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Getting Financially Organized

What do I need to do before I 'trade-up' to a bigger house?

Before you set out to trade in your current house for a "better" one, you need to take a good look at your overall budget and determine how much more, if any, of your monthly spending can go toward increased housing costs.

How do you figure out where all your money goes each month? Get out your checkbook register, credit card statements, paycheck stub, most recent year's tax return, and anything else that documents where you've been spending your money over the past six to twelve months. You may also need to do some tracking or estimating of cash purchases that don't leave a paper trail.

How do I determine how much money I will spend after buying my next home?

Knowing how you spend your money now on housing and other items is only half the picture. You also need to know how much you will spend after buying your next home. The following expenses are probably going to change the most if you sell your current house and buy a new home:

- Mortgage payment: Unless you've been squirreling away extra savings while living in your current house, the total amount you're borrowing through your mortgage (and, therefore, your monthly mortgage payment) will probably increase if you trade up.

- Property taxes: In most communities, the annual property taxes you pay on your next home purchase are initially set at a percentage of the property value. To find out the property tax rate in the area where you plan to purchase your new home, simply call the local tax collector, assessor, or other taxing authority. Don't base your property tax estimate on the amount that the seller of the home you're interested in buying is currently paying or on the amount you're paying on your present house. When you trade up, the taxes on the home you buy are usually reassessed upwards.

- Utilities: If you're trading up, some of your utility bills may stay the same, whereas others will change. Until you have a specific home in mind to buy, you can't request hard numbers on utility usage. In the interim, make some educated estimates. For example, if you're planning on moving into a larger home in your area with, say, 30 percent more square footage, you can estimate that your heating and electric bills will increase by about 30 percent. However, if you're moving from an old, energy-inefficient home into a newer and more efficient one, the new home may not cost you more in utilities even if it's a bit larger.

- Furniture: If you buy a larger home, you'll have more space to fill, so you're probably going to spend more money on furnishings. Make a reasonable estimate of how much you expect to spend on new furnishings.

- Maintenance: If you're buying a more expensive home, you're probably also going to spend more on maintenance, even if the home isn't a fixer-upper. A good way to estimate your annual maintenance costs is to multiply the purchase price of the home by 1 percent (use 1.25 percent of the purchase price for older and more run-down properties).

- Federal and state income taxes: If you buy a more expensive home and have larger mortgage payments and property taxes, your income tax bill will probably go down. Mortgage interest and property taxes are deductible expenses on Schedule A of your federal income tax Form 1040 and on most state returns.

- Homeowners insurance: If you buy a more expensive home, your homeowners insurance premiums will probably increase. In the absence of a specific quote for a property you're interested in buying, you can estimate that your homeowners insurance costs will increase in proportion to the increased size (square footage) of your home. Because land isn't insured, ignore the extra land that may come with your next home.

When would someone consider 'trading down'?

One day you suddenly come to the realization that you've got more space than you really need. If you're like most near or actual retirees, these feelings may also accompany the realization that you don't have as much money to live on during your retirement as you'd like. Don't despair! Now may be the time for you to trade down -- sell your current house and either buy a less expensive home or become a renter.

What are the tax implications of 'trading down'?

Thanks to the Taxpayer Relief Act of 1997, house sellers can more easily shield from tax a big portion of their house sales profits. Single taxpayers can avoid capital gains taxation on up to $250,000 and couples filing jointly up to $500,000 of profit. As long as you lived in the house as your primary residence for at least two of the previous five years, this tax exclusion is available to you.

Presuming you're willing to sell your primary residence, the new house sales tax law makes it easier to convert your home equity directly into liquid investments you can live off during retirement. Of course, such a strategy requires you to either trade down or become a renter; trading to an equal cost or more expensive home won't free up more of your money.

What is a reverse mortgage and how does it work?

As the name suggests, a reverse mortgage reverses the traditional mortgage process. Think back to when you bought your first home. Unless you had generous and affluent relatives, you probably had to scrape together the money for the down payment and seemingly never-ending closing costs.

And then you were likely saddled with what seemed like a mountain of mortgage debt. Every month, thereafter, you dutifully mailed to the mortgage lender a check for the monthly mortgage payment. In the early years of your mortgage, the vast majority of those monthly mortgage payments went to pay interest on your outstanding loan balance, but a small portion of each of those payments went toward principal, in other words, reducing the loan balance. (As the years roll by, the loan balance should pay down at a faster and faster rate until, eventually, your mortgage is paid off.)

A reverse mortgage reverses this process. When you take out a reverse mortgage, the mortgage lender typically sends you a monthly check. Imagine that! You can spend the check any way your heart desires. And, because the check represents a loan, the payment to you isn't taxable.

As the reverse mortgage lender gives you more payments, you accumulate an outstanding loan balance. Unlike other loan balances you may have, such as on a credit card or a business loan, you typically don't have to pay a single penny back on your reverse mortgage loan until the home is sold (and then the loan and the accrued interest is paid back from the sale proceeds) or, with some reverse mortgage programs, when you move out of the property.

What is an installment sale?

Some house sellers don't take their proceeds in one big lump sum. Instead, they set up an installment sale -- a plan that spreads out proceed payments over future years. In addition to delaying your required income tax payments until you receive the future house-sale money (and allowing you to earn interest on that money in the meantime), an installment sale can also lower your income taxes. For example, you may save tax dollars if -- because you're on the verge of retiring -- you're expecting to be in a lower tax bracket in future tax years.

Installment sales are potential financial and tax minefields. Because you're delaying receipt of some of the sale proceeds, you're risking that the buyer may not pay you everything you're owed. In addition, the correct planning and reporting of an installment sale for tax purposes can be complicated, especially if the installment sale arrangement is unfamiliar to you. So, if you're considering doing an installment sale, pick up a good tax advice guidebook and/or consult a competent tax advisor who has experience with such transactions.