Listing the pros and cons of an 'interest only' home mortgage

By Bob Bruss

Dear Bob: Please tell me the advantages and disadvantages of an "interest-only" home loan -- Robert W.

Dear Robert: Many mortgage lenders realize the benefits for the lender of an interest-only mortgage. The primary benefit is the lender keeps 100 percent of their funds working and earning interest for the lender.

For the borrower, the monthly interest only payments are fully tax deductible as itemized interest. Because there is no principal reduction, the monthly payment is the lowest amount possible.

During the first years of an interest only mortgage, there is no principal balance reduction. If you plan to stay in your home "forever" and want to eventually own it free and clear without any mortgage, this can be a disadvantage.

However, many interest only mortgages convert, often after 10 years, into amortized mortgages with the principal balance reduction beginning then. The result is a substantial increase in the monthly mortgage payment.

For most homeowners, their equity grows faster from the home's appreciation in market value than from the mortgage amortization principal reduction. For this reason, if you plan to sell the home within 10 years, an interest only mortgage might be ideal.

Dear Bob: To help a relative raise cash, I recently bought two mortgages from him at a substantial discount from their mortgage balances. The borrowers now make payments to me every month. My wife and I figured out our yield on dollars invested is about 16 percent. As a result, we would like to buy more mortgages at a discount. Where can we learn about discounted mortgages? -- Robin J.

Dear Robin: The best book about investing in discounted mortgages is "Invest in Debt" by Jimmy Napier. It is a very simple book that explains basics, such as how to calculate yields, and what makes a good discounted mortgage investment. This great book is available for $15 from Jimmy Napier, P.O. Box 858, Chipley, Fla. 32428.

Dear Bob: You often say, "For more details, consult a local real estate attorney." My question is how can I find a good local real estate attorney? -- Jennifer J.

Dear Jennifer: One method is to phone the local board or association of Realtors to ask for the name of their attorney. He or she is usually an excellent real estate attorney.

Another good method is to phone the county bar association to ask for the name of their Real Estate Section chairperson. He or she can either take your case or refer you to a quality local real estate attorney who specializes in your legal issue.

Dear Bob: My dad died this year. Mom wants to sell their large house and buy a smaller one. Does she still have the right to use dad's $250,000 home sale tax exemption? If so, how long does she have to use it? -- Brady F.

Dear Brady: After your mother has straightened out the home's title to remove your late father's name so she holds title in her name alone, she can sell the house. If she sells it in the year of his death, she can claim up to $500,000 tax-free principal residence profits.

That's presuming they both occupied it at least two of the five years before its sale.

However, if your mother waits until next year to sell the house, then she will only have a $250,000 single principal residence sale tax exemption. But that's all right.

The reason is after your mother receives your late father's share of the house, she will receive a new stepped-up cost basis as of the date of death for the inherited half of the house. If the house is in a community property state, and if your father left his half of the house to your mother, the house's entire market value is stepped-up to market value as of the date of your father's death.

Either way, there will probably be little or no taxable capital gain for your mother. She should consult her tax adviser to discuss the situation to learn if there is any compelling reason to sell before the end of 2003.

Dear Bob: You recently recommended home buyers should be represented by their own buyer's agent, rather than sharing the seller's listing agent. But how can I locate a buyer's agent. I looked in the phone book yellow pages and didn't find any buyer's real estate agents -- Jennie S.

Dear Jennie: Any licensed real estate agent or broker can represent you exclusively as a "buyer's agent," sometimes called a "buyer's broker."

There are a few real estate brokerages which only represent home buyers. They don't accept listings and don't represent home sellers. However, these brokerage offices are very rare.

That's why you will probably select a buyer's agent who sometimes represents home sellers when listing a home for sale. However, if your buyer's agent shows you a home listed for sale by that agent, or by another agent working for the same brokerage, then that agent will probably act as a "dual agent" for both buyer and seller. In some states, the law allows a buyer's agent in that situation to act as a "transaction agent."

Be sure to discuss with your agent who the agent really represents.

Dear Bob: Since Congress enacted Internal Revenue Code 121, to give home sellers that $250,000 or $500,000 tax exemption, I haven't heard much about adjusted cost basis. Can the costs of home improvements still be added to a home's cost basis to reduce the profit when the home is sold? Do landscaping costs count? -- Mary E.

Dear Mary: Yes. When Internal Revenue Code 121 was passed by Congress in 1997, nothing changed about calculating adjusted cost basis for your principal residence. You should add to your purchase price cost basis the expenses for capital improvements added during ownership, such as renovations, additions, and landscaping. Also add to your purchase price cost basis the closing costs, which were not tax deductible at the time of purchase. For more details, please consult your tax adviser.

Dear Bob: After we got royally ripped-off by our mortgage lender when we refinanced our home loan last summer, I read one of your articles where you warned about junk fees. I wish I had seen that article sooner. My husband and I spent about $5,400 on various lender fees. I'm sure many of those were unnecessary, if we knew what we were doing. Do you have a list of junk fees home loan borrowers should avoid? -- Mavis T.

Dear Mavis: No, I don't have an all-inclusive list of mortgage lender junk or garbage fees. The reason is the lenders keep changing the names and dreaming up new junk or garbage fees.

To recognize a 100 percent pure-profit lender junk or garbage fee, ask if it is to pay for a legitimate cost to a third party. Examples of valid loan costs include an appraisal fee, credit report fee, and lender's title insurance.

However, if the fee goes into the lender's pocket, it is probably an unnecessary junk fee, which can be negotiated away or at least reduced by the lender. Examples include processing fee, documentation fee, administration fee, warehousing fee, underwriting fee, and escrow waiver fee. These are not for legitimate services and actual costs and should be included as part of the lender's service. Instead, these junk fees line the lender's pocket with excess profits.

The best way to prevent a mortgage lender from charging unnecessary junk fees is to hold the lender to their "good faith estimate" of loan charges, which must be supplied to the borrower within three days of submitting a loan application.

If the final loan papers have junk fees that were not on the good faith estimate, that's the time to discuss them with the lender. When a lender refuses to waive them, then pay them under protest and sue the lender for a refund in local Small Claims Court.

Dear Bob: Suppose a house is held in a living trust. Then suppose the owner dies and the trust is in the hands of the successor trustor. When does the house receive its new stepped-up basis value? Is it at the time of the living trust owner's death or at the time it is deeded from the living trust to the heir? Are all distributions from a living trust treated as inheritances for tax valuation purposes? -- Robert S.

Dear Robert: After the living trust trustor dies, the successor trustee is supposed to promptly pay the deceased's debts and then transfer the remaining living trust assets to the beneficiaries.

Unless there are complications that cause delays, this process usually takes only a few months because probate court costs and delays are avoided. When the heir or beneficiary receives title to any real estate contained in the living trust, that beneficiary accepts the title with a new stepped-up basis of market value on the date of the decedent's death.

Distributions from a living trust are treated just like an inheritance. Of course, if the deceased's net taxable estate exceeds $1 million for a person dying in 2003 (the exemption increases to $1.5 million in 2004), the successor living trust trustee is responsible for paying any federal estate tax before distributing the living trust assets. For more details, please consult your tax adviser.

Dear Bob: When unimproved land (acreage) is sold, who is responsible for determining the boundaries? Is the legal description sufficient? -- Leigh C.

Dear Leigh: It is customary for the buyer to have a survey made when acreage is purchased. The purchase offer usually contains a contingency clause for a satisfactory survey. Sometimes, the buyer will accept the seller's survey. But it is safest for the buyer to hire their own surveyor when purchasing rural land.