Home Equity Sharing Agreements Can Have Both Pluses and Pitfalls

QUESTION: What do you think of home equity sharing? A local realty agent is putting together investors and residents. The investor makes the down payment and the resident pays the monthly mortgage, property tax and maintenance costs. In five years, the investor gets 33% of the appreciation in market value after return of the investor’s down payment. In addition, the investor can depreciate one-third of the house. But the big advantage is the investor doesn’t have to worry about maintenance or finding tenants. What do you think of this idea?

ANSWER: Please be very careful. Home equity sharing can either be very good or very bad for the investor and resident. This concept is authorized by Internal Revenue Code 280A and requires all equity sharing non-resident investors and resident owners to be titleholders.

But major problems can occur if the resident stops making the monthly payments, perhaps due to illness, unemployment or divorce. If you are the non-resident investor, how do you get your resident co-owner out of the house and off the title?

You can’t evict the resident co-owner like tenants are evicted. If you get a presigned quit claim deed it could be ruled invalid by a court if the resident built up substantial equity.

However, I don’t mean to be completely negative about equity sharing. It can work well, for example, between parents and their adult children where everyone knows and trusts each other. But equity sharing between strangers can easily lead to problems.

If You Have Bargain Apartment, Keep It

Q: You often encourage people to buy their own homes. But my husband and I have a bargain rental on a large apartment. It is owned by a wealthy widow who hasn’t increased our rent in the 12 years we have lived here. We manage the small apartment building for her so she never has any worry. In our low-rent situation, do you think we should move into a house?

A: Keep your bargain rental as long as possible. However, you should buy at least one house as a rental investment. Then you will have a place to move if your bargain rental comes to an end, such as can occur if the landlord sells your apartment and the new owner raises the rent.

Owner Holding Papers Profits in Foreclosure

Q: My wife and I are retired. We want to sell our home for several reasons. One is we want to carry back the mortgage for the buyer so we can earn higher interest income than we can earn at the S&L.; One sharp real estate saleswoman showed us if we take back a mortgage at 10% interest, we will earn about double the sale price of our home. However, we are concerned what happens if the buyer doesn’t make the payments and we have to foreclose. How much would that cost us?

A: I hate to say this, but foreclosure is the best thing that can happen to you. The costs of foreclosing are minimal. If there are no bidders at the foreclosure auction, then you get your home back and resell it for a second profit. But don’t get your hopes up. Very few mortgages go into foreclosure.

Is an Assumable or Fixed Mortgage Better?

Q: My wife and I have about $50,000 idle equity in our home. We want to refinance to reduce our mortgage interest rate. Our bank quoted us 9.25% on an adjustable-rate mortgage and 10% on fixed-rate loan. As the difference in monthly payments is not very great, we think the fixed-rate mortgage is the best. What do you advise?

A: You are correct. In today’s upside-down mortgage market, the fixed-rate mortgage is by far the “best deal.” Adjustable-rate mortgage loans are far too high. They should be at least 2% below fixed-rate loans to compensate for the lending risk that adjustable-rate loans shift to the borrower.

As you may have noticed, most of the shrewd adjustable-rate mortgage lenders have stopped offering highly discounted initial teaser or sucker interest rates. The result is borrowers realize how high and unfair the adjustable-rate mortgage interest rates are. I think you will sleep much better with a fixed-rate home loan.

Condo Dweller Warns of Complex Pitfalls

Q: Why don’t you warn condo buyers of the pitfalls to expect? My husband and I foolishly bought our condo about two years ago and have had nothing but trouble ever since. For the last year we have had our condo listed for sale with several excellent realty agents but they tell us our condo complex is especially difficult to sell because of poor construction, high monthly maintenance fee, bad soundproofing, an incompetent board of directors who run the place like a dictatorship and poor grounds maintenance. Unfortunately, we moved here for retirement and stupidly paid all cash. We have tried to get a mortgage loan, but no lender will loan because there are several lawsuits involving the board of directors. What should we do?

A: I wish I had an easy solution to your problem but there is none. Now you can understand why I do not recommend condo purchases. You might try trading your condo as a down payment on more desirable property such as a single-family house.

Another possibility is to lease it with an option to buy but chances of the tenant exercising the purchase option are slim because they are sure to learn of the condo’s drawbacks.

Your situation shows why condo buyers should be especially careful before purchasing. I often suggest prospective buyers ask current residents what they like best and least about the condo complex.

Also, since poor soundproofing is the No. 1 complaint of condo dwellers, prospective buyers should check the soundproofing before making a purchase offer.

In addition, condo buyers should make their purchase offer bid contingent on approval of the bylaws, CC&Rs; (conditions, covenants and restrictions) and financial condition of the homeowner’s association.

Why Sales Agents Keep Buyers, Sellers Apart

Q: We are working with a very professional realty agent who is trying to find us a house to buy. However, she seems obsessed with keeping us from meeting the home sellers.

We have made several purchase bids but none were accepted. I think the problem could be solved if we met the sellers and worked out mutually acceptable terms. When I asked the agent, she said it is customary for the buyer and seller not to meet. What do you think?

A: Your agent is correct that buyers and sellers usually do not meet each other, at least until after the purchase negotiations are completed. I have purchased many properties where I never met the seller. As long as the agent is doing a good job, let the agent handle the negotiations.

However, if you want to be present when your purchase offer is delivered to the seller, you can insist words such as “This offer to be presented to seller only in the buyer’s presence” be included in the offer bid.

How Much Should Home Payments Be?

Q: Some time ago you wrote home buyers should purchase a home priced not more than three to four times the annual gross family income, assuming a 20% down payment. However, my wife and I don’t have much of a down payment, so we will have to get one of those PMI (private mortgage insurance) 90% mortgages. How much of our monthly income should we pay for mortgage payments?

A: Most mortgage lenders want monthly mortgage payments to be 28% or less of the family gross income. However, a few lenders will approve mortgages that take 33%, 36%, 40% or even 50% of monthly family income. But PMI lenders have become especially tough about qualifications because low down payments and high monthly payments often lead to foreclosure. For exact details, talk with several local lenders to learn the maximum PMI mortgage you can obtain.

VA Mortgages Require Loan Origination Fee

Q: You said VA mortgages require no down payment. But when we applied for a VA mortgage last week, the lender said we must pay a 1% loan origination fee. Is this legal?

A: Yes. Most VA mortgage lenders charge a 1% loan origination fee, as allowed by law. Shame on me for not telling you about that expense.

Big Down Payment Isn’t Wise Investment

Q: We will have to buy a new home when my husband’s job is transferred to Dallas in a few months. After we sell our current home, we will be able to pay at least a 50% down payment for a home there. However, our friends, attorney and CPA tell us such a big down payment is stupid. What do you advise?

A: Listen to your smart friends, attorney and CPA. I surmise you want to make a big cash down payment so you can keep your mortgage payments small. While that is admirable, Uncle Sam has other ideas for you.

The 1987 tax law changes allow you to deduct only interest on a home-acquisition mortgage plus up to a $100,000 home-equity loan. If you make a big down payment for a house, and later realize your mistake, it is too late to change your mind. I suggest you make the smallest possible down payment and obtain the largest obtainable mortgage.

If you are not yet persuaded, additional reasons include (1) maximum leverage advantage by controlling the property with a small amount of cash, (2) resale is made easier with a large assumable mortgage, (3) thanks to inflation, you will be paying off your mortgage with cheaper inflated dollars worth less than today, and (4) you will have extra cash for other investments, such as sound realty.

Don’t Be Shy About Making Purchase Offer

Q: Since last April my wife and I have been seriously looking at homes for sale. I won’t bother you with all the horror stories of the incompetent realty agents we have met at Sunday open houses. Although we haven’t kept records, I estimate we have inspected at least 75 houses. We only made one purchase offer, which was rejected by the seller. These homes are so badly overpriced. How can we buy one at a fair price?

A: Don’t be afraid to make a purchase offer at a price you think is fair for the home. The best that can happen is a motivated seller will accept your offer. The worst that can happen is the seller might reject your offer and make a counteroffer.