Federal Income Taxes--How it works

My experience tells me that knowing how income taxes work is far from common knowledge. Here is my attempt to correct this problem. (This scenario applies to W2 employees. If you are self-employed, then stop reading.)

1. Your employer withholds a certain amount of money from your paycheck each pay period. This amount is based on your income and the information that you put on your W-4. (For more information on your W-4, go to www.paycheckcity.com/W4/w4instruction.asp.)
2. Between January 1 and January 31 your employer will send you a W-2. This W-2 is a form that is required by the IRS that shows your income and the amount of money that was withheld by your employer for the previous year.
3. You now use your W-2 to have your Federal Income Tax Form or 1040 filled out. Basically, your 1040 will show you and the IRS how much money you should have paid in the previous year to the Federal Government for your income taxes.
4. This number is derived by subtracting your deductions from the income that appeared on your W-2. (You can use the standard deduction or you can use your itemized decutions. The one that you use depends on which one is greater.)
5. You now know your taxable income. This amount is now put into a formula based on your tax bracket. (To find out your tax bracket and to see the formula that will be used to figure your tax liability go to www.moneychimp.com/features/tax_brackets.htm.)
6. Finally, you subtract any tax credits to which you are entitled. (These tax credits include the child tax credit and will also include the first time homebuyer tax credit.) You now know your tax liability for the previous year.
7. If your tax liability is less than what was withheld by your employer, then you will get a return. If it is greater, then you will owe money before April 15.

ARMs--Bad or Good?

Adjustable Rate Mortgages, better known as ARMs, have been chastised over the last year or two and have even been blamed for causing the current "global economic crisis." Imagine that, me convincing a homebuyer to get an ARM is the reason that Chrysler failed, McCain lost, and a homebuyer actually needs money in order to buy a house. I had no idea that I had that kind of power.

With all of this bad press, I wanted to try to clear the air and stick up for a tool that I actually used to buy my own house. ADJUSTABLE RATE MORTAGES ARE NOT BAD! What is bad is not understanding what you are getting when you get an adjustable rate mortgage. You are getting a loan that has a fixed rate for a certain period of time. In most cases, that period of time is 3 or 5 years. If you stay in this loan for longer, then your interest rate is going to adjust. Your new rate will be based on an index plus a margin. It is important that you understand this upfront.

It is also important that you understand this before deciding to refinance out of your ARM. Do the research or better yet, call me and I will do the research.

ARMs are not for everyone but they are a good fit for some. This includes me. I am still in my ARM and my rate actually went down this year. (Lesson: Do not be too quick to refinance out of that ARM.)

The problem with ARMs is not the loan. The problem with ARMs is a lack of understanding.

Home Valuation Code of Conduct--HVCC

I am curious to know how many people are aware of a recent change in the appraisal process for conventional loans. (Conventional loans are loans that are sold to Fannie Mae and Freddie Mac. Basically, this is any loan under $417,000 that is not an FHA or VA loan.) This change or law is called the Home Valuation Code of Conduct, commonly referred to as HVCC. Instead of boring you with the entire law, I am going to try to hit on some important highlights that could affect you.

1. Mortgage brokers are no longer able to order appraisals directly. They must use appraisal management companies. This could cause higher fees and will probably delay the loan process. This new law makes ordering a conventional appraisal similar to ordering a VA appraisal. Those of you that have had experience with VA appraisals understand that this is not always the smoothest process.

2. Mortgage bankers can order appraisals directly from an appraiser. However, this new law prohibits anyone in loan production, ie. loan officers, from ordering an appraisal. This is now done by a risk management department that has no loan production responsibilities at the company. Keeping this process "in house" carries a huge advantage over using the appraisal managment companies.

The obvious question now is what is the difference between a mortgage banker and a mortgage broker. That distinction is pretty easy to explain.

Mortgage bankers close loans in their own name and sell the loan to the "bigger bank" a week or two after the loan closes.

Mortgage brokers close loans in the name of the "bigger bank."

By the way, Midwest Mortgage Capital is a MORTGAGE BANKER.

Reverse Mortgages

In its simplest terms, a reverse mortgage is:

- a mortgage available only to seniors 62 and older
- a financial tool that provides access to a significant portion of equity in a senior's home (based on age)
- a mortgage that does not require monthly mortgage payments
- a mortgage for which credit and income are not qualifying factors

Other key features of a reverse mortgage are:

- just like all mortgages, ownership remains with the seniors; lenders never own the home
- upon death of last borrower, heirs or estate take title and, usually, sell the home and pay off mortgage
- reverse mortgage borrowers can never be forced to leave their homes
- vast majority are adjustable rate loans, but attractive new fixed rate is appropriate for some (but not all)

Proceeds (accessible equity) can be used in one of three ways or any combination:

- as a lump sum at closing (normally not recommended for reasons we must explain)
- as a guaranteed monthly payment for life or some shorter period
- left in a growing line of credit to be easily accessed whenever needed
- current liens must be paid off at closing, and their total must be less than available proceeds

How to use the $8000 tax credit for your down payment.

Most people withhold a certain percentage of their income each pay period in order to pay their federal income taxes at the end of the year. If you plan on purchasing a home before December 1 of this year and you are a first time homebuyer, then you will probably not need that money withheld from your paycheck because you will probably not have any federal income tax liability due to the $8000 tax credit that you will be receiving.



If you start now, you can stop withholding this money and save several thousand dollars that you can use as your down payment on a new house. Here is an example:



Yearly Income: $70,000

Income from today through December 1, 2009: $29,166

Federal Income Tax Withholding Percentage: 15%



Using this example, you can save $4375 ($29,166 X 15%) before December 1 to use as your down payment on your new house. This program would not require you to change your way of living at all in order to save this $4375.



In today's market, you are required to put 3.5% down on a house to get an FHA loan. This means that you would have enough money saved to put 3.5% down on a $125,000 house.



Start this program now because the $8000 tax credit ends when November ends.

The Past/The Present/The Future

THE PAST:

Late last year, the Federal Reserve Bank decided to purchase Mortgage Backed Securities. (For a good definition of Mortgage Backed Securities, go to www.wikipedia.org/wiki/Mortgage-backed_security.) This decision caused the value of Mortgage Backed Securities to rise due to an increase in demand for these particular securities. When this happens, interest rates go down. Lower mortgage interest rates was the goal of the Fed when they made the decision to purchase Mortgage Backed Securities. The theory was that lower interest rates will motivate individuals to purchase new homes and this would help lead our economy out of the economic slowdown. Basically, the purchase program succeeded in lowering mortgage interest rates. Rates have been around 5% since January with some days seeing rates dip to the mid 4s.

We are now seeing signs of this program losing its grip on the market as rates shot up to almost 6% last week. Why is this happening? There are two main reasons:

INFLATION FEARS--Inflation is always the number one enemy of any bond market. Even though inflation is relatively moderate right now, the market is very jittery as to the effect that the massive amounts of money that the Federal government is pumping into our economy is going to have on future inflation. This fear and anxiety has caused the value of mortgage backed securities go down.
INCREASED SUPPLY AND COMPETITION—In order to raise enough money to pay for all of the spending that the current administration is planning, the Federal Government sells bonds. These bonds now compete with Mortgage Backed Securities for investors and this increased supply has caused their value to go down and mortgage interest rates to rise.

THE PRESENT:

Investors are actually returning to purchase Mortgage Backed Securities after the steep sell off that we saw starting on June 1. Why? I believe it is because they saw the sell off as an over reaction. They are now returning because they see these securities as having a value higher than their current prices.

I have attached a chart that shows the value of Mortgage Backed Security over the last six months. Remember that a high value on the chart typically means lower interest rates. Hopefully this will help you understand what I have written in this email.

THE FUTURE:

Our prediction is that rates will be in the mid to high 5% range until our economy truly begins to show signs of life. When the economy starts to turn around, mortgage interest rates will go up.

Have a great day and a great week!