Deciding on Fixed-Rate or Adjustable Loans
QUESTION: We would like your opinion as to whether we should get a fixed-rate or adjustable mortgage on a home we are buying. Which do you think is best in today’s money market?
ANSWER: Adjustable-rate mortgages shift the lending risk that interest rates might rise from lender to borrower. To compensate for this risk, the ARM borrower should receive a lower interest rate.
That happened in the past when ARM interest rates were as much as 2% below fixed-rate loans. But, today the spread during the ARM “teaser period” for the first six months is only about 1.5% and after the first adjustment it is barely less than the fixed interest rate.
Because ARM borrowers aren’t receiving much of a lower interest rate to compensate for their risk, in today’s mortgage market I think borrowers who can qualify for fixed-rate loans around 11% will sleep better by staying away from adjustable mortgages.
But, if you can only qualify for an adjustable rate mortgage, go for the ARM which is tied to the cost of funds index. This index is rising but it moves very slowly. For example, it has only gone up about one-half percent in the last year. By comparison, the six-month Treasury bill index has risen almost 3% in the last year, so stay away from ARMs tied to the Treasury bill index.
How to Determine the Sales Price of a Home
Q: In a few months we plan to sell our home. We generally know what it is worth, but want to be certain we aren’t selling too cheap. I telephoned two appraisers listed in the phone book and they each want $250 to appraise our home. Do you think we need a professional appraisal?
A: When you are ready to sell your home, please invite at least three local realty agents to give you their listing presentations. Each agent should prepare a written “competitive market analysis” form showing recent sales prices of similar nearby homes as well as asking prices of neighborhood homes currently for sale (your competition). Then each agent will give you their estimate of your home’s probable sales price.
After you have this information you can best determine if you need to hire a professional appraiser. In most situations you won’t need to spend the money.
However, if your home is unusual or there are other local factors which influence your home’s market value, then a professional appraisal may be worthwhile.
Incidentally, before you list your home for sale with a realty agent be sure to check their references of previous sellers very carefully. Ask each agent for the names of at least three previous sellers. Then phone those sellers to inquire: “Were you satisfied with the agent and would you list your home for sale again with the same agent?” You will soon know which agent should get your listing.
How to Keep Property Ownership a Secret
Q: What is the best way to invest in real estate, but keep my name off the public records as a property owner? I live in a small town where I am well known. People think I am very wealthy because I own a few properties. The truth is, they are great investments, but I am not rich, yet.
A: Yes. Some local banks will allow you to hold title in their name as trustee. For example, my bank charges an annual $35 fee per property for holding title.
Another, and perhaps better alternative, is to have a living trust whereby you hold title as trustee. This choice is especially advantageous because it also avoids probate costs when you die.
An additional way to avoid holding property title in your name is to form a corporation to hold the title. But, this involves paper work and won’t give you complete privacy in case someone researches the corporate records. Another problem with corporate property ownership is the tax advantages are often not as good as individual ownership. Please consult your attorney for full details.
Cross-Country Swap Without Paying Tax
Q: My job has recently been transferred to Atlanta. My employer will handle the sale and purchase of a home for my family. But, I also own a 10-unit apartment building in which I have about $95,000 equity. I have heard there is some way I can sell it and avoid paying profit tax if I buy another building in Atlanta. Please clarify.
A: You are referring to an IRC 1031(a)(3) Starker delayed exchange. In such a tax-deferred property swap, you can sell your apartment building, have the sales proceeds held by a third-party intermediary such as a bank or attorney, designate a replacement property of equal or greater cost within 45 days, and complete the acquisition within 180 days.
Please consult your tax adviser or attorney for details. Further information is in my special report “Current Tax-Deferred Exchange Developments and Starker Delayed Exchanges” available for $3.50 from NewspaperBooks, Box 4386, Orlando, Fla. 32802.
Court Can Force Co-Owner to Sell
Q: Almost 10 years ago, my brother and I bought land together. Now we have received an offer from a developer who wants to build a small shopping center. But my brother thinks we can get a higher price if we wait. However, we have been waiting 10 years and this is the best and only offer we have received for this land which has no utilities. How can I make my brother sell?
A: If you want to get tough, you can bring a partition lawsuit to force the sale of the land. The court can order the land sold and the proceeds divided between the co-owners. Please consult a real estate attorney for details.
Selling the Old Home Before Buying New One
Q: Almost every Sunday my husband and I go looking at homes for sale. We have seen several we can afford to buy, if we can sell our present home for the price we think it is worth. However, the realty agents are very reluctant to take offers that are contingent on the sale of our home. What is the best way to handle this problem?
A: One way to solve the problem is when making your purchase offer be certain it includes a contingency clause for the sale of your current home. Most sellers will insist on a release clause, so if a better offer comes along, you have 24 hours to either cancel the contingency for the sale of your old home or cancel the sale.
But, a better solution, if you are serious about selling your home, is to list it for sale with your area’s best realty agent. When an offer materializes, if you provide for a long closing time, such as 60 to 90 days, you have plenty of time to buy another house. Selling your old home before buying a new one is wise because then you won’t be under pressure to accept the first purchase offer that comes along.
Holdover Seller Wants to Remain as Renter
Q: I sold my home and the sale closed at the end of March. But, the agreement says I can continue to rent the house for up to 90 days. The seller is harassing me to move out, but I can’t find an apartment where I want to move. Can the seller kick me out?
A: Yes. The new owner of your home can evict you by bringing an unlawful detainer lawsuit. In most areas such an eviction takes from 20 to 60 days, depending on court backlogs.
What Is Buyer’s Remedy for Defects?
Q: Before we bought our home we asked the realtor many questions about the condition of the house. She said as far as she knew the house was in good condition. But, after we moved in, we discovered that the roof is leaking into the attic insulation, which is moldy; the foundation is sagging; the garage door won’t close right, and the back yard drains toward rather than away from the house. Do you think the realtor is liable to us?
A: The real estate agent is obligated to point out readily observable defects that the buyer might not notice. However, the agent does not have a duty to crawl into the attic to determine if the roof leaks.
But, the seller might be liable for failing to disclose such a defect if the seller knew about it. A home buyer has two possible legal remedies for a defective house: rescission of the sale or monetary damages. Please ask your real estate attorney to explain further.
Repairs Not Part of Deductibles in Sale
Q: We are getting ready to sell our home and are trying to figure our profit. We paid $45,750, but have added a bedroom, bathroom, landscaping, roof, water heater, painting and concrete driveway for total costs of about $22,500. A real estate agent estimates the house will sell for around $175,000. Is our profit the difference between the sales price and our cost plus improvements?
A: Yes. However, let’s first take a closer look at the improvements you listed. Painting is always a repair cost, so subtract the painting cost from the $22,500 total.
The roof and water heater also are arguably repairs, which cannot be added to your home’s adjusted cost basis. The definition of a capital improvement is an item that enhances or extends the useful life of the property. But a repair, such as paint, preserves the existing property.
From your $175,000 estimated gross sale price, be sure to subtract selling expenses, such as the sales commission, transfer fees and other costs of the sale. The difference between your net sale price and your adjusted cost basis is your profit.
But, don’t forget you can defer tax on this profit if you buy a replacement principal residence of equal or greater cost within 24 months before or after the sale.
No Tax-Free Exchange of Stock, Real Estate
Q: I have some Boeing stock in which I have a handsome profit that I would like to trade for real estate without paying tax. Can I do this?
A: Sorry, the exchange you propose will not qualify as a tax-deferred “like kind” exchange. To qualify for such a trade, you must trade one investment or business real property for another such property. Personal property, such as common stock, is considered “unlike kind” property and cannot qualify for a real estate exchange.
Land Outside Dallas Not Good Investment
Q: I understand there are some bargains available on land for sale just outside of Dallas. Do you think this is a good investment opportunity?
A: No. Please don’t buy any vacant land you cannot use within six months after purchase. Thousands of people have purchased raw land on speculation and would be grateful to sell for the price they paid.
Although the Texas real estate market shows signs of recovery, there are thousands of foreclosed parcels being held off the market in hopes that prices will recover. When real estate prices rise, expect to see a glut of withheld properties come on the market, thus holding the market down.
Your best real estate opportunities are within a half-hour drive from your home. There is no need to go far afield to find real estate bargains. Few people lose money in investment property close to home, but many people lose everything in property located far from their residence.
Couple Dies at Same Time, Who Inherits?
Q: My wife and I own four properties as joint tenants with right of survivorship. After reading about that United Airlines plane out of Honolulu where several passengers were killed when part of the plane blew away, we got to wondering what would happen if we both were killed at the same time in a plane crash. Who would inherit our joint-tenancy properties?
A: When joint-tenant owners are killed at the same time, their wills determine who shall receive their property. If the joint tenants do not leave wills, then the state’s law of intestate succession determines which relatives receive their joint-tenancy property.
Even joint tenants should have wills that state who is to receive their share of the property in the event of simultaneous death.
Gross Multiplier Not Indicative of Value
Q: I would like to invest in apartments and have been looking at buildings offered for sale by several realty agents. But, I am confused because the gross rent multipliers vary between seven and 10. What is the correct gross multiplier to use?
A: Zero. Forget you ever heard those dirty words gross rent multiplier. Smart buyers of income property never use them because they fail to consider the building’s expenses.
To illustrate, suppose I show you two identical apartment buildings with the same gross rental income located adjacent to each other. One has a gross rent multiplier of eight and the other has a gross rent multiplier of 10. Which is the better buy?
At first you might say the one with a price of eight times the gross rents. However, then I tell you the landlord pays all utilities in that building, whereas tenants in the building with a multiplier of 10 have individual meters and they pay all their utilities. Now you might conclude the building with a rent multiplier of 10 is the better buy.
My point is, buy income property on the basis of its net operating income, disregarding mortgage payments and depreciation. If you can buy a building close to 10 times its net income you will probably be buying a bargain.
Be Wary of Land Contract Purchase
Q: My wife and I only have about $5,000 for the down payment on a home, so we realize we can’t be too fussy. However, we saw a newspaper ad for a house which the owner will sell on a land contract. As I understand it, we make the monthly payments to the seller and she pays the mortgage to the bank. But, we won’t receive the deed until we complete all our payments. Can we deduct our property taxes and interest? Are there any pitfalls to this type of arrangement?
A: A land contract sale means the seller retains the deed and the buyer becomes the “equitable owner” who can deduct the mortgage interest and property taxes. In some states this type of sale is called a contract for deed, contract of sale, agreement for sale and about 29 other names.
From the seller’s viewpoint, everything looks great unless the buyer defaults. Then the seller may encounter problems removing the land contract buyer from the property, if the buyer resists.
From the buyer’s viewpoint, you need to be sure the seller can deliver marketable title when you complete your payments. It would be a shame for you to make your final payment, only to learn the seller has unpaid liens that have attached to the property and prevent you from obtaining good title. Get a title check before you enter into the land contract sale.
Are VA and FHA Loans a Good Deal?
Q: You rarely mention VA and FHA mortgages. My husband and I want to buy a home, but we need help. He is a qualified veteran who earns a good income. I have a part-time job as a grocery check-out clerk. What do you think of VA and FHA mortgages?
A: I rarely receive questions about FHA and VA mortgages, so I presume everyone knows all about them. No-down payment VA mortgages are excellent for qualified veterans. But, the drawback is that $144,000 is the maximum for most VA mortgages. In many communities this is far too low.
FHA mortgages require down payments of less than 5%, but the maximum FHA loan in high-cost areas is only $101,250. While this is sufficient for many towns, it is not enough for most major cities.
If a VA or FHA mortgage meets your home finance needs, I highly recommend these fixed-rate mortgages. But, these loans appeal to fewer borrowers as home prices rise.
The Customary Sales Commission for Land
Q: I recently inherited about 40 acres of rural land. As I have no use for it, I want to sell. I contacted a realtor in a nearby town who said he would list the land for sale, but he wants a 10% sales commission. Don’t you find this rather outrageous?
A: No. Ten percent has been the customary sales commission for vacant land for many years. It seems to be a quite reasonable rate considering the work and long time which is often required to sell vacant land. I wouldn’t be surprised if the realtor insists on a six-month listing because he knows land sales can take considerable time and sales effort.
Is This Column Biased Toward Using Realtors?
Q: I enjoy your excellent columns except when you tell readers to list their property for sale with a realtor. I’ll bet you are a Realtor. Right or wrong?
A: Wrong. But, I must plead guilty to once upon a time having been a realtor. However, I realized it would be a conflict of interest to be a Realtor and try to be objective about answering real estate questions. So, I dropped my membership in good standing. No, they didn’t kick me out. However, I am a licensed real estate broker and a lawyer, so I still have several handicaps to overcome.
How to Trade a Home for Income Property
Q: I want to trade my home, worth about $300,000, for a four-plex worth about $400,000. How can I accomplish this without paying tax on my profit of about $170,000?
A: That’s easy. Move out of your principal residence. Rent it to tenants, thereby converting it from your personal residence to investment property. Then make an IRC 1031 tax-deferred exchange for the four-plex. Ask your tax adviser to explain further. P.S. Next time, please ask a tough question.
1st-Time Buyers Must Shop for a Mortgage
Q: My wife and I are not sure if we can afford to buy a home. We saw a newspaper ad from a local S&L; inviting prospective home buyers to attend a seminar for first-time home buyers. At the end of the program, which included speakers from the S&L;, a local realtor, an insurance agent and a professional property inspector, the attendees were invited to apply for a free mortgage loan evaluation and a reduction of loan fees for borrowers who qualified. About a week after we mailed in our loan application, a loan officer called to tell us we could not qualify for a mortgage on a home in the price range we indicated because the loan payments would take 32 percent of our income. My wife was very upset by this because she wants to buy a home badly. We have excellent credit, our only debt is our auto loan, we pay our credit cards in full every month and we have saved almost $25,000 for a down payment. Is there any way you see we can buy a home?
A: Yes. Thankfully, all mortgage lenders are not the same. It is too bad that S&L; went to the expense of holding their first-time home buyers program and then rejected well-qualified borrowers like you.
Many mortgage lenders would love to loan you money to buy a home. However, the S&L; where you applied apparently sells most of its loans in the secondary mortgage market to tough loan buyers such as Fannie Mae and Freddie Mac. Unfortunately, if you don’t meet Fannie’s or Freddie’s strict loan standards you don’t get the mortgage because the originating lender needs to sell its loans to raise cash to make more loans.
For example, Fannie Mae and Freddie Mac currently want home loans where the payments take up to only 28% of the borrower’s gross income.
But many other mortgage lenders are more flexible. Some lenders will approve your loan even if your payments take up to 35%, 40% and even 50% of your income if you have good credit and good income. These are “portfolio lenders.” They keep their mortgages instead of selling them so they can be more flexible than lenders who must sell their loans.
Shop around. Talk with other S&Ls;, banks and mortgage brokers. Explain your situation. You will find many lenders eager to approve your home loan.
Some Lenders Appear Anxious for Business
Q: I don’t know if this is true every place, but as a realty agent I have found, in the last few months, that mortgage lenders are extremely anxious for business. Several of the major lenders in our town are so eager for business their loan agents have suggested offering less than their posted rates and terms. Some of my buyers have taken advantage of these offerings and, to my surprise, got the loans they requested. I just thought I would pass along this information in case it might help your readers.
A: Thank you for sharing that valuable information. While I haven’t noticed lenders in my area willing to negotiate, I have had a rash of phone calls in the last few weeks from lenders begging me to refinance mortgages with them. However, the terms they offer are nothing special and they still want unnecessary documentation. Perhaps I’ll try your strategy of trying to negotiate better terms than the lender originally offers.
Must a Landlord Pay for Tenant’s Carpeting?
Q: I own several rental houses. They have proven to be great investments and, until now, I haven’t had any tenant hassles. But about a year ago, one of my tenants installed new wall-to-wall carpet at her expense. She didn’t say anything to me about it. Now she is moving out at the end of her lease. She expects me to pay her the $1,400 cost of the carpet. Does the law require me to do so?
A: No. The general rule is that a residence tenant’s improvements become the landlord’s property when the tenant vacates. Unless you agreed to pay for the new carpet, you have no legal obligation to reimburse your tenant for improvements she made without your permission. If she removes the carpet and leaves the floor in worse condition than when she moved in, then she is liable to you for any damage.
Home Is an Investment, Not Just a Residence
Q: Recently, I heard you on a radio talk show where you said a home should be looked at both as a personal residence and as an investment. Please elaborate more on how to look at a home as an investment.
A: If you were buying a common stock, you wouldn’t buy stock in a company with poor prospects for future earnings. Similarly, you shouldn’t buy a home which is unlikely to appreciate in market value.
Or, if you are investing in a bond, you expect the yield to be competitive with other investments. When buying a home, you can enhance the yield by making as small a cash down payment as possible, so if the house goes up in value your yield per dollar invested is maximized.
To enhance the probability that your home will increase in value, you should buy in a good neighborhood. Pay special attention to school quality, as it is usually worthwhile to pay extra for a home in your area’s best school district. No matter how terrific the bargain, stay away from neighborhoods with poor quality schools because good families won’t move there, thus holding down the value of homes in that area.
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.
