Sunday, February 13, 2005

The pros and cons of playing the real estate game

"Any homeowner who can should be moving every two years," the minimum to avoid capital gains taxes, says Kathy Courtney, owner of a Wellington real estate firm that just merged with Keller Williams Realty.

Why you should move every two years

Virtually anyone who owns a house in a market with low interest rates and high appreciation can make money, if he is willing to keep packing his bags, according to real estate agents.

The theory goes like this: By selling your house often and using your profits to trade up, you'll come out ahead. Rising real estate prices will build equity much faster than paying down principal, and the more expensive your home, the more its value will rise.

For example, if a couple buys a house for $200,000 and sells it for $300,000 two years later, they'll walk away with $100,000 cash. If they bought the house with an interest-only loan, they'll have earned that money while making rock-bottom mortgage payments and without paying anything toward principal.

If they then use their $100,000 profit as a 20 percent down payment on a $500,000 house, which they sell in two years for $700,000, they'll have raised $300,000 in only four years. That's enough to put 20 percent down on a $1.5 million mansion that could net even more profit — or enough to downsize and live debt-free.

By contrast, if they had remained in the $200,000 home with a conventional 30-year, fixed-rate mortgage, they not only would have missed out on the profits but also still would owe most of the $200,000 purchase price, since almost all of a mortgage payment goes toward interest in the early years of a conventional loan. (With a 6 percent loan, for example, they would owe $189,229 after four years.)

But be warned: If appreciation slows, you could be stuck in a house you can't afford to pay for — and can't afford to sell.

Why you might not want to

Some of the risks of playing the real estate game are hard to quantify: Will mortgage rates go up? Will appreciation slow down?

Others are as certain as . . . well, taxes.

If you want to try to make money by moving frequently — or if you're a long-time homeowner who's considering cashing in and trading up — don't be fooled by super-low, interest-only or deferred-interest mortgage payments. No matter how low your principal-and-interest payment, you'll still have to pay taxes and insurance, and those are certain to rise significantly if you buy a more expensive home.

Taxes will go up

When you move, your taxes will be assessed at the new home's market value, which generally is the price you paid for it. Tax officials and real estate agents say you should assume your taxes on a new home will be at least 2 percent of the purchase price a year. Actual taxes will vary by location.

For a $500,000 home, that means about $10,000 a year, or $833 a month, will be added to your mortgage payment to cover taxes.

Long-time homeowners might consider this scenario: You've lived in your house for 10 years. Your taxes are $2,500, or $208 a month. Although your home's market value has doubled or tripled since you bought it, your tax increases have been held down to 3 percent or less since the Save Our Homes constitutional amendment went into effect in 1995. In addition, your Florida homestead exemption means you don't pay taxes on the first $25,000 of your home's assessed value.

All of that changes when you buy a new house. Your taxes will now be assessed at the new home's value, even if the previous owner's taxes were held down under Save Our Homes. If your new home costs $450,000, say, your new tax bill will be roughly $750 a month. At $600,000, that bill jumps to $1,000 a month.

You also lose your $25,000 homestead exemption for the first year your own a new house. (You must reapply by March 1 of the next year).

Prospective home buyers should not assume taxes noted on the real estate agent's listing are what they will pay. That figure is what the previous owners paid, and in today's market, that figure is almost certainly far below what a new owner will pay.

Before buying a new house, check with the Palm Beach County Property Appraiser's office Web site to see an estimate your new taxes will be. Visit www.pbcgov.com/papa. Click on Records Search, enter the address of the home, then click on Tax Calculator.

Premiums will be higher

Still more sticker shock is likely when you learn what it will cost to insure your new house. Premiums are based on the replacement costs of your new home. If your new home costs more to buy, it will cost more to replace, and most major carriers in Florida have asked for permission to raise rates.

If you live in eastern Palm Beach County (east of Interstate 95 for homes south of PGA Boulevard; east of State Road A1A if your house is north of PGA Boulevard) and have a mortgage, you'll be required to have additional hurricane insurance. Rates for hurricane insurance from Citizens Property Insurance, the state's insurer of last resort, also are going up. Additionally, if you live in a flood zone, you'll need federal flood insurance.

What you need to know: Call your insurance agent and ask for a "conditional quote" on your new house, or ask the seller how much he pays. The figure you get will be only an estimate of your future bill, but it gives you one more tool in which to evaluate the ultimate costs of your new home. Make sure you get separate quotes for each type of insurance you'll need.