Is the Mortgage Crisis Over?

Photo by: respres

The mortgage crisis was clearly one of the dominating catalysts of the recent economic fiasco.  While many other factors contributed, this was one of the most visible and visceral to most people.  Thus many people, particularly homeowners, are now wondering whether they can breathe a sigh of relief.

How Did We Get Here

By now we’re largely aware of the underpinnings of this crisis.  Demand for securitized debt led to tremendous demand for mortgages.   This demand led to lowered lending standards, which led to tremendous demand for housing.   The demand for housing led to soaring housing prices.   When those with the least capacity to pay their loans, who incidentally had the most onerous terms to their loans, couldn’t make their house payments, the whole house of cards came down.  Foreclosures led to dropping housing prices, which led to more defaults, which continued the cycle.

The Subprime Crisis

During all of this we were told the mortgage crisis and the subprime crisis was one and the same.  Many people equate the end of the subprime problems with the end of our troubles in general.  This leads us to wonder if the subprime crisis is truly over.  Signs suggest that this is the case.1 After huge surges, the default rates on these loans have come down sharply, leading many to suggest that the crisis is over.  Of course, that depends on which crisis you’re discussing.

The Real Crisis

Subprime loans may very well be dropping in their defaults, however that statistic neither creates an increase in demand nor says anything about the impending wave of defaults in other types of mortgages. Falling home prices put everyone underwater increasing the chance of defaults across the board.  Although many people who bought houses during the boom bought them with subprime loans, many more did not. (more…)

1. Deutsche Bank – Subprime Chart [↩]

Investing Step #7: Home Ownership

Photo by: Hamed Saber

This post is step 7 in our Investing Template.

While there are no explicitly tax-deferred savings plans for housing, the Roth IRA can work very much like one.  If you are looking to buy your first home in the future, more than 5 years from now, or if you have a Roth IRA opened already, such an account may be a very reasonable option for your investing dollar.  While you cannot take your contribution out pre-tax, any income you make over those 5 years can be used tax-free to buy a house, up to $10,000 per person.  This can be a considerable savings.

While retirement and college may seem like distant issues, buying a home is much closer on our investment timeline for most of us.  If you already own a home, or have in the past, you can pretty much skip this section as a Roth IRA will not do you much good.  Its exemption for buying a home only applies to first time buyers, but it can be very powerful for those looking to maximize their earnings.

Your Strategy

When you contribute to your Roth IRA, the account must have been opened for 5 years for you to be able to withdraw money to help buy your first house.  Additionally, you can only withdraw a maximum of $10,000 per person.  This means that if you are married you can withdraw $20,000.  If you are slowly saving for a house, putting money into an Roth IRA can be a great option, since all of your investment proceeds can be used without ever paying any tax on them.

Generally your approach here would be to contribute money towards your Roth IRA until it looks like your window is getting close.  At the point where you approach your maximum contribution for your home, you will have to consider whether continuing to contribute to your Roth makes sense.  You may have better options for your other investment goals, but why pay taxes on your home down payment investment when you don’t have to?

An Example

Imagine if you want to buy a house in 10 years.  Each year you put $1000 in your Roth IRA and it earns 11% (a lofty goal, but it helps illustrate the power.)  If you pay 33% in taxes each year, by the time you were ready to buy the house you would have almost $3,500 more dollars in your Roth IRA than you would in a regular investment account.  The Roth would have $18,561 vs $15,097 in the regular account.  You made $3,500 simply by selecting the right account in which to save your money.

This is a fairly narrow option.  It only applies to those who have never owned a home and who can qualify for the specifics of the Roth IRA, bu it should be included in your timeline if it applies to you.  Dedicate some of your investment funds to your Roth and you can get the massive returns that the absence of taxes can provide you.

Investing Step #4: Tax-Advantaged Accounts

This post is step 4 in our Investing Template.

Why pay taxes?  A lot of people claim they wouldn’t if they didn’t have to. However many of us are voluntarily paying taxes on money we could be pocketing tax-free with tax-advantaged accounts.  These are investment accounts where your taxes are either paid when you take the money out, or sometimes not at all.  Many people are familiar with retirement accounts like 401(k)s or IRAs, but there are other options that are often overlooked entirely.  Many times, if you know you’re going to have an expense in the near future, you can pay for that expense tax-free.  This many not seem like a big deal to you, but let’s do some simple math.

If I have a $100 expense this year and I’m in the 33% tax bracket, I have to earn $150 to pay for this expense if I have to pay taxes on the income.  If, on the other hand, I don’t have to pay taxes, I only have to spend $100.  This means that if I “invest” that money in tax-advantaged accounts that allow me the option to put away a certain amount pre-tax, I’ve immediately made 50% on that money.  A 50% guaranteed return is unheard of anywhere else, yet many of us overlook opportunities to achieve these same returns daily.  We’ll look at 4 broad categories of accounts that allow you to either defer, or completely avoid taxation on your income.

Tax-Deferred Accounts

• Retirement Accounts
• College Tuition Accounts
• Home Investment Accounts
• Health Savings Accounts

While each of these programs have nuances, they are closely related to your investing timeline.  Health Spending Accounts are for near-immediate expenses, home accounts are usually a fairly short timeline, college programs can be quite a while in the future, and retirment accounts are often the furthest off.   This collection of accounts can save you a great deal of money if used properly, so we’ll look at them individually over the coming days.