How to Tell Whether to Refinance Your Home
Q: I have an adjustable-rate mortgage that is now at about 10.25%. Under the terms of the mortgage, the rate can rise as high as 12.75%. Given the recent drop in fixed-rate mortgages to the 10% range, does it make sense for me to refinance now? If not, when would it? Or am I stuck forever with this adjustable rate? I owe about $245,000 and have about 27 years left on the loan. --A.R.
A: Whether you--or any home owner--should consider refinancing a mortgage depends on a variety of factors, including the reasons for the refinance and how long you plan to own the house.
If your goal is to save money on your monthly mortgage payments, as yours apparently is, our lending experts say rates must drop a minimum of two points below what you are currently paying, and you must continue to own your home for at least another three years after the refinancing to begin reaping the benefits.
Typically, a refinancing will cost you about $1,700 in fees plus about another 2 points, the equivalent of 2% of the amount refinanced. In your case that would amount to about $6,600. (By the way, because your loan balance is above $187,450, it is considered a “jumbo” loan, and you can expect any new mortgage rate to be about 0.5% higher than your institution charges smaller borrowers.)
However, if your motive is to consolidate outstanding mortgages or pay off a looming balloon loan, refinancing can be appropriate. Often your present lender and title insurance company can offer you the best rates, but don’t stop there. A thorough search frequently can result in more favorable rates and charges.
If your motive for refinancing is to cash in on some of the equity you have accumulated in your house, our experts suggest that you consider a home-equity loan instead because fees are typically lower. It is also better suited to homeowners who plan to sell within the next few years.
Owning Share in Office Building May Be Risky
Q: My friend owns an entire office building with seven office spaces. He sold me an undivided one-seventh interest in it and designated one office space for my medical practice. I pay one-seventh of the insurance, property taxes, grounds maintenance and other operating costs of the building. Am I responsible for any loss of income or the cost of repairs he incurs on the remaining six-sevenths of the building? This is not a partnership or condominium. He just sold me a one-seventh undivided interest in the building. What is my situation?-- S.M.
A: According to Daniel McIntosh of the Century City law firm of Seyfarth Shaw Fairweather & Geraldson, although you may think that you purchased a single office and are responsible only for the cost of maintaining that office, if you have an undivided one-seventh interest in the building, you most likely have a co-tenancy ownership interest. In this case you are generally liable for your pro rata share of the entire building expenses, including the costs of repairs.
Even though you may not be directly liable for paying the mortgage, if the building secures the mortgage on it, your interest in the property could be lost if the mortgage is not paid. If you had to begin paying the mortgage to protect the property from foreclosure, you would be entitled to a lien on your friend’s interest in the building to the extent of the amount you paid. You could also be required to pay more than your pro rata share of the property taxes in order to protect the building from county authorities. In this event, you would also have the right to repayment from your friend.
McIntosh recommends that you obtain a title report on the building to determine the manner in which ownership of the building is shared by you and your friend. This report can also tell you whether there are any other co-tenants. Take the report to an attorney and find out what your rights and liabilities are and whether they are consistent with what your friend told you.
Deducting Interest on a 401(k) Loan
Q: I participate in a 401(k) plan at work and borrowed against my balance earlier this year. I plan to repay the loan within the next three years. Meanwhile, how do I handle the interest portion of the payments on my tax returns? I am repaying the loan--principal plus interest--with “after tax” money. But will I be taxed again on the interest portion of the payment when the funds are finally withdrawn from the account upon my retirement? --H.K.
A: There may be a simple way to handle the interest on the loan repayment, and it could settle the matter for the present--and years from now when you finally distribute your 401(k) account. Deduct the interest you are paying on the loan from your taxes throughout the loan’s three-year duration.
However, first you must determine if you are eligible for the deduction. You are not eligible if you are designated a “key employee” of your company in its 401(k) plan. If you’re not a key employee and if you are borrowing against 401(k) pretax contributions that you voluntarily made, you are not entitled to deduct the interest on any loan.
Finally, there is the issue of how you used the loan proceeds. If your use qualifies as deductible interest--home purchase, home improvement, investment and business are the four major categories--then you are free to take the deduction up to the legal limits.
If you can’t pass all of these tests, the interest you are paying on your loan will be made with after-tax dollars and your withdrawals from the account will be taxed again upon your retirement.
There are limits to how much you can borrow against your 401(k) account before the loan is considered a taxable distribution. In general, the IRS lets you borrow 50% of the account balance, to a maximum of $50,000. If your account is small, you can borrow up to 100% of it, to a maximum of $10,000. And unless the loan was taken out to purchase a home, it must be repaid within five years.
