Idle Equity? A Reverse Mortgage Could Be the Answer.

By Robert J. Bruss
Saturday, August 26, 2006

Q: DEAR BOB: My husband and I, ages 74 and 77, live in our home worth about $900,000 for which we paid $125,000 in 1978. We have a remaining mortgage of $44,000 at 5.25 percent interest with $330 monthly payments. But we dislike sitting on all that "dead money" in our home equity. We have been investigating a reverse mortgage to pull out some of that money either to invest or to help our daughter buy a house. However, we are not interested in additional monthly income. Is a reverse mortgage the way to go? -- Darlene MacP.

A: DEAR DARLENE: Are you in reasonably good health and do you plan to stay in your home at least five years? If your answer is yes, then a reverse mortgage could be ideal for your situation.

Sitting on about $850,000 in idle equity must be frustrating. Giving your daughter the money to buy her house is like an advance inheritance if you are certain you will never need your home equity for personal use.

However, I do not recommend obtaining a reverse mortgage to use the cash for investments because chances of your earning at least as much as the money costs are slim.

Because a senior-citizen reverse mortgage must be recorded as a first mortgage, $44,000 of the proceeds will be used to pay off your current first mortgage.

I suggest you consult a reverse mortgage originator who represents the Federal Housing Administration, Fannie Mae and Financial Freedom Plan to compare their offerings. Because of your home's high market value, the Financial Freedom Plan will probably be best for your situation. You can find reputable reverse-mortgage lenders at http://www.reversemortgage.org/ .

DEAR BOB: Last October we bought a house in Minnesota. We like the neighborhood, but after we moved in, we realized we had bought a money pit. The house was offered for sale as-is. About a month after moving in, we had to replace the furnace for $6,000. Recently, our basement was flooded and we had to spend more than $10,000 replacing drain tiles and re-drywalling. Our contractor said the existing drywall was not installed to building code -- it had no insulation. The sellers were obviously house flippers, but surely our home inspector should have caught the defective furnace. Are the sellers liable for the defective drywall they installed? -- Brian G.

DEAR BRIAN: When a house is sold as-is, that doesn't excuse the seller from disclosing known home defects. An as-is sale means the seller must reveal defects but does not have to pay for repairs. Your big problem is proving the seller knew about the defective furnace and the incorrect drywall installation.

If you hired a professional home inspector, he or she should have inspected the furnace and discovered any dangerous condition such as a cracked firebox heat exchanger. The professional inspector's contract with you, however, probably limits liability, so do not count on holding the inspector liable unless you can prove the inspector was negligent and should have discovered the furnace defect. As for the defective drywall, it can be difficult to prove the sellers knew of it.

DEAR BOB: I added my neighbor and his wife as joint tenants with right of survivorship to my home, intending to leave it to them when I die. Will this create a tax problem for them? -- Don W.

DEAR DON: This was a mistake. You gave up control over your property in case you need to sell it to pay for your nursing home care. If you decide to sell it, they can demand their share of the sales proceeds. Worse, they can refuse to sell and you would have to bring a partition lawsuit to force a sale, with them getting two-thirds of the sales proceeds.

As gift recipients, your neighbors' basis in the property becomes your probably low adjusted cost basis. When they eventually decide to sell, they will owe a substantial capital gains tax.

And because you deeded part of your property away, the tax assessor will probably reassess the property value, forcing you to pay higher property taxes.

Instead, you could have created a revocable living trust and named your neighbors to receive your title after you die. Meanwhile, you would maintain 100 percent control, including the ability to sell if you desire.

After the neighbors inherited your property, they would get a new stepped-up basis to market value on the date of your death and would owe little or no capital gain tax if they sell shortly thereafter.

Sorry to bring such bad news. You should have consulted a lawyer first.

DEAR BOB: You have mentioned several times that when a group of individuals owns and occupies a house, such as three roommates buying a house together, they each will be entitled to a $250,000 principal-residence-sale tax exemption if they each meet the 24-out-of-last-60-months ownership and occupancy test. Would the same condition apply if I place my 7-year-old son on the deed to my home? Will each co-owner then be entitled to $250,000 tax-free capital gains after living in it for 24 of the 60 months before the sale? -- Richmon T.

DEAR RICHMON: Yes, but there are major pitfalls of adding a minor's name to a real estate title.

When you and your wife decide to sell your home, unless your son is then 18 or older, you must have a court-appointed guardian to represent his interests.

Perhaps that guardian might decide his share of the sales proceeds should be held in trust until he becomes 18 (or 21, or some other age). I do not recommend doing what you contemplate.

Remember the rule is minors can receive real estate title, but they cannot convey title until they become 18.

DEAR BOB: My life partner and I bought our home as tenants in common. But I make all the mortgage payments, as I earn most of the income. Can I deduct all the mortgage payments or do they have to be split between the two of us? -- Michael S.

DEAR MICHAEL: Itemized income tax deductions for principal-residence mortgage interest and property taxes depend on who actually paid the payments.

If you pay 100 percent of those expenses, only you can deduct those costs you paid. However, if you pay 75 percent and your co-owner pays 25 percent, then you each get to deduct the amounts you paid. Consult a tax adviser for details.

DEAR BOB: My boyfriend and I want to buy a piece of land where we might wish to someday build a retirement home. We both live in a house my boyfriend owns. I want to buy half the house from him, which would give him cash to buy the land. Will a bank extend me a mortgage for half a house? I have excellent credit and the house is now worth triple what my boyfriend bought it for some years ago. -- Lily R.

DEAR LILY: No institutional lender will make a mortgage loan secured by half a house. You and your boyfriend must be co-owners holding title. Then a mortgage lender can make a loan secured by the house and signed by both co-owners. Work with an experienced mortgage broker to see if it is possible to accomplish what you and your boyfriend want so you can buy that land together.

DEAR BOB: My wife and I own three properties. We rent two and live in the other. I am 68 and she is 61. Can we obtain a reverse mortgage on our home while owning two rental properties? -- Robert U.

DEAR ROBERT: The two rental properties are irrelevant. The reverse mortgage is secured by your primary residence only. If you wish, you can own 100 rental properties and still obtain a reverse mortgage.

However, you have a slight problem. Your wife is not old enough to obtain a reverse mortgage on your principal residence. She must be at least 62 to qualify.

This problem can be solved by waiting until she becomes 62 before obtaining a reverse mortgage, or, if she is willing, she can remove her name from the title to the home so you can qualify for a reverse mortgage.

This might be a better alternative because at age 68 you can qualify for a larger reverse mortgage than if you wait until she becomes 62. When two co-owners qualify for a reverse mortgage, the entitlement is based on the age of the younger applicant.

DEAR BOB: Twenty years ago my husband's parents put their home into the names of my husband and his brother. The parents died a few years ago. The house has been vacant since. My husband's brother has decided to buy out my husband's half of the house based on an appraisal. That is acceptable to my husband. For tax purposes, can my husband treat this transaction as a monetary gift with no tax consequences rather than a taxable sale? -- Cathy J.

DEAR CATHY: No. The brother is buying out your husband's half interest in the house. That is not a tax-free gift but rather a taxable sale on which your husband will owe capital gains tax.

Because your husband received a gift of a 50 percent interest in the house 20 years ago, he took over half the probably low adjusted cost basis of his parents. The tax result will likely be a large capital gains tax.

This situation is another example why it is usually better to inherit property and receive a stepped-up basis than to receive a before-death gift. Your husband should consult a tax adviser.

DEAR BOB: My daughter and I own a house as joint tenants. She has lived in the house for the last two years. I have never lived there. We plan to sell it and expect a net profit around $100,000. Can the entire profit be allocated to her so it will be exempt from capital gains tax? -- Arnie C.

DEAR ARNIE: Yes. If your daughter owned and occupied her principal residence at least 24 of the 60 months before its sale, Internal Revenue Code 121 entitles her to claim up to $250,000 tax-free home-sale profits. This includes the entire $100,000 expected sale profit so no capital gains tax will be due on the sale. Consult a tax adviser for details.

DEAR BOB: I have renters living in the houses on each side of my house. These rented houses have trees that overhang my property. Is the owner responsible for trimming these trees? If not, can I trim these overhanging trees? -- Jim H.

DEAR JIM: A property owner can trim overhanging trees back to the property boundary. However, be sure your trimming is not so severe that it kills a tree or causes it to fall and cause damage, in which case you could be held liable for the loss.

Before trimming the overhanging trees, try to contact the adjacent owners on a friendly basis. I recently did that about two trees that leaned toward my house.

My nice neighbor paid to have his trees removed to avoid future possible damage liability if they fell and damaged my house.

DEAR BOB: Thanks for those recent items about raising the home sales commission to 7 percent, with 4 percent going to the buyer's agent, to get a house sold in a slow market. That is exactly my problem. However, when I showed your article to my listing agent, her broker said it would be "unethical" to charge a 7 percent sales commission so he refused. My listing still has about 60 days left and I want the house sold. What should I do? -- Pat C.

DEAR PAT: I have never heard of a real estate broker refusing to raise the sales commission to push through a sale. There is nothing unethical, illegal, immoral or even fattening about a home seller offering to pay a 7 percent sales commission with 4 percent going to the buyer's agent and 3 percent to the listing agent.

If I were in your situation, I would phone the listing agent's broker, politely explain you want to get your house sold in a slow market, and wish to raise the sales commission to increase the incentive for buyer's agents to sell your house. If he or she refuses to agree, then it's time to consider canceling the listing for lack of due diligence so you can list with a better agent.

DEAR BOB: I don't expect you to print this letter because I am a nontraditional real estate agent who charges my home sellers a set sales fee of $9,950, which is not commission based on the home's final sales price. I still make a profit while doing the exact same things traditional agents do for their clients. My client's best interest and net savings always come first. It is unfortunate some Realtors claim to be ethical while practicing their self-serving interests. Instead of a taking seminar courses on how to defend your commission, they should take courses on true ethics to look out for your client's best interest. -- Luis T.

DEAR LUIS: That chip on your shoulder must be heavy. Lighten up. Real estate agents are in business to earn a profit, as you are. If your brokerage office can survive on $9,950 per home sale, good for you. However, I question if you are really looking out for the best interests of your home sellers to get top price for their residences.

You conveniently neglected to say if all your listings are immediately placed in the local multiple listing service and on the Internet to give your home sellers maximum exposure to the market of prospective buyers represented by other agents, and how those buyer agents are compensated.

DEAR BOB: I am considering buying rental property near Austin, which is a good rental market. Our real estate broker recommends a 10 percent first mortgage to buy this property. My wife and I both have excellent credit. Does this make sense? -- Byron T.

DEAR BYRON: There are two potential mistakes. The first is buying rental property out-of-state where you are not able to manage your own property. Nobody has as great an interest in your investment property as you.

The second mistake is paying 10 percent mortgage interest for a rental property in today's market.

You should be able to obtain a much lower interest rate on investment property. Borrowing at 10 percent to buy a rental property makes it extremely difficult to create a positive cash flow.

Readers with questions should write Robert J. Bruss at 251 Park Road, Burlingame, Calif. 94010, or contact him via his Web page, www.bobbruss.com.

2006 Inman News Service