Confusion About Mortgage Insurance

QUESTION: The recent earthquake in San Francisco forced thousands of families throughout the Bay Area to flee their homes and find other living arrangements. I understand that those homeowners with earthquake insurance stand to recover a substantial portion of their losses. But even these fortunate people are faced with extra living expenses, as well as their regular monthly mortgage. Is this a case where having mortgage insurance would be a great benefit? --J. R. B.

ANSWER: No, not really. Mortgage insurance is designed to offer other types of protection. But this is not to say there isn’t some coverage available for homeowners forced to find temporary housing as a result of an earthquake or other disaster.

Let’s start with what mortgage insurance is--and isn’t. Traditionally, mortgage insurance has been tied to life insurance policies. In the event of the death of a family’s breadwinner, the policy pays off the remaining mortgage on the house.

More recently, what is known as “private mortgage insurance” has been introduced. These policies are designed to protect the banks and thrifts that lend home buyers the money to purchase their houses. Typically, lenders require home buyers who are considered an special credit risk, or who make a down payment of less than 20% of the home’s purchase price, to buy an insurance policy that pays off the lender in the event the borrower defaults on the loan.

Neither type of mortgage insurance would be of benefit in the event of a catastrophe, except in the unlikely event that the homeowner dies, in which case the life insurance coverage takes over, or he defaults on the loan and walks away from his investment, allowing the lender to seek restitution from the underwriter under the private mortgage insurance.

Still, although no insurance policy will pay off the mortgage on a house damaged during a catastrophe, most catastrophic insurance, including earthquake policies, cover personal living expenses incurred as a result of a disaster.

According to the Western Insurance Information Service, a trade association in Tustin, the average homeowner’s policy that offers you fire insurance would cover your expenses if you were forced out of your home due to a fire.

If you have earthquake insurance, you would have similar coverage in the event of an earthquake. And, unlike the basic earthquake insurance that carries a 10% deductible, living expenses are entirely covered and usually for as long as they are incurred.

So, although you must continue to pay the mortgage on a house you can’t live in, at least you do not face a double set of housing expenses.

Home Equity Provides Retirement Income

Q: In two years I will be eligible to collect Social Security payments of about $500 per month. I own a house that has a market value of about $230,000 on which I still owe $23,000. Can you suggest some way I can use the equity in my house to generate additional retirement income? Moving out of the state and leaving my grandchild is out of the question.--R. R.

A: You don’t have to move out of the state. But our financial advisers do strongly recommend that you sell your house. When you sell, you should be able to take advantage of the one-time exclusion of $125,000 in profits available to homeowners over 55. If your profit exceeds that exclusion, you should buy a new home with a purchase price that at least exceeds your remaining profit; this way you will owe no taxes on the transaction.

Our advisers recommend that you look for a small house or condo that you can buy outright, leaving you no mortgage payments. The remainder of your proceeds from the sale of your house, perhaps as much as $100,000, could be invested in a safe, reliable certificate of deposit or money market fund. At 9% interest, your investment would generate $750 a month, giving you a total monthly income--including your Social Security benefits--of $1,250.

At current tax rates, you would owe about $800 a year in federal taxes and $100 in state taxes on your $15,000 annual income, our advisers calculate. Remember, you have no mortgage payment; your only housing expenses are property taxes, insurance and routine residential maintenance. Your income should be able to handle the remainder of your daily living expenses and, quite likely, a few occasional luxuries.

Self-Employed to Get New Tax Break in ’90

Q: Last week you wrote that half of the Social Security taxes paid by self-employed people can be deducted as a business expense. Since when? Please tell me more.--S. S.

A: Beginning in the 1990 tax year, self-employed taxpayers may deduct one-half of their Social Security contributions as a business expense on their tax filings. The new provisions are designed to more equitably treat the self-employed worker, who is actually half employee and half employer.

All employed taxpayers now pay half of the total contributions made to Social Security on their behalf; their employers pay the other half. However, employers have long been able to deduct these contributions as a business expense. Beginning next year, self-employed individuals will be able to claim the “employer” share as a business expense and report it on Schedule C of their tax forms. Their “employee” contributions, just as those from corporate employees, are not tax deductible.

For more information, see Section 1449.725 of the Internal Revenue Code.

Computing the Gains of Stock Reinvestment

Q: I owned stock in a utility company and participated in its utility reinvestment program until selling the stock a few months ago. Since my gain comes from the shares I had owned for several years as well as from those I had held just a short period of time, must I report the sale on both the short-term and long-term sections of the tax form? Or may I just complete the long-term section? I would like to save myself from unnecessary work.--N. J. L.

A: Our tax advisers say you should report the sale as a long-term investment. Since the abolition of capital gains tax rates, there is no longer a distinction between long-term and short-term gains. The tax rate applied to the gain is the same, regardless of how long you held the stock.