Are All Deeds Since 2005 (Not Just Foreclosed Ones) At Risk?

October 13, 2010

Worms crawling out from under the rocks of foreclosures.I was listening to a radio program this week (The Kojo Nnamdi show on WAMU in Washington, D.C.) and the topic was–what else–the foreclosure crisis and robo-signing. OK, I thought, this might be interesting. And it was. Not from Kojo’s guests–who were OK but pretty predictable–but from one of the callers. It was a guy named Matthew (who I think is Matthew Weidner, a Florida attorney) who raised a scary point about the foreclosure mess.

Incidentally, Matthew Weidner’s blog has all sorts of fascinating information on it. Some of it’s a bit technical, and some of it’s Florida-specific (that’s where he is), but it’s worth looking at.

While robo-signing is the most recent problem to arise, a deeper problem is all the paperwork that accompanied all the purchase and sale transactions since about 2004 or 2005. Basically, the paperwork is a mess–severely flawed–since all those loans were sliced and diced over and over again to sell to investors. Heck, I even blogged about that–a book review called The Big Short by Michael Lewis. [Tip: Buy it. Read it.]

But caller Matthew’s point was that none of these properties–foreclosure or not–really can be said to have clear title. The paperwork’s bad on all of them. He called this “the elephant in the room” that no one wants to talk about. And, obviously, for good reason.

A lot of the problems with the foreclosure paperwork are coming to light because one of the parties (the owner) is highlighting the problem and using it to block further action. You don’t have the same situation in cases where you’ve got a willing seller, a willing buyer, and no bank in the middle of that transaction.

However, just because no one’s raising a fuss doesn’t mean the problem doesn’t exist. And as those rocks start getting turned over and the worms start wiggling out, someone’s going to notice that a lot of those worms are crawling out from supposedly “clean” sales.


Realtors Must Stop “Playing Dumb” on School Quality

September 30, 2010

Zipped LipsAsk the average guy on the street about the quality of schools in the District of Columbia, and he’ll tell you that it’s not too good.

Ask the President of the United States about whether the quality of D.C. schools is comparable to those of certain private schools and (on the Today Show and reported in the Washington Post) he’ll say:

“I’ll be blunt with you: The answer is no, right now,” Obama said. D.C. public schools “are struggling,” he said, but they “have made some important strides over the last several years to move in the direction of reform. There are some terrific individual schools in the D.C. system.”

Ask a Realtor about public schools in D.C. or elsewhere, and you’ll hear: “Well, umm. I really can’t say. I’m not permitted to say. So I really can’t help you. Sorry. But I encourage you to check online. And talk to some parents of kids who go to the school. Try calling the PTA. Or talk to the school principal.”

What?!?!?!

I acknowledge that a school that’s great for some kids may be terrible for others. I’ve written about that before from personal experience. My son attended an elementary school with a great reputation. But it was absolutely a horrible experience for him. And I’m not picking on D.C. schools. There are plenty of other examples, good and bad, out there. So it’s true that you can’t accurately sum up an entire school with a grade of “A” or “F.”

Still, there’s a growing focus on the quality of education in the United States, and how it compares to that in other countries. There’s the movie Waiting for Superman, which is attracting a huge amount of interest and focusing laster-like attention on our educational system.

Ignoring realities doesn’t help buyers. Refusing to share expertise and perspective on quality of school doesn’t help buyers. From the Preamble to the Realtor Code of Ethics:

Under all is the land. Upon its wise utilization and widely allocated ownership depend the survival and growth of free institutions and of our civilization. . . .They require the creation of adequate housing, the building of functioning cities, the development of productive industries and farms, and the preservation of a healthful environment. Such interests impose obligations beyond those of ordinary commerce. They impose grave social responsibility and a patriotic duty to which REALTORS® should dedicate themselves.

Are these goals–creation of adequate housing, development of productive industries, preservation of a healthful environment–possible if, in our professional roles, we deliberately ignore educational successes and failures? If we ignore reality? If we deliberately withhold information from clients and customers?

I think not.


Buyers Say the Darndest Things: Bowser the Buyer

December 4, 2009

Remember Art Linkletter’s “Kids Say The Darndest Things“? Well, would-be real estate buyers sometimes say some pretty darned odd (and funny) things, too.

I’ll start posting some of them here. I’m not making fun of these folks, but in some cases I do wonder how they manage to even get up in the morning. In other cases, the would-be buyers are vastly overcomplicating a situation. We’re not talking about the intricacies of real estate transactions. Usually, it’s just plain common sense that seems in short supply.

So, let’s begin.

This one comes from Trulia, a consumer-oriented Web site with a question-and-answer area, where I post answers pretty frequently. Names have been removed to protect the innocent. (Curious? Here’s the link to the full posting.)

Does B****** Real Estate not want to sell houses? They consistently hold open houses without listing the address.
Apparently, they don’t want you to buy a house they are selling unless you are working with one of their realtors. I’ve spent hours just trying to track down the address of a supposed “open house” they are holding. Their website is convoluted and won’t let me search their listings (the “registry” doesn’t work and you can’t see any info without it). I refuse to work with one of their agents for the simple fact that they have made my home search process such a pain in the neck.

Huh? I guess I understand your frustration at not being able to determine from the one company where the open houses are. But the only reason to keep pounding your head up against a brick wall is that it feels so good when you stop. So: Stop pounding.

Contact a Realtor from another company. You choose. And you screen the Realtor so you’re comfortable with both the company and the Realtor. then explain what you want. And–here’s the good part–it’ll mean less commission for the listing agent and for the listing firm! You see, the commission is already agreed to. If you buy the house through the listing agent, he/she gets both ends of the commission. So, help the company share the wealth . . . with an agent of your own choosing.

Notice the would-be buyer says he’s spent hours trying to track down the address of a single open house. Maybe he could have called and asked? Or, as I suggested in my answer, maybe he could have called a Realtor with another firm?

And beyond that, I’m reminded of the story of a dog chasing a car. The dog chases and chases it. One day, it finally catches the car. Success! Except . . . now that it’s caught the car, what does he do now?

In this case, we have Bowser the Buyer chasing open houses for hours on end. What would happen if Bowser the Buyer finally finds out the super-secret location? Imagine: He discovers the location, goes to the open house and, miracle of miracles, decides he wants to buy the house. Well, what then? He says, “I refuse to work with one of their agents.” So, he’s got no agent of his own and he refuses to work with one of theirs.

Like they say, you can’t get from here to there. But I guess you can keep yourself pretty busy running in circles.


Government First-Time Home Buyer Tax Credit Can Be Used For Closing Costs, Interest Rate Buy-Downs

June 6, 2009

New home buyers seeking to use the 10% tax credit can use that money up front to help pay for closing costs or to “buy down” their mortgage rate, according to the U.S. Department of Housing and Urban Development.

That’s significant: While the 10% tax credit is great (buy an $80,000 property; get an $8,000 tax credit), buyers used to have to wait until they filed their tax returns to actually benefit from the credit. Now there’s a way to instantly monetize the credit.

And although the tax credit can’t be used for the minimum 3.5% downpayment required by FHA, it can be used to supplement it. And numerous states offer buyers programs to help cover that 3.5%.

[For information on the tax credit itself, see my earlier post at https://realestatesolutions3d.wordpress.com/2009/02/24/first-time-homebuyer-tax-credit-fact-sheet/ ]

Here’s a summary from the National Association of Realtors:

Under the guidance, FHA-approved lenders can develop bridge loans that home buyers can use to help cover their closing costs, buy down their interest rate, or put down more than the minimum 3.5 percent.

The loans can’t be used to cover the minimum 3.5 percent, senior HUD officials told reporters on a conference call Friday morning.

Thus, buyers applying for FHA-backed financing with an FHA-approved lender that offers a bridge-loan program can get a bridge loan to bring down the upfront costs of buying a home significantly but would still have to come up with the minimum 3.5 percent downpayment.

There remain many sources of assistance for buyers needing help with the 3.5 percent downpayment, including many state and local government instrumentalities and nonprofit lenders.

In addition, some state housing finance agencies have developed their own tax credit bridge loan programs, so buyers in states whose HFAs offer such programs can monetize the tax credit upfront to cover all or part of their downpayment. These programs are separate from what HUD announced today.

The first-time homebuyer tax credit was enacted last year–and improved upon earlier this year–to help encourage households to enter the housing market while interest rates are low and affordability is high. The credit is worth up to $8,000 and is available to households that haven’t owned a home in at least three years. The credit does not have to be repaid, and is fully reimbursable, so households can get their credit returned to them in the form of a payment.


Just Offering a Lower Price Doesn’t Mean You’re Negotiating

May 18, 2009

I’ve run into a number of situations lately in which potential (or prospective, or would-be, or maybe just wannabe) buyers have confused the act of offering a lower price with negotiating. In fact, there’s very little connection between the two.

For example, in my role as a Realtor I was showing some clients  some properties. They had pretty strict limits as to maximum price, condition of house, location, and so on. We’d looked at half a dozen the weekend before, and none fit the bill. Some were too old (mid-1970s). Some were too small. Some weren’t in good-enough condition. Still, we’d started with a list of perhaps 20 foreclosures and a few short sales. And most had been snapped up within 3-5 days of listing.

A couple weeks later, we went out again. This time we saw 3 properties–an REO in a bad neighborhood that’d been on the market for 4 months ($160,000), an REO that’d been totally gutted before the rehab money ran out ($150,000), and a great home, nearly perfect condition, granite countertops/stainless steel appliances, for $180,000. The comps (for other REOs) in the same neighborhood, probably for homes in not-so-good condition, were about $230,000. It was a great buy. And the buyers had been prequalified up to $250,000.

They liked the house . . . enough to want to offer $160,000. Huh? I cautioned them that it’d sell fast, and was clearly underpriced. They said they really wanted the house. So, back at the office, they agreed to raise their offer to $165,000. I said that while I’d be glad to submit any offer, that the comps were well above $200,000 and the market for those properties had gotten hot lately. Still, they figured $165,000 was a good negotiating strategy.

Offers were cut off at 3 pm on Monday, after just 4 days on the market. Our offer was 1 of 8 submitted. Of the 8–I found out–ours was by far the lowest. The accepted offer was for $185,000, all cash, no contingencies. A much cleaner offer for $20,000 more. And the would-be buyers were “shocked” that they hadn’t gotten the hosue.

Second example: This past weekend, I was showing a property–a manufactured home. The comps are around $40,000. This one was priced at $25,000, and was in good condition. The owner was at home, and the potential buyers started talking to her. The owner was willing to come down to about $21,000–her real bottom line, since she needed the cash to buy another property. Remember: Comps are about $40,000. So the most they’re interested in offering is about $14,000. As they say in the South, “That dog won’t hunt.”

Look, negotiating’s great. And there’s nothing wrong in offering a low (or lower) price. But the two (offering a lower price and negotiating) are two entirely different things. Sometimes, as with the REO, there isn’t much room to negotiate. You just figure out what the best deal is . . . what your bottom line is . . . and make an offer. Those buyers could have offered $225,000 . . . been well within their affordability range . . . and had a good shot at getting the property. They chose not to.

In the case of the manufactured home, there were other areas that the seller indicated flexibility on. Plus, the home was priced (after the initial negotiations) at about half the comps. Offering 33% less, after getting a reasonable idea of the seller’s bottom line, isn’t negotiating. It’s just playing a losing game.


First-Time Homebuyer Tax Credit Fact Sheet

February 24, 2009

Here’s a fact sheet on the first-time homebuyer tax credit prepared by the National Association of Realtors. I’m not a lawyer or accountant, so I can’t vouch for the NAR’s analysis, but it looks pretty thorough. I’ve added a few annotations that look like this through the analysis. Those are my own personal comments and observations. They in no way reflect the NAR’s positions, policies, or analysis.

FIRST-TIME HOMEBUYER TAX CREDIT

 

Frequently Asked Questions

 

In 2008, Congress enacted a $7,500 tax credit designed to be an incentive for first-time homebuyers to purchase a home.  The credit was designed as a mechanism to decrease the over-supply of homes for sale. 

 

For 2009, Congress has increased the credit to $8,000 and made several additional improvements.  This revised $8,000 tax credit applies to purchases on or after January 1, 2009 and before December 1, 2009. 

 

Tax Credits — The Basics

 

1.        What’s this new homebuyer tax incentive for 2009?

 

The 2008 $7,500, repayable credit is increased to $8,000 and the repayment feature is eliminated for 2009 purchasers.  Any home that is purchased for $80,000 or more qualifies for the full $8,000 amount.  If the house costs less than $80,000, the credit will be 10% of the cost.  Thus, if an individual purchased a home for $75,000, the credit would be $7,500.    It is available for the purchase of a principal residence on or after January 1, 2009 and before December 1, 2009. 

 

2.        Who is eligible?

 

Only first-time homebuyers are eligible.  A person is considered a first-time buyer if he/she has not had any ownership interest in a home in the three years previous to the day of the 2009 purchase. [Note that this really means that you can have owned a home before. The test is only whether you’ve had an ownership interest in the past three years. So, if you owned, then sold and have rented for three years, you’d generally be eligible. That’s an important point.]

 

3.        How does a tax credit work?

 

Every dollar of a tax credit reduces income taxes by a dollar.  Credits are claimed on an individual’s income tax return.  Thus, a qualified purchaser would figure out all the income items and exemptions and make all the calculations required to figure out his/her total tax due.  Then, once the total tax owed has been computed, tax credits are applied to reduce the total tax bill.  So, if before taking any credits on a tax return a person has total tax liability of $9,500, an $8,000 credit would wipe out all but $1500 of the tax due.    ($9,500 – $8,000 = $1,500)

 

4.        So what happens if the purchaser is eligible for an $8,000 credit but their entire income tax liability for the year is only $6,000?

 

This tax credit is what’s called “refundable” credit.  Thus, if the eligible purchaser’s total tax liability was $6,000, the IRS would send the purchaser a check for $2,000.  The refundable amount is the difference between $8,000 credit amount and the amount of tax liability.  ($8,000 – $6,000 = $2,000)  Most taxpayers determine their tax liability by referring to tables that the IRS prepares each year.  

 

5.        How does withholding affect my tax credit and my refund?

 

A few examples are provided at the end of this document.  There are several steps in this calculation, but most income tax software programs are equipped to make that determination.

  

6.       Is there an income restriction?

 

Yes.  The income restriction is based on the tax filing status the purchaser claims when filing his/her income tax return.  Individuals filing Form 1040 as Single (or Head of Household) are eligible for the credit if their income is no more than $75,000.  Married couples who file a Joint return may have income of no more than $150,000. 

 

7.        How is my “income” determined?

 

For most individuals, income is defined and calculated in the same manner as their Adjusted Gross Income (AGI) on their 1040 income tax return.  AGI includes items like wages, salaries, interest and dividends, pension and retirement earnings, rental income and a host of other elements.  AGI is the final number that appears on the bottom line of the front page of an IRS Form 1040.

 

8.        What if I worked abroad for part of the year?

 

Some individuals have earned income and/or receive housing allowances while working outside the US.  Their income will be adjusted to reflect those items to measure Modified Adjusted Gross Income (MAGI).  Their eligibility for the credit will be based on their MAGI.

 

9.        Do individuals with incomes higher than the $75,000 or $150,000 limits lose all the benefit of the credit?

 

Not always.  The credit phases-out between $75,000 – $95,000 for singles  and $150,000 – $170,000 for married filing joint.  The closer a buyer comes to the maximum phase-out amount, the smaller the credit will be.  The law provides a formula to gradually withdraw the credit. Thus, the credit will disappear after an individual’s income reaches $95,000 (single return) or $170,000 (joint return). 

 

For example, if a married couple had income of $165,000, their credit would be reduced by 75% as shown:

 

Couple’s income             $165,000

Income limit                      150,000

Excess income                  $15,000

 

The excess income amount ($15,000 in this example) is used to form a fraction.  The numerator of the fraction is the excess income amount ($15,000).   The denominator is $20,000 (specified by the statute).

 

In this example, the disallowed portion of the credit is 75% of $8,000, or $6000

($15,000/$20,000 = 75% x $8,000 = $6,000) 

 

Stated another way, only 25% of the credit amount would be allowed.

 In this example, the allowable credit would be $2,000 (25% x $8,000 = $2,000)

 

 10.    What’s the definition of “principal residence?”

Generally, a principal residence is the home where an individual spends most of his/her time (generally defined as more than 50%).  It is also defined as “owner-occupied” housing.  The term includes single-family detached housing, condos or co-ops, townhouses or any similar type of new or existing dwelling.  Even some houseboats or manufactured homes count as principal residences. 

 

11.     Are there restrictions on the location of the property?

 

Yes.  The home must be located in the United States.   Property located outside the US is not eligible for the credit.

 

12.    Are there restrictions related to the financing for the mortgage on the property?

 

In 2009, most financing arrangements are acceptable and will not affect eligibility for the credit.  Congress eliminated the financing restriction that applied in 2008.  (In 2008, purchasers were ineligible for the $7,500 credit if the financing was obtained by means of mortgage revenue bonds.)  Now, mortgage-revenue bond financing will not disqualify an otherwise-eligible purchaser.  (Mortgage revenue bonds are tax-exempt bonds issued by a state housing agency.  Proceeds from the bonds must be used for below market loans to qualified buyers.)

 

13.    Do I have to repay the 2009 tax credit? 

 

NO.   There is no repayment for 2009 tax credits.  [This is an important change. See the next question. Last year’s so-called “tax credit” wasn’t really a tax credit at all, but rather an interest-free loan that had to be repaid.]

 

14.    Do 2008 purchasers still have to repay their tax credit?

 

YES.  The $7,500 credit in 2008 was more like an interest-free loan.  All eligible purchasers who claimed the 2008 credit will still be required to repay it over 15 years, starting with their 2010 tax return. 

 

Some Practical Questions

 

15.    How do I apply for the credit?

 

There is no pre-purchase authorization, application or similar approval process.   All eligible purchasers simply claim the credit on their IRS Form 1040 tax return.  The credit will be reflected on a new Form 5405 that will be attached to the 1040.  Form 5405 can be found at http://www.irs.gov.

 

16.   So I can’t use the credit amount as part of my downpayment?

 

No.  Congress tried hard to devise a mechanism that would make the funds available for closing costs, but found that pre-funding would require cumbersome processes that would, in effect, bring the IRS into the purchase and settlement phase of the transaction. 

 

17.   So there’s no way to get any cash flow benefits before I file my tax return?

 

Yes, there is.  Any first-time homebuyers who believe they are eligible for all or part of the credit can modify their income tax withholding (through their employers) or adjust their quarterly estimated tax payments.  Individuals subject to income tax withholding would get an IRS Form W-4 from their employer, follow the instructions on the schedules provided and give the completed Form W-4 back to the employer.  In many cases their withholding would decrease and their take-home pay would increase.  Those who make estimated tax payments would make similar adjustments. [Check with your HR Department. What you just have to do, in many cases, is adjust the number of exemptions. It’s really very simple. One other observation: While people often like to get a refund after they file their taxes, that isn’t the best thing to do, financially. Ideally, you want to end up neither owing nor being owed any money after you file your taxes. So don’t worry about that big refund shrinking down. It’s really to your advantage if you get little or no refund.]

 

Some “Real World” Examples

 

18.   What if I purchase later this year but can’t get to settlement before December 1?

 

The credit is available for purchases before December 1, 2009.  A home is considered as “purchased” when all events have occurred that transfer the title from the seller to the new purchaser.  Thus, closings must occur before December 1, 2009 for purchases to be eligible for the credit.

 

19.    I haven’t even filed my 2008 tax return yet.  If I buy in 2009, do I have to wait until next year to get the benefit of the credit?

 

You’ll have a helpful choice that might speed up the process.  Eligible homebuyers who make their purchase between January 1, 2009 and December 1, 2009 can treat the purchase as if it had occurred on December 31, 2008.  Thus, they can claim the credit on their 2008 tax return that is due on April 15, 2009.  They actually have three filing options. 

 

·         If they purchase between January 1, 2009 and April 15, 2009, they can claim the $8,000 credit on the 2008 return due on April 15.

·         They can extend their 2008 income-tax filing until as late as October 15, 2009.  (The IRS grants automatic extensions, but the taxpayer must file for the extension.  See http://www.irs.gov for instructions on how to obtain an extension.)

·          If they have filed their 2008 return before they purchase the home, they may file an amended 2008 tax return on Form 1040X.  (Form 1040X is available at http://www.irs.gov) 

 

Of course, 2009 purchasers will always have the option of claiming the credit for the 2009 purchase on their 2009 return.  Their 2009 tax return is due on April 15, 2010.

 

20.    I purchased my home in early 2009 before the stimulus bill was enacted.  I claimed a $7,500 tax credit on my 2008 return as prior law had permitted.  Am I restricted to just a $7,500 credit?

 

No, you would qualify for the $8,000 credit.  Eligible purchasers who have already claimed the $7,500 credit on a 2008 return for a 2009 purchase may file an amended return (IRS Form 1040X) for the 2008 tax year.   This amended return will enable them to obtain the additional $500 credit amount.

 

21.    If I claim my 2009 $8000 credit on my 2008 tax return, will I have to repay the credit just as the 2008 credits are repaid?

 

No. Congress anticipated this confusion and has made specific provision so that there would be no repayment of 2009 credits that are claimed on 2008 returns.

 

22.    I made an eligible purchase of a principal residence in May 2008 and claimed the $7,500 credit on my 2008 tax return.  My brother, who has never owned a home, wishes to purchase a partial interest in the home this spring and move in.   Will he qualify for the $8,000 credit, as well?

 

No.  Any purchase of a principal residence (or interest in a principal residence) from a related party such as a sibling, parent, grandparent, aunt or uncle is ineligible for the tax credit.  Since you and your brother are related in this way, he cannot qualify for the credit on any portion of the home that he purchases from you, even if he is a first-time homebuyer. 

 

23.    I live in the District of Columbia.   If I qualify as a first-time homebuyer, can I use both the $5,000 DC credit and the $8,000 credit?

 

No; double dipping is not allowed.  You would be eligible for only the $8,000 credit.  This will be an advantage because of the higher credit amount, plus the eligibility requirements for the $8,000 credit are somewhat more easily satisfied than the DC credit.

 

24.    I know there is no repayment requirement for the $8,000 credit.  Will I ever have to repay any of the credit back to the government?

 

One situation does require a recapture payment back to the government.  If you claim the credit but then sell the property within 3 years of the date of purchase, you are required to pay back the full amount of any credit, including any refund you received from it.  A few exceptions apply.   (See below, #24).  Note that this same 3-year recapture rule applies, as well, to the $7500 credit available for 2008.  This provision is designed as an anti-flipping rule.

 

25.   What if I die or get divorced or my property is ruined in a natural disaster within the 3 years?

 

The repayment rules are eased for many circumstances.  If the homeowner who used the credit dies within the first three years of ownership, there is no recapture.  Special rules make adjustments for people who sell homes as part of a divorce settlement, as well.  Similarly, adjustments are made in the case of a home that is part of an involuntary conversion (property is destroyed in a natural disaster or subject to condemnation by eminent domain by an authorized agency) within the first three years.

 

26.    I have a home under construction.  Am I eligible for the credit?

 

Yes, so long as you actually occupy the home before December 1, 2009.

 

 

WITHHOLDING EXAMPLES: 

Note:  The impact of estimated tax payments would be the same.

 

Situation 1:  Sally plans her withholding so that her withholding is as close as possible to what she anticipates as her income tax liability for the year.  When she fills out her 1040, her liability is $6,000.  She has had $6,000 withheld from her paycheck.  She also qualifies for the $8,000 homebuyer credit. 

 

Result:  Sally’s withholding satisfies her tax liability and reduces it to zero.  She will receive a refund of the full $8,000.

 

Situation 2:  Nick and Nora file a joint return.  Nick is self-employed and makes estimated payments; Nora has taxes withheld from her salary.  When they compute their taxes, their combined withholding and estimated tax payments are $11,000.  Their income tax liability is $9,800.  They also qualified as first-time homebuyers and are eligible for the $8,000 refundable tax credit. 

 

Result:  Ordinarily, their combined estimated tax payments and withholding would make them eligible for a refund of $1200 ($11,000 – $9,800 = $1,200).  Because they are eligible for the refundable tax credit as well, they will receive a refund of $9,200 ($1,200 income tax refund + $8,000 refundable tax credit = $9,200)

 

Situation 3:  Cesar and LuzMaria both have income taxes withheld from their salaries and file a joint return.  When they file their income tax return, their combined withholding is $5,000.  However, their total tax liability is $7,200, generating an additional income tax liability of $2,200 ($7200 – $5000).  They also qualify for the $8000 first-time homebuyer tax credit.

 

Result:  Cesar and LuzMaria have been under-withheld by $2,200.  Ordinarily, they would be required to pay the additional $2,200 they owe (plus any applicable interest and penalties).  Because they are eligible for the refundable homebuyer tax credit, the credit will cover the $2,200 additional liability.  In addition, they will receive an income tax refund of $5,800 ($8,000 – $2,200 = $5,800).  If they owed penalties and/or interest, that amount would reduce the refund.


17 Questions To Ask Before Signing A Lease-Option

February 7, 2009

Recently, a person who was looking for a new place to live told me she was thinking of doing a lease-option–a rent-to-own–to buy a place. Her credit wasn’t that good, and a lease-option sound like a good idea. The rent-to-own was being offered by a real estate investor. This was going to be her first home purchase, and she figured she should be asking a lot of questions. But she didn’t know where to begin.

I provided some suggestions, and some explanations for why she should be asking those questions. Here’s what I told her to ask, and why.

What is the length of the option? [Aim for a minimum of 2 years. Longer is better–3, 4, or 5, for instance. It often takes more than a year to clean up your credit, accumulate sufficient option credits, and position yourself to buy a home. And in today’s economic climate, refinancing/purchasing in just a year may be difficult if not impossible.]

Is there a provision in the agreement that allows me to extend the option if I’m unable to get financing during the option period? [There should be. It probably would come at an extra cost, such as $1,000 or $2,000 to extend the option period.]

If the price of the home declines below the option strike price, what protections do I have? [Possibilities include extending the option period to allow home prices to climb again, or renegotiate the purchase price of the home so that the purchase price doesn’t exceed its true value.]

What will be the purchase price of the house? [That should be specified in the option agreement. Usually that’s specified as an exact price–for example, $425,000. It’s also permissible to say that the price will be determined upon exercise of the option. In that case, though, the exact method should be specified.]

What happens if the property owner can’t make his payments and there’s a foreclosure? [Straight answer: You’d lose out. The option would become worthless. An honest real estate investor will tell you that.]

How can I make sure the owner is making his mortgage payments? I don’t want to lose the property to a foreclosure. [There’s a document called “Authorization to Release.” It’s signed by the home owner, allowing the investor to contact the owner’s lenders and verify account balances, payments, and so on. Real estate investors typically have owners sign an authorization so they can make sure that there isn’t a looming default or foreclosure. Usually the tenant-buyer doesn’t request such a document, or even know of its existence. But someone should be monitoring the owner’s mortgage status to make sure that all is OK.]

Is this a sandwich lease-option? [It probably is if there’s an investor involved. That means the investor has negotiated a deal with the seller regarding monthly payment, purchase price, and other details. The investor then seeks a tenant-buyer. Generally the investor charges the tenant-buyer more per month than the investor is obligated to pay the seller. And the option price that the tenant-buyer pays is greater than the price negotiated between the seller and the investor. There’s nothing wrong with that arrangement. But it’s important to understand the role of all the players.]

Who is responsible for repairs on the property? [Often, it’s set up so that the tenant-buyer is responsible for the first couple hundred dollars of any repair, with the owner responsible for the remainder. The owner should keep his/her insurance in place on the property, to cover any insurable problems. And sometimes one of the parties–the investor or the tenant-buyer–will purchase a homeowner’s warranty to cover other problems and failures.]

How much of my rent payment is credited toward the purchase price? [It’s whatever you negotiate. Very roughly, 20% is often considered fair. If it’s much less, there may not be sufficient incentive for the tenant-buyer. And if it’s a lot more, that could cut into the seller’s (or investor’s) profits. But I’ve seen it as low as 10% and as high as 110%.]

How much up-front option money do I need? [That’s negotiable. Often, it’s the equivalent of 2-4 month’s rent. Generally, it shouldn’t be much more than that.]

If I don’t buy, what happens to my up-front option fee and my monthly option credits? [Honest answer: You lose them in most cases. Virtually all lease-options are written so that the tenant-buyer forfeits any option fees and credits if he/she doesn’t exercise the option.]

I know I need to improve my credit to buy. What would you suggest? [If the investor knows what he’s doing, he’ll suggest that you begin working immediately to clean up your credit. Often, the investor will have a mortgage broker or lender on his team, and will refer the tenant-buyer to that lender. It is NOT adequate to say “We’ll worry about that later” or “If you make all your payments on time, there shouldn’t be any problem.]

Since I’m buying, do I get to claim the taxes and interest on my tax return? [This is a question to determine the investor’s honesty and knowledge. The answer is “no.”]

How often do people like me buying a house on a rent-to-own actually end up buying the house? [We’re testing the investor’s honesty and knowledge again. The answer can vary anywhere from a low of 10% to as high as perhaps 70%. It depends on the conditions of the lease-option, the screening process used to select tenant-buyers, and the credit clean-up and restoration process of the tenant-buyer. Even in the best of circumstances, the figure seldom exceeds 70%.]

How can I make sure the owner doesn’t sell the home to someone else while I’m in it doing a rent-to-own? [The investor should have filed a “Notice of Agreement” with the local county or city records office. That notice will “cloud the title” of the property. Thus, whenever a title search is done on the property–which would occur if the owner attempted to sell the property to someone else–the notice will appear, clouding the title. The notice would have to be resolved before the seller could convey clear title to a new purchaser If a tenant-buyer is working directly with the seller, the tenant-buyer should have the seller sign a “Notice of Agreement” and file it.]

Won’t a rent-to-own trigger the “Due on Sale Clause” in the seller’s mortgage? And if it does, what happens to me? [If there’s a mortgage on the property, a rent-to-own can trigger the “Due on Sale Clause,” thus making the mortgage due and payable immediately. Frankly, that seldom occurs. Many lenders don’t notice the signs that possibly indicate that a lease-option has occurred. And even if they do, there isn’t much incentive for them to call a performing mortgage due. Currently, they have more than enough non-performing mortgages to worry about. But, technically, a lease-option or rent-to-own could trigger the Due on Sale Clause.]

Can I take the rent-to-own documents to my lawyer so he can review them? [The answer must be “YES.” Absolutely. If any investor, or any homeowner, shows any reluctance about allowing a tenant-buyer to have all documents reviewed prior to signing, then run away from that deal. And don’t settle for “That’s not our policy” or “We’ve never been asked that before” or “Sorry, but these are proprietary documents.” The answer must be “YES.” Period.]

Well, those are just a few of the questions a tenant-buyer should be asking the investor (or home owner, when an investor isn’t involved). Rent-to-owns actually can be win-win situations for everyone: owner, investor, and tenant-buyer. But the investor and the tenant-buyer both need to understand what they’re doing.