Q: Several times in the last few months I have read about financing a house purchase by means of the owner "taking back a note." These articles have been from the owner's point of view. Ten years ago, we purchased a home in Northwest Washington, and the owner took back a note. The principal becomes due in October of this year, for about $18,000.
The home cost us $33,000, the note was for $27,000 and houses in our neighborhood are now selling for more than $100,000. We have no intention of selling, but do not know what to do about the old mortgage. Should we try to negotiate a new arrangement with the former owner? Should we try to get a conventional mortgage?
A: It appears that you have a balloon note arrangement with your original seller. Under such an arrangement, you made relatively low monthly payments, but the entire principal on the mortgage became due and payable (i.e., ballooned) at the end of 10 years.
There are a number of ways to pay off your outstanding mortgage. First, you can dip into your own savings, if you have $18,000, to pay off the mortgage. Personally, I don't recommend this approach, because it is my belief that too much equity in a house is not an economic advantage to a homeowner.
Second, you can go to a bank or savings and loan association and borrow the $18,000. Most lending institutions in this area will be more than willing to lend you the money, insofar as an $18,000 loan on a house worth more than $100,000 is a very secure investment.
You should shop around for the best possible rate. I suspect that your present rate is somewhere between 6 and 8 percent a year. Don't anticipate finding this rate again -- at least in the foreseeable future.
However, you should be able to find a new mortgage loan with an interest rate of around 12 percent. While this may appear quite high, if you run the numbers out you will find that the tax benefits of this new loan will considerably reduce the actual interest rate.
Assuming that you have an income, the higher interest payments will be deductible for tax purposes. No doubt you have not been receiving significant tax benefits on your old loan in the past.
Third, discuss the situation with your present lender -- the old seller. I doubt that the lender will be willing to extend the old loan at the same rate of interest. However, you may find the seller willing to extend the loan for another period -- perhaps three to five additonal years -- at a rate of interest equal to or somewhat less than the market rate.
After all, your present lender may not be able to invest the $18,000 cash in any investment that will bring a rate of return of 11 or 11 1/2 percent. Thus, it is possible that your present lender will be willing to extend the loan, if you agree to raise the rate.
However, do you really want to borrow only $18,000? Assuming that you have an income and are paying taxes, you should consider borrowing more than you need to pay off your outstanding mortgage.
You have a home worth over $100,000. Your equity presently is approximately $82,000, deducting the $18,000 that you presently owe. Why not consider borrowing $20,000 or $30,000 above the $18,000, so that you will have some additional cash to use for other purposes?
The equity in your home will continue to appreciate whether you borrow $18,000 or $50,000. Thus, if you do not use your equity, in my opinion, it is just sitting there going to waste.
The bottom line, of course, depends on your income, your ability to pay and your interest in other investments.
Finally, regardless of how you come up with the money to pay off your first mortgage, don't forget to have that mortgage holder sign the original promissory note and mark it "paid and cancelled." Take that cancelled promissory note to your attorney and have the original mortgage released from the land records.