Tax Interest Cost Current Proposed After-Tax Interest Cost

29 Tax & Cash Flow Impact of Gifts and Inter-Family Loans

30 Purchase a Home Reduce Mortgage Balance to Refinance Gifts Reduce Negative Equity to Sell

31 $14k per person $14k per person $14k Annual Gift-Tax Exclusion (replenishes each year)

32 $14k per person Reduce the Bucket Each Time I Use It $14k per person $14k Annual Gift-Tax Exclusion (replenishes each year) $5,430,000 Lifetime Exclusion (does not replenish)

33 Lifetime Exclusion Used ($100,000) Estate Tax Exclusion Remaining ($5,330,000) $5,430,000 in Total exclusions

34 Gift Tax Exclusion Estate Tax Exclusion $5,430,000 Lifetime Exclusion (does not replenish)

35 1 Two Buckets of Exclusions 2 No Tax to Gift Recipient Federal Gift Tax 3 No Relationship Required

36 Gift Taxes Example 1: Annual Exclusion $56,000 = Funds Needed For Down Payment & Closing Costs $14k per person $14k From Mom to Daughter $14k From Mom to Son-in-Law $14k From Dad to Daughter $14k From Dad to Son-in-Law $14k per person $14k Annual Gift Tax Exclusion

37 Gift Taxes Example 2: Lifetime Exclusion $200,000 = Funds Needed For Down Payment & Closing Costs $14k From Mom to Daughter $14k From Mom to Son-in-Law $14k From Dad to Daughter $14k From Dad to Son-in-Law $200,000 - $56,000 = $144,000

38 Gift Tax Exclusion ($144,000) Estate Tax Exclusion ($5,286,000) $5,430,000 in Total exclusions

39 1 $5,430,000 Exclusion (2015) Federal Estate Tax 2 Many States Have Lower Limits 3 Unlimited Marital Exclusion 4 Portability

40 Portability $5,430,000 My Lifetime Exclusion $5,430,000 My Spouse s Lifetime Exclusion

41 $10,860,000 Total Exclusion for a Married Couple Using Portability

42 Underwriting Guidelines: List loan as a debt/liability on 1003 But it s Just a Loan Include loan payment in DTI IRS Guidelines: Borrower must pay interest on the loan

43 Is the recipient of the money paying the applicable Federal Rate? But it s Just a Loan Short = Less than 3 years Mid = 3-9 years Long = Greater than 9 years Is the lender of the money paying taxes on the interest they receive? Is there a pre-arranged plan to forgive the loan?

44 Conclusion Cash vs. Mortgage: how to help clients evaluate whether to pay cash for a property vs. using a mortgage To Consolidate or Not: How to help clients evaluate the before and after-tax impact of debt consolidation Gift or Loan: How to evaluate the tax and cash flow impact of gifts of equity and cash gifts used for a down payment