Borrow as Much Money as Possible to Make Biggest Real Estate Profits

QUESTION: I think you are wrong to tell home buyers to make the smallest cash down payment and to take the largest mortgage they can get. They will be in hock forever. When my wife and I bought our home about 30 years ago, we had saved to make a large down payment, so we only needed a mortgage for about 50% of our purchase price.

Last year, we made the final payment on our mortgage. That was a mighty good feeling to know we have no mortgage payments left to pay. But home buyers today are mortgaging themselves to the hilt. That’s why there are so many foreclosures. Don’t you think it is smart to make a big down payment to hold down the monthly mortgage payments?

ANSWER: No, no, no. When you bought your home over 30 years ago, inflation was only 2% or 3%. Today it is at least 5%. Mortgage interest rates were around 5.5%. That is a big difference from today’s home loan interest rates of more than 11%.

Also, the income tax laws were different in 1958. Today’s tax laws allow home mortgage interest deductions only on “acquisition loans” plus up to $100,000 on a home-equity mortgage. Even home buyers who can afford a big down payment should make a minimal down payment to conserve their cash and maximize their mortgage-interest deduction.

Another reason to make a small down payment is that home buyers can maximize their profit per dollar invested by using leverage. That means as a home goes up in market value, the profit per dollar invested is greatest when the borrowed money is largest and the down payment is the smallest.

Incorporating Is Not the Wisest Way to Go

Q: Four friends would like to each contribute $10,000 toward the purchase of a rental house. Do you think we should form a corporation to limit our liability in case of a lawsuit?

A: No. Please consult a real estate attorney. There are many drawbacks and few advantages to forming a corporation for real estate ownership. If you want to limit your liability, carry adequate liability insurance for the property. Perhaps a better alternative is to form a limited partnership so the tax advantages can be passed through to the investors, but the liability is limited. Another partnership advantage is the agreement spells out the rights and duties of each investor.

Tenants in Common and Survivorship

Q: Some time ago, you said friends who buy a house as tenants in common, one owning 75% and the other owning 25%, cannot legally provide that upon the death of either the decedent’s share shall go to the survivor. Why can’t the right of survivorship be achieved by written agreement and recording so that, like a mortgage, it is binding on the decedent’s estate and takes priority over any contrary provision in the deceased’s will?

A: Let’s back up, because we just lost 99% of the readers. When two people buy real estate together and they want the title to go to the survivor when the first co-owner dies, joint tenancy with right of survivorship is the way they should hold title. In some states, husband and wife can accomplish the same result by holding title as tenants by the entireties. A joint tenant’s will has no effect on property held in joint tenancy with right of survivorship.

However, joint tenants should be aware the survivorship feature can be defeated if one of the joint tenants conveys his interest before death, either to another person or to himself as a tenant in common. Consent of the other joint tenant is not necessary for such a conveyance to break up the joint tenancy. However, if title is held by spouses as tenants by the entireties then both spouses must agree to any conveyance.

Another major problem with joint tenancy is that all joint tenants must own equal interests. To illustrate: two joint tenants each own one-half, whereas three joint tenants each own one-third interest in the property.

If two co-owners want to own unequal shares, then a tenancy in common would be appropriate. But the shares of tenants in common are subject to each co-owner’s will.

I question whether your idea of combining the survivorship feature of joint tenancy with the unequal ownership feature of tenants in common will work. Frankly, I don’t see why the co-owners would want unequal ownership shares plus the survivorship feature.

As a lawyer, I see many problems. For example, one of the tenants in common could convey his interest before death to someone else. I doubt that the recorded agreement would have any legal effect on such a conveyance. Also, a recorded agreement might not prevail over a deceased tenant in common’s will. Another problem is you would not get the benefit of avoiding probate, as joint tenants do. I give you an A for creative thinking, but I think there are too many uncertainties.

Home Purchase Offer Can Be Withdrawn

Q: We are caught in the middle of a mess. Our offer to buy a home said it was good for five days. The realty agent suggested that we use that period to “give the seller time to consider the offer.”

We made the offer on Monday. By Wednesday we had heard nothing, so we phoned the realty agent. She said the sellers were considering our offer. At that time, my husband told the agent to withdraw our offer because the house is too small for our family.

But the agent protested, claiming our offer was valid through Friday. On Thursday morning the realty agent phoned to say that the sellers had accepted our offer. However, we don’t want the house. How can we get our $2,000 earnest money deposit back?

A: Make a written demand upon the real estate broker or whomever is holding your deposit. You are clearly entitled to the refund since you revoked your offer before it was accepted by the seller. Your revocation on Wednesday to the seller’s agent is clearly sufficient, so the seller could not accept your offer on Thursday. If necessary, consult a real estate attorney to help get your deposit refunded.

Don’t Rush Buying in New Community

Q: In about six weeks, my husband will be transferred out of town to a new job. We have visited the community twice but are thoroughly confused as to which suburb is best. The one we can best afford has cross-town school busing, and we don’t like that. But the town with the best schools has home prices that are too high for our budget. Do you think we should learn to live with the busing situation?

A: No. Don’t be in a hurry to buy a home in your new community. As you discovered, school quality has a big effect on home prices, so you don’t want to make a costly mistake.

Your best alternative is to lease a home with an option to buy. Try to get a rent credit so all or part of your rent is credited toward the down payment if you decide to buy. Benefits of lease-options include getting to try the home before buying, and leasing is usually cheaper than buying.

Sale of an Inherited Home Not Too Taxing

Q: About six months ago, my brother and I inherited our mother’s house. At first, he thought he wanted to live in the house, but his wife vetoed that idea, so we have agreed to sell the house. But his attorney tells my brother that our taxable profit is the difference between the net sale price (estimated at $225,000) and our mother’s cost basis ($24,000). But my tax adviser says our taxable profit, if any, is only the difference between the house’s value when our mother died and the sale price. Who is right?

A: Your tax adviser is right, your brother’s lawyer is wrong. This is a classic example of why it is better to inherit property rather than receive it as a gift before the owner’s death.

Since you and your brother inherited the property, your taxable profit is only the difference between the home’s market value on the day of your mother’s death and its net sale price. This difference is probably a very small amount. However, if you had received the house as a gift before your mother died then your taxable profit would be the difference between your net sale price ($225,000 estimated) and your mother’s cost basis ($24,000).

Appraisal Fee Should Not Depend on Value

Q: We recently sold our home for $178,000 and bought a larger home for $245,000. Before we sold our old home we hired a professional appraiser who charged us $225 for the appraisal. That was money well spent because we would have sold too cheap if we had listed at the price the realty agent suggested. However, when we got our mortgage on the house we bought, the appraiser charged us $300 for the appraisal. When I questioned her fee she said the appraisal cost was higher for the more expensive homes. This doesn’t seem right to me. What do you think?

A: There is no reason the appraisal for the more expensive home should be priced higher than for the less expensive home. However, appraisers charge fees that the traffic will bear. Their professional societies say the appraisal fee should not be tied to the value of the property, but your situation is a classic example of what happens.

Perhaps you are aware the appraisal industry is under intense scrutiny. Federal licensing is threatened if the states don’t take over the job. Yet the appraisal societies are fighting among themselves. Ask most mortgage lenders, and you will find bad appraisals are the major cause of their loan losses. Yet being an appraiser is an extremely profitable business.

Which Index Is Best for Adjustable Loans?

Q: We are shopping for a home loan, but can’t quite qualify for a fixed-rate mortgage, so we are stuck with an adjustable-rate mortgage. We have been offered loans tied to the cost-of-funds index, the prime rate and the Treasury bill index. Which is best for us?

A: I like the cost-of-funds index best because it moves slowly. But the prime rate is controlled by the major banks and is set arbitrarily. The Treasury bill index fluctuates with money-market rates but tends to be rather volatile, up and down. As a borrower.

Land Contract Sales Can Bring Problems

Q: We are considering buying a home which the seller wants to sell on a land contract. The realty agent says we get all the tax benefits of home ownership. However, not receiving the deed until we make 60 payments worries me. What do you advise?

A: Be very careful. As you know, a land contract seller retains the deed until the buyer makes all or an agreed number of payments. However, the buyer gets to deduct the interest and property tax payments.

But the big drawback of land contract sales, called contracts of sale, agreements for sale, or contracts for deed in some states, is that the seller may not be able to deliver marketable title when the buyer makes all the agreed number of payments. From the seller’s viewpoint, another problem is that the buyer may default but claim an equity in the property and refuse to vacate unless paid to do so. Please consult a real estate attorney for full details.

Change in Purchase Offer Cancels Deal

Q: A realtor brought me a purchase offer for land I have listed for sale. The offer was acceptable except I wanted a 60-day closing date instead of the 90 days specified in the offer. So I crossed out 90 days, wrote in 60 days, and accepted the offer. But the buyer says my slight change canceled his offer so he doesn’t have to buy my land. What should I do?

A: Cry. You made a serious mistake. Even the slightest change made by the seller to the buyer’s purchase offer rejects the offer and creates a counteroffer. If the buyer doesn’t agree to your change from 90 to 60 days for the closing of the sale, you have no sale.

Lease-Option Helps Raise Down Payment

Q: My husband and I earn over $50,000 per year but we only have about $5,000 in savings for a home down payment. We realize that is not enough, but we can’t seem to save much more. Any ideas how we can buy a home in our situation?

A: In most communities $5,000 is not enough for a home down payment. However, it is plenty to pay as consideration for a lease with option to buy.

Start shopping for homes in the newspaper classified ads under both “houses for sale” and, more important, “houses for rent.” When you see a house you want to own, ask the owner to lease with an option to buy. Not every owner will accept. But owners of rental houses will be especially eager to listen to your proposal because the rental market is soft in most cities.

To structure a good lease-option from your viewpoint, be sure to ask for a rent credit toward the down payment. For example, suppose the rent is $1,000 per month. You should ask for at least a 25% to 50% rent credit. If the landlord agrees to a 50% rent credit, at the end of 12 months you will have $6,000. Even if you have to pay above-market rent to get a decent rent credit, the extra rent will be worthwhile, because you can’t save as fast as you will build credit toward the down payment.

Don’t Buy Land That You Can’t Use Soon

Q: In January, we inspected a new land development project in Florida. The developer has an excellent reputation. However, we are concerned about buying a lot in a development where there are no houses built yet. What do you think of buying a lot for $15,000 in such a project? We would build on the lot in about 12 years when I retire.

A: Please don’t buy unless you plan to use the lot within six months. The reason is that too many things can happen to change your retirement plans within the next 12 years. If you insist on buying, invest only money you can afford to lose, because that is probably what will happen.

A week never goes by when I don’t receive at least one letter, usually from a widow or from a person who wants to know how to sell a lot in a retirement development. Unfortunately, most of these lots are virtually unsaleable because the owner is competing with the developer who has hundreds, sometimes thousands, of lots for sale.

Mortgage Insurance Is Hard to Get Rid Of

Q: We are considering buying a two-bedroom home with a 10% down payment and a 90% mortgage. Our idea is to add a third bedroom and a second bathroom. This will greatly increase the home’s value and also meet the needs of our family. However, when we talked to the lender about getting rid of the PMI (private mortgage insurance) premium, she said we could be locked in as long as seven years. As the PMI cost is very high, how can we be sure of canceling this when we complete the improvements?

A: Congratulations for planning ahead. Most home buyers who pay 10% down are not aware of the difficulty of getting rid of the unnecessary PMI premium when their loan-to-value ratio drops below 80%.

Most lenders will allow dropping the PMI premium when a new appraisal is obtained and the loan balance is below 80% of the appraised market value. However, if you have the misfortune of having your loan sold to the notorious Federal Home Loan Mortgage Corp., then current rules lock you into seven years of unnecessary PMI premiums. Therefore, when you obtain your PMI loan, be sure to insist on the lender’s written promise that the loan will not be sold to Freddie Mac.

Good Landscaping Well Worth the Cost

Q: We plan to sell our home soon. However, our yard is rather bare. When the weather gets better, a landscape architect says she can improve our yard with new shrubs, plants and lawn with underground sprinklers for a total cost of $2,450. While this seems high to us, she says it will add at least $5,000 to the value of our home. Do you agree?

A: Of course I can’t give specific advice, but I have learned that professional landscaping pays many times its cost. While $2,450 seems like a lot of money, if the landscaper knows what she is doing you could add several times the cost to the value of your home.

I suggest you ask the landscaper for references from her previous clients and ask them if they were satisfied. Having personally seen how quickly and profitably landscapers can transform a property, I am an enthusiastic advocate of hiring a professional landscape architect.

Both Claim $125,000 Profits Tax-Free

Q: My friend and I have owned and lived in our home about 14 years. Recently we decided to split up. We put a lot of money into our house and greatly increased its value. Our net profit will be about $300,000. As we are both over 55, can we each use that “over 55 rule” $125,000 exemption you often discuss or can only one of us use it?

A: Yes, you can each claim up to $125,000 of tax-free home sale profits. The “over 55 rule” is available to any home seller, age 55 or older, who has lived in his principal residence three of the five years before the sale and never used this tax break before. You and your co-owner appear to both qualify.

However, only one “over 55 rule” tax benefit is available to married couples. Since you and your friend are not married, each of you can claim up to $125,000 of tax-free home sale profits or $250,000 total tax-free profits. Please consult your tax adviser for further details.

Tax Must Be Paid on Property Profits

Q: I have been acquiring income properties, mostly apartments, for more than 10 years, and have not made tax-deferred exchanges. I estimate my equities are over $2 million. My question is, how can I sell out without paying huge taxes?

A: You can’t. If you want to liquidate you will pay at least 28% federal tax plus any state tax. Of course, the ultimate tax shelter of all is to die. Then, Uncle Sam will forgive tax on your capital gain.

Presuming that you don’t want to use the ultimate tax shelter of death, another alternative is to refinance your mortgages to take out tax-free cash. However, such refinancing will increase your mortgage payments, but you will then have tax-free cash to spend as you wish.

Fewer Lenders Offering VA, FHA Mortgages

Q: You often comment on the benefits of obtaining a VA home loan. My husband qualifies, but the saving and loan where we have a savings account and the bank that has our checking account do not offer VA mortgages. Where can we get one?

A: Many mortgage lenders have discontinued offering VA and FHA home mortgages because of all the government red tape. However, you will find many mortgage brokers, banks and S&Ls; offering VA and FHA home loans. Look in your phone book under “real estate loans.”

Letters and comments to Robert J. Bruss, a San Francisco-area lawyer, author and real estate broker, may be sent to the Real Estate Section, Los Angeles Times, Times Mirror Square, Los Angeles 90053.