The dream of homeownership ... people have been dreaming this dream for decades. Particularly once the Federal income tax code allowed for deductions for interest paid on a mortgage. Homes are usually seen as a good investment of one's hard-earned money. Up until recently, future homebuyers dreamed as they worked long and hard to come up with a down payment. That was before nonprime mortgages made it easier to get a mortgage with no down payment, low documentation and less-than-needed income. So, now, lots of people have moved into their dream houses. But both prime and non-prime borrowers may soon find out that home investment is an illusion, as Bob Prechter describes in his most recent Elliott Wave Theorist.
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Excerpted from The Elliott Wave Theorist, September 2007
What is the financial status of a home? Many people say they “invest” in their homes. But a home is not an investment. It is an item that loses value through deterioration even if no one lives in it. A home is expensive to finance, expensive to maintain and expensive to buy or sell. Ironically, it is also very costly to realize the loss of value on a home. How can it be? Well, there are two costs that few consider:
(1) Did you know that if you sell your home at a loss and the bank agrees to cancel your mortgage for less than you owe, your taxes will rise? It’s true. The IRS considers forgiven mortgage debt to be a payment to the homeowner, and it’s not considered a capital gain but rather is taxed at the ordinary-income rate. But wait; it gets worse. Suppose your income that year was $30,000, so you were in the 15 percent federal tax bracket. If your bank forgave $70,000 worth of mortgage debt, your “income” suddenly jumps to $100,000, pushing you up into the 33 percent income-tax bracket, which in most states is effectively the 48-55 percent bracket inclusive of federal and state income taxes and Social Security taxes.
(2) But wait. Your forgiving bank is hit just as hard. According to The Boston Globe (8/24/07), “Foreclosing on a house and selling it in an auction costs $50,000, on average, in New England, and that amount is on top of the funds the lender needs to pay off the loan itself.”
Think about the size of these costs. While you are paying extra taxes on the forgiven loan, the bank must pay all the fees required to dispose of the house on top of taking a loss on its value. These costs combined could amount to a significant portion of the value of the sale! Under such circumstances, can anyone say with a straight face that you owned an “investment”? Even a desired home costs money, but an unwanted home is nothing less than a giant albatross of decay and expense.