Paul Ferraresi

Oftentimes, when a person does not prepare adequately for retirement funding, they consider using a reverse mortgage just to exist.

Assume a retiree’s home is paid off. They can go to a bank and obtain a reverse mortgage loan against the property. Depending on the person’s age, their health, and the property value, the lender will provide funding to the retiree. The amount may be, say, 50% of the appraised value of the property. There are no payments due to the bank. The principal and interest accrue. Once the person dies, the bank will take the property and sell it. The outstanding mortgage may be 80-90% of the home’s value at the person’s death, so, the bank can still make some money once it sells the home. On the other hand, the surviving spouse or heirs could pay off the loan and take ownership.

A recent article in the September 2011 issue of Investment Advisor magazine showed AARP suing Fannie Mae and Wells Fargo over reverse mortgages.

HUD had established original rules that “…a borrower or heir would never pay more than the home was worth at the time of repayment.” In 2008 HUD changed the rules…. The heir must pay the full mortgage amount even if it exceeded the value of the home. AARP sued and HUD returned to the original rules.

A new suit has come up, by AARP, toward Fannie Mae and Wells Fargo. These institutions are failing to give notice to surviving spouses and heirs of their rights to buy the property for the lower value. These institutions are foreclosing and seeking to evict an heir who is attempting to pay off the current fair market price on an underwater home.

Thus, a stranger could purchase a reverse mortgage home for the fair market value where an heir could not.

A simple solution to not getting caught in this trap is to start early funding for your retirement. Sit down with a Certified Financial Planner no later than your early thirties to get a plan in place to actively fund your plan. Day after day I have a large number of people, around the age of 58, who earn $100,000 per year or more, and have less than $50,000 saved for retirement, call into the office, looking for a quick solution. With only $50,000 that will fund the first six months of their retirement. Sad….

As always, discipline or regret.

The Community Reinvestment Act of 1978 signed by Jimmy Carter was the initial salvo of destruction that paved the way to the 2008 financial crisis. This was further reinforced by a bill signed by Bill Clinton in 1993.

Barron’s did a masterpiece on this subject in the August 16, 2010 edition. An article by Gene Epstein titled “Imports Hit Second-Quarter GDP Growth.” In his article, Mr. Epstein writes….

“Housing-finance consultant Edward Pinto could contribute indispensable insight to this Tuesday’s Conference on Housing Finance Reform hosted by the Obama administration. The topic, according to the Treasury Department press release, will be ‘the future of our nation’s housing finance system, including Fannie Mae and Freddie Mac’ – those two government-sponsored enterprises now in government receivership. Among other qualifications, Pinto spent five years at Fannie Mae, the last two as chief credit officer.

“Pinto has just completed, on his own time, a massive report called ‘Government Housing Politics in the Lead-up to the Financial Crisis.’ The report should be required reading for participants at the conference, who will include ‘leading academic experts….market participants, and other stakeholders.’

“His account augments the mini-book by economist Russell Roberts, Gambling With Other People’s Money: How Perverted Incentives Caused the Financial Crisis, which I still recommend. Roberts argues the government’s ‘too-big-to-fail’ policy effectively conveyed the message that profits could be privatized, while losses would be absorbed by the taxpayer.

“Pinto agrees with this, but adds key elements. For one thing, the government played the race card, issuing clear threats that any lending institution not active in high-risk mortgages could be hauled before President Clinton’s Justice Department on charges its policies were discriminatory.

“The government put further teeth in its campaign to loosen standards with the Riegle-Neal Interstate Banking Act of 1994, which effectively allowed a bank to expand via interstate acquisitions on condition that it meet requirements for the issuance of high-risk mortgages. As Pinto notes, it is no coincidence that bank mergers and acquisitions were concentrated among those firms with stepped-up participation in high-risk mortgages.

“Perhaps most crucially, government policies managed to ‘break the credit culture’ among many lenders, as prudent lenders tended to be replaced by high rollers.

“Cato Institute scholar Arnold Kling, who did a long stint at Freddie Mac, has called Edward Pinto ‘a one-person financial-crisis inquiry commission,’ adding, ‘His final report will be the one to read.’ Tuesday’s conference is the first salvo in an attempt to pass major legislation on housing finance. To avoid marching in the wrong direction on this issue, Pinto’s voice will be worth listening to.”

Funny how the politicians say the big bad bankers were predators on helpless borrowers. No, they were forced into it.

In addition, the Obama administration is considering paying off the mortgages of those people who are behind on their mortgages for the second time….majority are subprime borrowers.

In order to pay for this, they are considering eliminating the mortgage interest deduction for those that are paying their mortgage.

So let me get this straight….If you do not pay your mortgage….your neighbor will pay it off. But if you pay your mortgage, you lose tax benefits.

Madness….madness!!

Most people think that the worst of the housing crisis has passed. They should be preparing for a flood of home inventory that will overwhelm the markets and cause prices to fall even further.

For the past 3-4 months there has been a form of moratorium on foreclosures set up by the present administration. Most institutions with delinquent mortgages have not foreclosed and your tax money has been used to cover the bank losses during this period (dumb move). There are only a few foreclosure signs in the neighborhoods, but, the rest of the banks are rushing to get their properties onto the market.

From December 2008 until March 2009 the number of bank asset managers inquiring about foreclosures dropped by 80%. Recently, the number of inquiries has skyrocketed as they see the inventory coming to market. Expect a flood of new properties in June.

Many investors entered the market too early and are now unable to “flip” the properties. They will now have these same homes foreclosed on them.

All of the administration’s efforts to revive the housing markets have failed. Those who are losing their jobs cannot buy homes, interest rates are rising, crowding out buyers and prices are continuing to fall.

Rental properties now have negative cash flows and will also come onto the market. In addition, builders are being supported in states like California. The state is providing a $10,000 credit to buyers of new houses bought directly from builders on top of the $8,000 Federal Credit. This encourages builders to build more houses that are not needed. It is estimated that more than 500,000 new homes will be built this year.

Lastly, many second homes were bought from the equity in people’s primary residence. Many of these homeowners need cash so they are selling the vacation homes which adds more inventory.

So with the end to the foreclosure moratorium and unemployment increasing it shows that more foreclosures are on the way. Keep you powder dry as there will be GREAT opportunities for you to make “buys” as prices continue to erode.

I hear from people that with the current mortgage crises in place it is very tough to refinance their homes. These individuals are distraught as many want to obtain a better interest rate or pay off their mortgage at a faster pace. Following the principles of Doug Andrew’s bestselling book Missed Fortune, I think one should keep the early payoff in perspective. Ric Edleman, who extols the same principles as Doug Andrew, has written many books and articles on the subject. One of them is…10 Great Reasons to Cary a Big, Long Mortgage.

Here are Ric’s top ten reasons for keeping a mortgage along with my thoughts. There is a link at the end of the article so you can read the whole article. I welcome your questions at any time.

Reason #1: Your mortgage doesn’t affect your home’s value.

True, your home value goes up or down whether or not you have a mortgage. Your home does not know it has a mortgage. Go ahead…stand in front of your home and ask your home if it has a mortgage or not.

Reason #2: You’re going to build equity anyway.

True, equity is built in two ways
• Through increases in the value of your home
• Through principal paid monthly. (which is very small in the opening years) Any cash put into your home earns a zero (0) rate of return. Stay with the home values increases to build your equity.

Reason #3: A mortgage is cheap money.

Also true, as long as interest rates are low. When inflation is high this leads to higher interest rate. Thus, your future mortgage payments in an inflated environment mean you are paying back in cheaper dollars. Thus, rates are cheap in most situations on a relative basis.

Reason #4: Mortgage interest is tax-deductible.

True again, as long as you can itemize deductions. If your income is too high, then these deductions are not available. To circumvent this, you can run the mortgage interest expense through your side business LLC, so it is deductable.

Reason #5: Mortgage interest is tax-favorable.

This is tied into #4 but holds true in that our government looks favorably on a mortgage deduction in order for that most people to participate in home ownership.

Reason #6: Mortgage payments get easier over time.

If you have held a mortgage for a long time then this is understandable. In the opening years of paying a mortgage most people are strapped with the payments. As years go by a person’s income goes up while the mortgage payment is a constant. Thus, as a percentage of the higher income the mortgage is a smaller percentage.

Reason #7: Mortgages let you sell without selling.

As your equity increases in your home do not sell the home to get out the equity. Instead refinance, take out the equity, invest those monies rather than leaving them in the home earning a zero (0) return.

Reason #8: Large mortgages let you invest more money more quickly.

The strategy is to place a small down payment and invest the remainder since any cash in the house earns zero return.
Reason #9: Long-term mortgages let you create more wealth.

Consider the after tax cost of your mortgage and invest the difference in a higher tax free return investment.

Reason #10: Mortgages give you greater liquidity and greater flexibility.

A 30 year mortgage gives you more flexibility than a 15 year mortgage. You can always pay off a 30 year mortgage earlier, but, you cannot stretch a 15 year mortgage into a 30 year plan.

See the whole article: http://www.ricedelman.com/cs/education/article?articleId=232

Assess the Ultimate Goal

Usually when you ask clients whether they plan to buy a second home for pleasure or investment, the response is “pleasure.” The follow-up questions should then be: “How long do you anticipate owning it?’ Then, “What, if any, growth rate do you expect on the value of the home?” Very rarely are there “rational” responses like “20-plus years” and a “5% or so return” (which is the approximate national residential 20-year average rate of return for a home).

Many buyers anticipate that the value of their second home will double, even though they say it is not an investment.

Often clients will buy on emotional and perhaps irrational factors. They will also base their decisions on some misguided information or misinterpreted facts. The following are some of the more common misconceptions:

A vacation home is a vacation home. A vacation home can be categorized in three different ways: personal, rental, and dual purpose. The one that pertains to your individual circumstance will depend on the days used and the days rented.

I always can deduct my mortgage interest on my second home. With so many affluent clients purchasing McMansions these days, it is not uncommon to see a large mortgage on their primary residence. Remember that you can generally deduct qualified residence interest on up to $1.1 million of home mortgage debt ($1 million worth of acquisition debt on up to two homes plus $100,000 of home equity debt on up to two homes). Any excess interest on home mortgage debt is generally nondeductible. Furthermore, the owner’s overall interest deduction may be lessened due to the itemized deduction phase-out rule for higher-income taxpayers (for 2007 the AGI level is $156,400). This rule is expected to sunset by 2010. As such, if nothing is done, in 2011 it will revert back to full phaseout. (Now there are legal methods that we use with our clients that allow them to deduct interest on well above the $1.1 mm limit).

I always have to report rental income. Rental income is completely tax-free for property that meets the rules for personal-use property, but has a very limited opportunity to generate rental income (generally 14 days or less). From a tax perspective, this can be quite a boon for clients with properties that can be rented at an exorbitant rate for a short time (e.g., properties located near a major golf event, Olympics, or Super Bowl location).

Vacation home donations are always a good idea. Unfortunately, the IRS considers vacation home donation days as personal use days, not rental days, since the owner did not receive a fair market rental for the use if the home. In addition to not qualifying for additional rentals expenses, the owner receives no charitable deduction for donating the use of the home to charity.

I can use the capital-gains tax exclusion ($500,000) upon sale. The exclusion applies only to principal residences.

A 1031 (tax-deferred) exchange can be done on a vacation home. A recent Tax Court ruling (Moore, T.C. Memo 2007-134) disallowed tax-deferred treatment for a personal vacation home. The court held that a couple’s exchange of vacation homes did not qualify for like kind exchange treatment because the homes were not held for investment purposes (as required by § 1031(a)).

Rental income will be offset by cost. With property prices still high, some clients may believe they will offset the cost of a second home by renting it. Unfortunately, clients forget that in order to cover their costs they often will have to rent it out at peak season, coincidently the weeks they want to use it the most.

This is a “business.” Many people say they manage their property and thus “materially participate.” In other words, they are in the business of renting real estate and are able to take losses against other taxable income.

You can go home again. And, finally, do not “impulse buy” while enjoying a vacation. If you have an interest in purchasing real estate at a great place where you vacationed last month, I suggest that you hold off until you have “felt out the neighborhood” for a while, meaning you should visit the location a few more times. You should focus on the commute to work, the community, people, activities, and amenities, and, very important, talk to as many locals as possible, particularly those who have owned vacation homes there for some time. Do you have a similar feeling of happiness each time you visit the location? Are your experiences consistent over time?

The financial ramifications as well as the emotional toll of purchasing vacation homes can be complicated. But understanding these rules and your expectations will open the door to some great discussions with your advisors.