 Inherited home creates financing questions
|  Dear
Dr. Don,
I own a townhouse that is worth about $300,000 with a $67,000
mortgage at 7.37 percent with 11 years remaining. In 2006 I inherited about
$200,000 in cash and a single-family home that is also worth about $300,000. There
is no mortgage and this is my current residence. Both places need repairs
-- the townhouse about $10,000, to get it in shape to rent or sell, and my primary
residence, which is about 50 years old, needs a minimum of about $25,000.
I'm looking for some advice on the following options, or any additional
options I haven't considered.
 |
Options for refinancing: | |
|
| • | Refinancing
the primary residence for 30 years at 5.37 percent (2.25 points), paying off the
townhouse mortgage and (conservatively) investing the proceeds for use in the
repair upgrades to both properties. | | • | Same
basic scenario as above, only difference is the rate would be 5.78 percent and
no points. | | • |
Use the cash I have
on hand and pay off the existing townhouse mortgage and
then pay for any repairs -- also with cash on hand. This
would leave me mortgage-free, but would reduce my cash
on hand by at least 50 percent. |
| • | Some
other combination of the above three options. | |
Any
comments and/or advice would be very much appreciated. Also, do the rates I mentioned
seem reasonable, and are rates expected to do down or up as a result of the current
drop on Wall Street in recent days?
Thank you,
-- Tom
 Dear
Tom,
Bad news on Wall Street often translates into lower interest rates
as stock investors look for a home for the cash they generated by
selling positions. Lower interest rates on U.S. Treasury securities,
especially the 10-year Treasury note, means that the interest rate
on a 30-year fixed-rate mortgage is also likely to decline.
You can keep your finger on the pulse of what's going
on in the mortgage market by reading Bankrate's Rate
Trend Index every Thursday. That, along with Holden Lewis'
column every Thursday on mortgage
rates, keeps me informed. I have a copy of both sent to me every
Thursday via e-mail. You can too. The rates you quote
are highly competitive in today's market as you'll see by reading
these Thursday columns.
Points
paid on a mortgage come in two flavors, discount
and origination points. Origination points are compensation to the lender
for originating the loan. Borrowers try to avoid paying origination points.
Discount points are prepaid interest allowing you
to buy down the nominal rate on your mortgage. Discount points make
the most sense when you plan on staying in the house and the loan
for a long period of time. That's not the case for most homeowners,
so points often don't make sense. Bankrate has an interactive
worksheet
that can help you decide whether paying discount points makes sense
for you and allow you to calculate how long you would have to be
in the loan for it to make sense to pay the discount points.
If you lived in the townhouse
as your primary residence for two of the last five years, you may want to look
into selling the townhouse while exempt from paying capital gains tax on the sale.
The 2006 IRS Publication 523, "Selling
Your Home," lays out the exclusions in greater detail. If
you decide to rent the townhouse, it normally makes sense for you to have a mortgage
on the rental property so the interest expense on the rental goes against the
rental income, reducing the net income on the investment. The IRS publication,
"Passive
Activity Losses - Real Estate Tax Tips," has more information on tax
accounting for rental properties. My rule of thumb in deciding
whether or not to use savings to pay down or pay off the mortgage is to compare
the after-tax return on your savings against the after-tax cost of your mortgage. If
your mortgage is costing you more on an after-tax basis than you're earning after-tax
on your savings then it can make sense to pay down/pay off the mortgage.
Since you're looking at financing the home repairs and improvements,
you can make the same type of decision for that $35,000 investment. If you
decide to finance the improvements, and not sell the townhouse, odds are you're
best off with $102,000 borrowed in a cash-out financing against the townhouse. Keep
an eye on the big picture too. How close are you to retirement? What
are your financial goals? What are your other investments? Don't just look
at the pile of savings and the mortgage.
You really should run all of this by your tax adviser,
especially what renting the townhouse does to your tax picture,
both in annual income and any loss of the capital gains exclusion.
To ask a question of Dr. Don, go to the "Ask
the Experts" page, and select one of these topics: "Financing
a home," "Saving & investing" or "Money."
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