| FINANCIAL ISSUES
Understanding Your Mortgage
Q. Who owns the mortgage on my house?
A. Traditionally, banks and savings and loan institutions owned
most residential
mortgages. Today, it is much more common for mortgages to be securitized
and sold to
investors such as mutual funds and insurance companies. This means that
borrowers are
usually dealing with a mortgage servicer, rather than the actual person
or institution that
holds the mortgage.
Q. What happens when your mortgage is transferred?
A. Most mortgages are sold soon after they are originated. This means
that most mortgage
holders will be dealing with at least two and possibly more mortgage servicing
agents
during the life of the mortgage. The mortgage servicer is responsible
for collecting
monthly payments and handling the escrow account, such as paying property
taxes. The
National Affordable Housing Act, passed in 1990, addresses the responsibilities
of a
mortgage servicer and consumer protection in this area. Under this act,
lenders are
required to do the following:
• Notify you at least fifteen days before the effective date of
the transfer of your loan
servicing. (The servicer has up to thirty days after the transfer if you
have defaulted on
the loan, the original servicer filed for bankruptcy, or the servicer's
functions are being
taken over by a federal agency.)
• Notice must include the following: name and address of the new
servicer; date the
current service will stop accepting mortgage payments and date the new
servicer will
accept them; and a free or collect-call telephone number for both servicers
if you have
questions about the transfer.
• The new servicer may not change any terms or conditions and this
must be disclosed
to the borrower. For example, if your former lender did not require that
property taxes
or homeowner's insurance be paid from an escrow account, the new servicer
cannot
demand that such an account be established.
• During a sixty-day grace period, a late fee cannot be charged
if you mistakenly send
your mortgage payment to your former servicer, and the new servicer cannot
report
late payments to a credit bureau.
Q. What can you do if you have a problem with a mortgage servicer?
A. Contact your servicer in writing if you believe a late penalty was
improperly imposed,
or for any other problem. Include your account number and explain why
your account is in
error. The servicer must acknowledge your inquiry in writing within twenty
business days
and has sixty business days to either correct your account or explain
why it is accurate.
During this time it is important that you not withhold any disputed amount
of mortgage
payment, which could allow the mortgage to be declared in default.
Q. What is an escrow account?
A. This is the account established by lenders to pay for such items as
property tax and
homeowner's insurance. The lender establishes the monthly amount required
to maintain
escrow by adding up the annual costs of property tax and possibly insurance
and dividing
by 12. This is the amount that is stipulated in your monthly payment.
The Real Estate Settlement Procedures Act limits the amount of money that
can be
held in an escrow account. The calculation is rather complex. Let's say
the expenses paid
by your escrow account add up to $3600, or $300 a month. The law requires
that at least
once a year, the escrow account be no more than two times the monthly
payment required,
or $600. The practical effect of this is that taxes are usually collected
once or twice a year.
Between collections, the account may have a sizeable balance, but immediately
after the
collection it should have no more than $600 in the account. If you notice
on your monthly
statement that your escrow is larger than that sum, you have the right
to question the
lender. This happens more frequently than one might imagine, so take the
time to figure
out if your lender is following escrow regulations. Otherwise, you are
paying more in
monthly payments than you should be.
Q. How do I determine how much equity I have in my home?
A. Equity is the value of your unencumbered interest in your home. It
is determined by
subtracting the unpaid mortgage balance and any other home debts, such
as a second
mortgage or home equity loan, from the home's fair market value. For example,
if your
mortgage is $50,000 and your home is worth about $100,000, you would have
$50,000 in
equity or 50 percent equity in your home. On the other hand, if the value
of your home has
fallen, you may have less equity than when you purchased the home.
Q. What can I do if falling home prices have cut my equity?
A. Many homeowners have found themselves in this sorry state, particularly
if they
bought their home in the mid to late 1980s when home prices were soaring.
Now that
prices have fallen drastically in some areas, homeowners are faced with
the problem of
having no or little equity in their property.
This is a particularly horrible situation if you are trying to sell or
refinance. If you
sell, you may owe the lender more money than you receive from the sale
of the home,
because the sale price is lower than the remaining mortgage. If you're
trying to refinance,
a lender will want to know that you have at least 20 percent equity in
the home, but an
appraisal may not bear this out. Be sure, however, to not accept the first
appraisal. You
may find another appraiser will value your home more highly.
Unfortunately, if your equity has fallen below what you owe on your mortgage,
there is little you can do in this situation. If you must sell, you'll
have to take a loss on
your home and perhaps pay the bank to retain a good credit rating. If
you are trying to
refinance, you may be able to talk to your lender and renegotiate more
favorable rates on
your outstanding mortgage. The one exception is for homeowners who have
FHA and VA
loans, who can apply for a special refinancing without an appraisal. (See "Refinancing
FHA and VA Loans.")
Q. Is there anything I can do if I can't pay my mortgage?
A. Most people get behind on their mortgage payments because of job loss,
divorce,
illness, and medical bills. The first thing to do if you are having trouble
making your
mortgage payments is to take the matter seriously. Many people refuse
to face the facts
that their home is on the line and delay doing anything until it is too
late.
Most financial institutions do not like to foreclose on properties (see
sidebar), and
there may be ways to work with the lender to reduce your monthly payments
or at least
delay foreclosure until you can sell your house. That is why it is important
to contact your
lender as soon as possible. Call or write to explain your problem, and
be sure to notify the
lender of your account number to speed the process. Sometimes the lender
will allow you
to defer paying principal or may even refinance the loan at a lower rate
to help make your
payments affordable. If you can prove that you are actively trying to
sell your home, your
lender also may cooperate with reducing monthly payments.
Next, contact the nearest housing counseling agency, which offers advice
and
services to help you ward off foreclosure. If your loan is HUD-insured,
for example, a
HUD-approved agency can help you apply for federal mortgage-relief programs
that may
provide temporary aid. If you have a VA-insured loan, contact a local
VA office for
assistance. In some states, filing for bankruptcy also may ward off immediate
foreclosure,
but you are well advised to contact an attorney to begin bankruptcy proceedings.
Q. What happens when a lender forecloses on the mortgage?
A. Depending on the state where you live, certain protections are afforded
homeowners,
but generally all your rights to your home will end if a foreclosure sale
occurs or soon
thereafter (usually no more than six months). This means that once a lender
files a
foreclosure suit, you must act immediately. In Illinois, for example,
when a foreclosure
suit is filed, the homeowner has ninety days to make up the back payments
to reinstate the
mortgage. After that date, the lender can legally require that the mortgage
be paid in full
within seven months of the original foreclosure notice. The important
fact to remember is
that you must act immediately to protect your home if your lender intends
to foreclose.
Sidebar: When the Lender Forecloses
Lenders do not like to foreclose on property because they usually will
not retrieve the full
amount of their loan. In most cases, the homeowner would sell and repay
the mortgage if
he or she could do so; so the practical consequences of foreclosure mean
that the bank
ends up with a property that is not worth the outstanding amount on the
mortgage. A
lender may recover all its money only if it is foreclosing on a home that
has much more
equity than the money owed on the mortgage.
Sidebar: Liability On an Assumption
If you allow buyers to assume your mortgage, are you liable for the loan
if they default?
That depends on when and how your mortgage originated. For example, some
assumable
mortgages may dictate your responsibilities in case of an assumption.
With loans insured
by the FHA before Dec. 15, 1989, and on most assumable conventional loans,
you remain
liable for the life of the loan. On FHA mortgages originated after that
date, you would
share liability with the new owner for five years.
Refinancing and Home Loans
Q. How can you figure out whether it makes sense to refinance your mortgage?
A. This is an easy question for some homeowners—if you have a double-digit
interest rate
on your mortgage when rates have dropped to below 8 percent, there is
no question that
you will save money by refinancing. Other homeowners may need cash out
of their home
equity to fund other expenses, such as college tuition. Borrowing the
money on your
house and deducting the interest is almost always going to be cheaper
than taking out a
personal loan.
For others, the question is more difficult. First you need to compare
interest rates
to figure out how much you would save on your monthly payments, as well
as the life of
the mortgage. For example, on a $100,000 mortgage, a mortgage interest
rate of 7 percent
versus 8 1/2 percent results in a savings of about $100 a month, or $1,200
a year on a
thirty year loan. To more precisely calculate the difference, you will
want to get an
amortization chart from a banker or real estate agent. Compare what you
are currently
paying in principal and interest per month with what you would be paying
on the new
loan.
Second, add up the costs of points, closing costs, title insurance, etc.
of the
refinancing. Third, you may want to also calculate the difference between
your current
payment's after-tax cost versus your future payment's after-tax cost.
Because Uncle Sam
gives you a tax break (fifteen to thirty-one cents per every dollar of
interest paid,
depending on your tax bracket) on mortgage interest, it is important to
figure this into your
calculations, particularly if you are in the top tax bracket and/or expect
to be in an even
higher bracket. Simply multiply the annual interest you pay currently
by .15 or .31,
depending on your tax bracket, to figure out your current tax savings.
Then multiply your
annual interest paid on the new loan versus the same number. For example,
if you're
currently paying $7,800 in mortgage interest annually ($650 per month)
and you're in a 31
percent bracket, you currently have an annual tax savings of $2,418 ($7,800
multiplied by
.31).
Q. Are there times when it doesn't make sense to refinance?
A. In almost all cases, you won't recover the closing costs for a few
years, so if you are
planning to sell your home in the near future, it makes little sense to
refinance unless you
can obtain a no-points adjustable-rate mortgage at a low "teaser" rate.
Q. What's the difference between a home equity loan and a second mortgage?
A. They are similar in that the interest on both is tax deductible (on
loans up to $1
million), and the home serves as collateral for both types of loans. They
differ because a
second mortgage usually consists of a fixed sum for a fixed period of
time, while a home
equity loan usually works as a line of credit on which you may draw over
time. Typically,
a home equity loan carries an adjustable interest rate, while a second
mortgage carries a
fixed rate, although this is not always the case in today's market.
Q. Which is better?
A. If you need a lump sum of cash, you are probably better off with a
second mortgage
because you will get a better interest rate on the loan. If you need money
over a longer
period of time, such as to pay college tuition or to pay for renovations
planned over the
next few years, it may be better to obtain a home equity loan. That way,
you won't be
paying interest on the money until you actually withdraw it when you need
it.
Q. Do the same rules apply to original mortgages and refinancing?
A. When you refinance, you pay off the original mortgage and take on a
new one. State
and federal laws protect consumers in both cases, but you will want to
go through the
same steps as you would in obtaining a first mortgage. (See the "Buying
and Selling a
Home" chapter for advice on shopping for mortgage interest rates
and mortgages.)
Sidebar: Refinancing FHA and VA Loans
Homeowners who have an FHA or VA loan may be able to qualify for a special
program,
called FHA Streamline Refinancing, which does not require a home appraisal,
employment verification, or qualifying ratios as long as the mortgage
is current. If you
want to refinance an FHA or VA loan, call your local HUD office for information.
Q. Can I deduct on my federal tax return the points I paid to refinance
my
mortgage?
A. With one exception, points paid on a refinancing must be amortized
over the life of the
loan, while points paid to obtain an initial mortgage may be deducted
in the year the home
was purchased. For example, if you paid two points to refinance a new
thirty-year
mortgage, you would be allowed to deduct one-thirtieth of the points paid
each year over
the next thirty years. If you pay off the loan before it is due, however,
you may deduct any
remaining amount in the year the loan was paid in full.
The exception to this rule is if you pay the points yourself and use part
of the
proceeds of the refinancing to pay for home improvements. Then you are
allowed to
deduct a portion of the points in the year of the refinancing. For example,
if you paid
$2,000 or two points to refinance a $100,000, fifteen-year mortgage and
you used $25,000
to renovate your kitchen, you would be able to deduct 25 percent of the
$2,000 or $500 in
the year that you refinanced; the other $1,500 would have to be divided
over fifteen years,
allowing a $100 annual deduction.
Sidebar: Refinancing Tips
• Get a copy of your credit report before you apply and correct
any errors.
• Make sure you have a minimum 20 percent equity in your home; otherwise,
you'll be
expected to put down more money or be forced to pay Private Mortgage Insurance
(PMI).
• Make sure you understand the fee you will be charged when using
a mortgage broker.
• Consider shortening the term of the loan, perhaps from thirty
to fifteen years; you will
pay more each month but save a lot in interest payments over the life
of the loan.
• Be prepared to wait. Refinancing can take three months or more,
because when
mortgage interest rates decline, many homeowners jump at the chance to
refinance.
Tax Considerations
Q. What tax breaks are available to homeowners?
A. On your federal tax return, both your local property tax and mortgage
interest paid on
your home loan (up to $1 million) are deductible against other income
as long as you
itemize and do not use a standard deduction. "Deductibility" simply means that you don't
have to pay federal taxes on the income you spend on mortgage interest
and state and local
taxes. In the early years of a home loan, for example, when most of your
payment goes
toward interest, you might shelter as much as a quarter to a third of
your income. This
deduction can be spread over both a first home and a vacation home, as
long as the
vacation home is not being used principally as a rental property.
Federal tax law also allows you to deduct interest paid on up to $100,000
of a
home equity loan as long as the total debt on the home (including the
first mortgage) does
not exceed the fair market value of the home.
You also may be eligible for a deduction of property tax paid on your
home on
your state income tax return, but this is not the case in all states.
Q. Is there any way to lower the property taxes on my house?
A. To lower property taxes, you need to lower the assessed value of your
property, which
is the basis of your taxes. By providing evidence that the assessed value
of your home or
business property is too high, you should succeed in lowering the assessment,
as well as
your property taxes.
In most states, an assessor or a board of assessors places a value on
your property
for tax purposes. If the property has recently been sold, its sale price
will be an important
factor in setting the value. If there has been no recent sale, they will
estimate its market
value using other evidence. This assessment may be done annually or on
some other
schedule, such as every four years. In most cases, then, the assessor
uses a complicated
schedule to get from appraised value to dollar amount of taxes owed. For
example, in
many states, the value is reduced by a certain percentage, then multiplied
by the local
property tax or millage rate to establish the amount of taxes you will
actually pay.
Your role in the process should begin when you get a notice indicating
the
assessed value placed on your property. If you think it is too high, you
will want to file an
appeal as soon as possible. To challenge the assessment, first look for
obvious mistakes in
the notice. Make sure the address and description of your property is
correct. It may be
necessary to look up the information about your home at the assessor's
office. Check to
make sure the number of rooms, bathrooms, square footage, etc. is accurate,
and make a
note of any discrepancies.
Next, check to see if you qualify for a special tax break. Some jurisdictions
provide tax breaks to certain categories of property owners. For example,
tax waivers of
10 percent or more may be available to owner-occupied homes, owners age
sixty-five and
older, disabled veterans, and persons with certain disabilities. Lastly,
make sure the
assessor has any information about damage to the property, such as flood
or fire damage.
If any of these conditions apply, ask your local assessor's office how
to file an appeal and
note any of these problems in your appeal.
Even if none of these special conditions apply, investigate whether the
market
value determined by the assessor is higher than the true market value
of your property.
Local real estate agents or the county registrar of deeds should be able
to provide recent
sales of comparable or similar properties in your area. Also, check the
assessed value of
similar neighboring properties; this is public information in most places.
Remember,
however, that the assessed value may reflect one-year-old values; in other
words, the
assessment usually is based on the market value of your home the previous
year, not its
current value. Once you have the information you need to protest your
assessment, you
will either be required to fill out a form or make an appointment with
the assessment
board. Be prepared to bring facts and figures. If your appeal fails, depending
on your state
you may appeal that decision to a special board of equalization, a board
of appeals, a state
court, or a special tax tribunal. State laws vary as to how and when property
is assessed
and appeal procedures. For specific information, consult your local government
officials
or your lawyer.
Sidebar: Filing an Assessment Appeal
Most municipalities allow a limited time for assessment appeals; don't
wait until you get
your tax bill, which is usually too late. In most states, the procedures
for tax appeals are
relatively simple and homeowners may be able to represent themselves.
If the case is
complex or involves a large amount of money, you may want to consult an
attorney or real
estate appraiser.
Q. How can you qualify for a tax deduction on a home office?
A. If you run a business from your home, or work there for your employer’s
convenience,
your office expenses are probably deductible. Depending on the size of
your home and
how much of it is designated office, the deduction can be significant
enough to justify the
extra effort needed to qualify. If your office meets the standards spelled
out by the IRS,
you can deduct the cost of repairs, furniture, computers and office equipment,
extra
telephone lines and other business-related expenses. You can also deduct
a proportional
share of your home's depreciation (ordinary wear and tear), utility bills
and insurance. Be
aware, though, that you can deduct no more than your business actually
generated.
Although you can no longer deduct the entire cost of a desk or computer
the first
year, you may claim accelerated depreciation if you use the item more
than 50 percent of
the time for your job. This allows you to claim most of the deduction
the first two years.
The IRS, however, reserves the right to declare that your "business" is really a
hobby, or that your home office doesn't meet its rather stringent standards
for deductible
business use of the home. For more on IRS standards in this area, see
sidebar, "Your
Home Office."
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