Dianne Stow
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Real-estate

4/27/2007

Donít depend on homeís value to pay off your debt

Q: Weíve been in our house about five years and plan to stay for a while. We refinanced about 18 months ago to pay off credit card debt. Now, we have credit card debt again and little equity, but need to make home repairs that could be costly. What do you suggest as far as a home equity line of credit or other methods to raise more cash?

A: It sounds like you have a pretty serious spending problem you must take care of before you can tackle future home repair or improvement projects.

Hereís the real problem: You canít count on using your home equity to pay off future credit card debt. What if your homeís appreciation slows down or, worse, levels off? What if your homeís value falls?

I would have thought that tapping into your home equity once would have helped you realize that you need to figure out how to live within your means. Clearly, the message didnít get through because you now have more debt and little home equity to tap.

You need to talk with someone about your budget and figure out whether you can cut back on some of your spending or if you need to find a way to bring in more money, even through a short-term second job to pay off credit card debt and perhaps finance those repairs. The truth you have to face is that no lender will give you a home equity loan if you donít have any home equity.

Think carefully about what kind of repairs and improvements you want to make and whether you can wait to do them. Adding another $40,000 in credit card debt isnít going to help your situation.

Consumer Credit Counseling Services (www.cccsinc.org) offers free budget counseling over the phone, the Internet or in person. Iíd start there.

Q: I was recently divorced and my ex-wife and I have sold our house. We each received $20,000. In addition to that cash, Iím scheduled to receive $1,000 per month in maintenance payments from her. I earn $43,000 dollars each year. How much extra tax will I face next year because of this extra cash? I assume weíll both file as single individuals. Who should help me work through these issues?

A: If you and your ex-wife lived in your house as your primary residence for at least two of the last five years, the two of you are each entitled to keep up to $250,000 in profits tax free from the sale. There shouldnít be any taxes owed on the $20,000 in profits you received.

Regarding your $1,000 in monthly maintenance, this is also known as alimony. Alimony payments are usually tax deductible by the payor (your ex-wife) and taxable to the payee (thatís you).

So if your annual income this year was $43,000, and you got $2,000 extra from your ex-wife this year, it shouldnít change your tax picture too much come April 15. But next year, youíll receive $12,000 on top of your $43,000 in salary. That may change your tax bracket for the taxes youíll pay on April 15, 2008.

Talk to your tax advisor to find out how this income will show up on your income tax form. If you file your own tax return, you can use tax preparation software to estimate the taxes youíd have to pay with the $12,000 increase in your income.

Q: Iíve been shopping around for a cash-out refinance loan on a piece of rental property I own. Currently, the property has no mortgage.

Iím self-employed and was told I needed a stated-income loan. I walked away from one closing because of the high interest rate (they upped the rate to 8.2 percent at the closing table) plus additional closing costs not quoted on the good faith estimate.

On the most recent application I filled out, Iíve been offered an adjustable rate mortgage with a starting rate of 8.63 percent. I requested a loan without a pre-payment penalty and recently received settlement papers from a sub-prime lender noting that I may or may not have pre-payment penalty.

My mortgage broker informed me that the pre-payment penalty is 1 percent of the loan. My credit score is 735 and I expected to find a fairly decent loan with decent interest rates. Is this the penalty for the stated loan program, or what is the problem?

A: The real problem is that you have a host of issues working against you.

First, youíre trying to finance a rental property rather than an owner-occupied property. Interest rates for investment property are usually .50 percent to 1 percent higher than for an owner-occupied property. In other words, even if you werenít self-employed, your starting interest rate would be around 7 to 7.5 percent for this loan.

On top of this, youíre getting a stated income loan. That means the lender is just taking your word for it that you can afford this mortgage. That could easily bump up the interest rate another one percent or more. The fact that youíre getting quotes from sub-prime lenders could indicate that thereís something else going on. Please talk to a knowledgeable mortgage broker or local bank to find out what other options you have.

If the bank where you have your checking and savings accounts also grants mortgages and then keeps them in its own portfolio, the bank may have the ability to give you a loan on better terms than other lenders. If you own the home that you live in, you might get a better interest rate by taking out a loan on that property rather than trying to finance the rental property. You may also need to refocus your efforts and find a good lender in your area thatís still working to help real estate investors like you. Try calling some community savings and loans or local banks to see if theyíd be willing to help you.

Ilyce R. Glinkís latest book is ď100 Questions Every First-Time Home Buyer Should Ask, 3rd Ed.Ē (Three Rivers Press, $18). If you have questions, you can call her radio show at (800) 972-8255 any Sunday, from 11 a.m. to 12 p.m. EST. You can also write to Real Estate Matters Syndicate, P.O. Box 366, Glencoe, IL 60022, or visit www.thinkglink.com.