Reverse-Mortgage Plans Should Be Studied Carefully

Q: Two years ago I obtained a reverse mortgage from a big insurance company. I am 72, in good health, but needed more income. I saw an ad in the AARP (American Association of Retired Persons) magazine so I called the company. They sent out a nice young man who explained how the reverse mortgage could pay me a lump sum for a new roof and would pay me monthly income for the rest of my life.

He mentioned, but didn't emphasize, there was an up-front loan fee which, when the papers were finally drawn up, was about $15,000. I talked it over with my two children. They didn't like it, since I was borrowing against their inheritances, but they couldn't offer any better alternative since I needed the money for the new roof and was barely getting by on Social Security plus a modest pension.

I fully realize I was ripped off by this insurance company. But the reverse mortgage took care of my financial problems. Do you think I made a big mistake?

A: No. You don't owe your children any inheritance. Your home equity was sitting there doing you no good. Now it is producing a monthly income for you. There is nothing wrong with what you did.

Having reviewed some of these reverse mortgage transactions, it is obvious they are extremely profitable for the lenders. Reverse mortgages are ideal for insurance companies that need to invest premium dollars at higher yields than can be earned elsewhere with safety. I agree the up-front fees charged by some lenders are outrageously high. However, these lenders are taking an unknown risk because nobody knows how long elderly homeowners like you might live.

Readers interested in reverse mortgages for homeowners age 62 or older who have no mortgage or a small balance should study this topic very carefully. The best book is "Retirement Income on the House" by Ken Scholen (National Center for Home Equity Conversion, 326 pages, $24.95) available in stock or by special order at local bookstores and libraries.Q: Recently on a radio talk show the real estate expert mentioned an easy mortgage "streamline refinance" program. Do all lenders offer this plan? Where can I get details? A: VA and FHA borrowers can refinance their current home loans with an easy "streamline refinance" program that minimizes red tape. Usually, no appraisal is necessary. However, the borrower cannot take cash out of the refinancing by increasing the mortgage balance. The big benefit is lowering the interest rate with minimal paperwork and costs. Details are available from VA and FHA lenders.

However, I am not aware of any conventional mortgage lenders offering streamline refinance programs to current borrowers. But they should.

Recently I heard of a borrower who wants to refinance his perfect-payment-record 12.25 percent interest rate home loan. But he can't get a new mortgage at 7 percent interest because he was unemployed last year and incurred some credit problems.

The nation's largest lenders, Fannie Mae and Freddie Mac, could perform a valuable public service by offering their borrowers streamline refinance programs like VA and FHA offer.

Q: I own a two-family duplex. I live in half and rent out the other half. My tenant has made me an offer to buy that I cannot refuse. However, I am concerned about the profit and how I can avoid tax. Is it true if I buy a house costing at least as much as the duplex's sales price I can avoid the tax?

A: No. For income-tax purposes, the sale of your duplex is really two sales. One is your personal residence, the other is the sale of investment or business property.

For example, suppose the duplex sells for a net price after selling expenses of $100,000. If each half is valued equally, you can defer the profit tax on the $50,000 sale of your personal residence by buying a replacement principal residence costing at least $50,000 within 24 months before or after the sale. This is the "rollover residence replacement rule" of Internal Revenue Code 1034.

But the profit tax on the sale of the $50,000 rental half of the duplex only can be avoided by making a tax-deferred exchange for another investment or business property of equal or greater value and equity.

In other words, you can't receive any taxable "boot" or net mortgage relief. To make the trade easier, you can make an Internal Revenue Code 1031(a)(3) Starker delayed tax-deferred exchange.

That means you sell the duplex, but have the sales proceeds from the rental portion held in trust by a third-party intermediary, such as a bank trust department, beyond your constructive receipt.

You then have 45 days to designate the exchange property to be acquired with these proceeds and 180 days to complete the acquisition.