There Are Some Tricks to Finding and Buying Seller-Financed Homes

QUESTION: Recently I heard you speak at a seminar. You said one of the best ways to buy a home is to get the seller to carry back the first or second mortgage. But all the homes I’ve been shown by realty agents require getting a new bank mortgage. How can a buyer find a home that the seller will finance?

ANSWER: Just ask. Over the years I have purchased many homes for investment that the sellers financed for me. I’ve found sellers are, by far, the cheapest and best mortgage finance source. But I can recall only two of those houses being advertised with “seller financing.”

On all the others I had to ask. First, I asked the realty agent why the seller is selling. A few nasty agents replied, “That’s none of your business.” But I disagree. It is the buyer’s business to know why the seller is selling so he/she can make a purchase offer to meet both their needs.

When the agent indicates the home seller is retiring, I get excited because that often means the seller would welcome steady monthly mortgage payments at an interest rate higher than is attainable on a CD or money market account.

Second, when I inspect a vacant house I also get excited. The seller is usually anxious to sell the house and will often listen to a reasonable purchase offer involving seller financing.

Third, even if the realty agent tells me the seller needs an all-cash sale, I still make purchase offers involving seller financing. I am constantly amazed at how many times the seller accepts a written offer with seller financing. Until you make a written offer bid and the seller sees it with the amount of monthly payments to be received, you will never know for sure if the seller will help finance your home purchase on favorable terms.

‘Wrong’ Spouse Owns Home for Tax Break

Q: My wife and I plan to sell our home. I am 59 and she is 53. We estimate our profit will be about $110,000. But the problem is, we put the house into her name alone about 10 years ago when I had bad heart problems and was expected to die. However, about nine years ago I had a heart bypass operation and have fully recovered. If we put my name back on the deed can we then qualify for that “over 55 rule” $125,000 home sale tax break you often discuss?

A: Not immediately. To qualify for the “over 55” $125,000 tax exemption you must be 55 or older on the day your principal residence is sold, have owned and lived in it at least three of the five years before sale and never have used this tax break before. Only one $125,000 tax exemption is allowed per married couple.

Your problem is that the wrong spouse owns the house. Since your wife is only 53, she must wait two more years before becoming eligible for this tax exemption. Adding your name to the deed won’t help either because to qualify, you must have owned and occupied the home at least three years before the sale.

Why It Pays to Hire Professional Help

Q: My husband and I are considering making substantial improvements to our home, including kitchen and bathroom remodeling as well as adding a family room and extra bedroom. We can do this work gradually as we can afford it with my husband and his buddies doing the labor. Or we can get a bank improvement loan and hire a contractor to complete the job in a few months. If my husband and his friends do the work, how much value can we add to our home since we expect to sell it within a few years?

A: If your husband and his friends do the home improvement work, you can only add the cost of purchased materials to the basis for your home. However, if you hire a contractor or other workers, you can add the entire cost you pay to your home’s basis.

In other words, the IRS places no value on the labor of your husband and his friends when they improve your home. But the entire cost of hiring professional workers to improve your home can be added to its basis.

Don’t Be So Critical, Appraiser Cautions

Q: You shouldn’t be so critical of appraisers. We have a tough job to objectively evaluate a property market value. Do you realize the pressure on appraisers? If we don’t come up with a high enough value, the property owner isn’t happy. But if we determine too high a valuation then the lender criticizes us. You often say professional property managers have a thankless job, but isn’t it time you recognize the tough job appraisers have?

A: Yes. Shame on me for not being more understanding of the difficult job real estate appraisers have. However, I am shocked at the incompetence of some of the appraisers I have encountered. Like everything else, we rarely compliment people when they do a great job. But when they do an unsatisfactory job we remember that.

A Good-Faith Test Applies to Contingency

Q: I am a real estate broker. Many of my buyers want to put an inspection contingency clause in their purchase offers and I make no objection. However, recently two buyers rejected the houses after making detailed inspections with professional home inspectors. Nothing was seriously wrong with either house. I think the buyers just got cold feet. When there is a home inspection clause in a purchase offer, can the buyer arbitrarily disapprove the inspection?

A: A good-faith reasonableness test applies to home inspection contingency clauses. However, if a buyer arbitrarily disapproves an inspection report over a minor detail, it is very difficult for the seller to either hold the buyer to the contract or liable for damages. It is usually best to let the buyer out of the sale and sell the house to a serious buyer.

Tax Break Applies to 3-Year Ownership

Q: Thank you for your wonderful column. But a real estate agent representing me in a possible home sale has the impression the “over 55 rule,” $125,000 home-sale tax exemption requires ownership for five years rather than the three years you state. It would be very helpful if you can clarify this important tax rule.

A: The one-time, $125,000 home-sale tax exclusion is found in Internal Revenue Code 121. But your realty agent is mistaken; five years of ownership is not required to be eligible.

At the risk of boring you, please let me quote: “At the election of the taxpayer, gross income does not include gain from the sale or exchange of property if (1) the taxpayer has attained the age of 55 before the date of such sale or exchange, and (2) during the five-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as his principal residence for periods aggregating three years or more.”

In simple everyday English, this means you can qualify if you own and live in your principal residence any three of the five years before the sale.

Another advantage of this “over 55 rule” is you can move out as early as two years before the sale and still claim the $125,000 profit tax exemption.

Vacant Lots Are Not a Good Investment

Q: My husband and I own a house close to our work. But we don’t like the neighborhood. Someday we would like to sell our home and build one that better meets our needs. My husband has found a large lot that he thinks we should buy now for future use. It is in a fair neighborhood, which doesn’t excite me. We can handle the down payment but the monthly payments of about $400 seem steep to me. What do you advise?

A: Don’t buy vacant land you can’t use within six months after purchase. Your plans will probably change before you get ready to build a home. In the meantime, if you buy, you will be straining your budget for a lot you really don’t like.

Worse yet, you should read the sorry letters I receive from buyers of lots (mostly in Florida, New Mexico, Arizona, California and Texas) who planned to retire and build a dream home someday, but now their plans have changed and they discovered their lot is unsaleable at any price. I don’t want you to get caught in the same mess. A better alternative is to save your $400 each month in a high yield money market account and buy a lot when you are ready to build.

Things to Find Out When Buying a Condo

Q: I want to buy a house but I don’t think I can afford one so I am looking at condos. As I am single, age 29, and travel frequently on business, perhaps a condo would be ideal for me. However, several of my friends have made condo purchases that have turned out badly. One lost her $10,000 down payment when she was one of the very early buyers in a 200-unit condo complex where only about 40 units were sold before the bank foreclosed on the builder.

Because condos seem to be overbuilt in my town, I am looking only at well-established complexes with recreational facilities such as pool, tennis courts and exercise facilities. Please tell me if I am crazy to buy a condo and what questions I should ask.

A: Condos can be great personal residences. Personally, I’ve done well with condos and my elderly mother lives in one in Minneapolis, which is ideal for her and where she has a handsome profit in it if she should wish to sell.

Don’t necessarily avoid a brand-new condo. They are often the best bargains if you buy in a highly desirable complex with all the features you list. However, be careful about being an early buyer. If the builder doesn’t sell all or most of the condos, you could be in a minority, with the builder owning a majority of the units.

If you buy in an established condo complex, of course be sure to check the recent sales prices to be certain you don’t overpay.

Also, insist on receiving a copy of the condo bylaws, CC&Rs; (conditions, covenants and restrictions) and rules. Ask about any unusual rules, especially about pets and restrictions on rentals. For example, my mother’s condo complex prohibits pets and rentals over 12 months. This helps increase the market value but discourages some prospective buyers.

In addition, check with the condo owner’s association about their financial situation, current monthly maintenance assessments and any plans for increases, as well as the adequacy of reserves for major maintenance such as roof replacement. If necessary, consult a real estate attorney for further details.

Renting Old Home Offers Big Advantages

Q: My husband and I have contracted to buy a new house that is now under construction. Our down payment will be $65,000, which we can raise from savings and cashing in a small CD. However, we are undecided about selling our old home or keeping it as a rental. It is about six miles from our new home, so renting it would be no problem. This house has been our best investment, so we are reluctant to sell it as the neighborhood is excellent and homes appreciate about 7% annually. Should we sell or rent?

A: You can never own too much real estate. Because your old home is appreciating nicely in market value and is nearby--so you can easily manage it--I strongly recommend you keep it as a rental investment.

That 7% you are earning is probably far higher when you consider how much you have invested in the old house. For example, suppose you bought your home for $100,000 with a $10,000 cash down payment. A 7% annual appreciation of $7,000 in market value is actually a 70% annual return on your $10,000 investment.

In addition, you will have tax deductions for mortgage interest, property taxes, operating expenses and depreciation.

However, if you sell your home and buy a more expensive replacement principal residence within 24 months before or after the sale, Internal Revenue Code 1034 allows you to defer all your profit tax.

Only if you have a more profitable place to invest your home sale cash, which will give you a higher yield than you can receive by renting your old home, should you consider selling.

Adjustable-Rate Loan OK If Selling Soon

Q: We plan to buy a new home due to a corporate job transfer. However, my husband’s employer has told him to expect a major promotion in about three years. The realty agent advises us to take an adjustable-rate mortgage but we think they are too expensive as compared to fixed-rate loans. What do you advise?

A: I agree, adjustable-rate mortgages are far too expensive as compared to fixed-rate mortgages. As I write this, fixed rate mortgages are around 11%, whereas adjustable rate loans, after the initial “teaser rate,” are about 10.50%. That slightly lower adjustable rate doesn’t compensate for the high risk the adjustable-rate borrower incurs that rates may rise in the future.

If you were buying your home for the long term, I would recommend a fixed-rate mortgage. However, a big advantage of the adjustable-rate loans is that most are assumable by a future buyer.

I suggest you take an adjustable mortgage tied to the cost of funds index, which moves very slowly, but only if the ARM is fully assumable on the original terms by a future buyer of your home.

No Maximum Age for Obtaining Mortgages

Q: My husband and I are retired. We have about $40,000 annual income. In addition, we have around $300,000 in various savings accounts and CDs. We also own common stocks and bonds worth about $250,000. We have decided to buy a small retirement home. After considering the income tax angles we have decided we should make a small down payment and get the biggest mortgage for which we can qualify. As we are buying in Florida, the realty agents tell us lenders are liberal with us old folks. However, my husband is 79 and I am 72. Do you think we will be disqualified because we are too old?

A: No. Mortgage lenders cannot discriminate because of the borrower’s age. You are correct that Florida lenders are more accustomed to lending to senior citizens, but in any state lenders cannot reject a loan due to the age of the borrower. I congratulate you for making a minimum down payment and taking a maximum mortgage on your new home.

Can’t Cancel Insurance on FHA Home Loan

Q: Several weeks ago, you wrote about how to cancel PMI (private mortgage insurance) on a home loan. But I contacted my lender and was told FHA mortgage insurance cannot be canceled. Why can’t I cancel my FHA insurance to save money?

A: The article to which you refer outlined when PMI insurance can be canceled on conventional mortgages, generally after the loan-to-value ratio drops below 80%. However, FHA mortgage insurance is not the same.

Although FHA authorities have written me several times to point out that FHA mortgage insurance can be canceled by the lender, I have yet to hear of any lender who allows cancellation. However, the good news is that when you pay off your FHA mortgage in full, then you will receive a partial refund of your FHA mortgage insurance premium.

When Is Option Money Taxable?

Q: I want to sell my home for top dollar, but am in no hurry to sell. Many times you mentioned lease-options, so I felt this would be a perfect way to sell. I have a tenant who pays me $1,000 per month rent and who paid me $3,500 non-refundable consideration for the option. Do I have to pay tax on the $3,500 this year if the tenant hasn’t exercised the option yet?

A: The traditional answer has been “no.” The reason was the owner didn’t know if the option money would be taxed as ordinary income or at the lower long-term capital gain tax rates. But the 1986 Tax Reform Act removed the tax difference between long- and short-term capital gain.

Some so-called tax experts feel option money should now be reported to the IRS in the year it is received. But there is little or no authority for this view. I suggest you be guided by your tax adviser’s advice.

Prepayment Penality Is Seller’s Problem

Q: We have a house under contract to purchase. The listing said: “Buyer to assume existing mortgage.” But our purchase offer did not specify anything about our assuming the old mortgage, which we felt was not desirable. We are paying cash, with the help of a new mortgage from another lender. However, the seller says we must pay his prepayment penalty of about $2,000. But our purchase contract says nothing about any prepayment penalty. Must we pay?

A: No. Any prepayment penalty due on an existing mortgage is the obligation of the seller, not the buyer. Please consult a real estate attorney for further details.

If Home Seller Dies, Is Purchase Still Valid

Q: We are in the process of buying a house from an frail elderly seller. She has moved to a retirement home. The reason she’s selling her house is she needs the money to pay for her care. Although we have never met this lady, the realty agent says she is in very poor health and looks like she could die any minute. But we need at least 30 days to get our mortgage. If we seller dies, do we lose the house?

A: No. I presume you have a well-written purchase contract that makes the agreement binding on the heirs of the seller and buyer. If either of you dies, the other party can then enforce the contract against the deceased’s estate.

If the seller dies before delivering title to you, then you will receive the deed from her estate. Although the seller’s death may delay the closing of your purchase, you still can enforce your right to buy the house against the seller’s estate.

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.