DEAR BENNY: For the life of me I cannot fathom why all real estate people insist borrowers keep a mortgage going. My husband and I bought our house and paid it off in five years. Now, instead of getting a deduction off our taxes, we have our paychecks free and clear. I cannot see how paying $1,000 a month for 30 years would have been better. With that money in pocket we amassed nearly $1 million in savings. Here is what it allowed us to do:
- We paid outright for my college education. No huge debt on graduation!
- We bought two rental properties, which we also paid off within 10 years and now collect all of the rent. We pay only the taxes.
- We bought a really nice boat that will be paid off in four years from the rents and no mortgage on our house.
- We have traveled both the U.S. and Europe with our family.
- We have put in a swimming pool.
When the market went nuts, we stayed in our 1,600-square-foot, three-bedroom ranch house. It is paid for, and no one can touch it, take it or foreclose on it. If we sold it today, we would still make a profit. My friends who got huge mortgages are truly strapped by their houses for now and for the foreseeable future. They lose sleep over it.
We saved hundreds of thousands of dollars in interest that we get to use as we see fit rather than handing it over to a bank.
I was able to stay home and take care of our kids for five years! All of this from the meager salaries of a teacher and enlisted sailor!
The mortgage deductions we "lost" would have recouped us about 28 cents tops on the dollars we put out. But we would still be under the payments all these years later, losing 72 cents per dollar. Why do you not see that? House rich and cash poor? How? Our paychecks and rents are money in the bank.
When my husband was without a job for a while, we never had to worry about losing the home we love. Nor did we have to worry about choosing to pay a mortgage or feeding our family. We had enough money left over each month to invest and save for retirement so that we don’t have to worry in the future. If we ever need nursing care, our kids can sell the house and not have to be burdened with paying for nursing homes, plus they will still inherit a nice chunk of money.
Unfortunately for my recently passed father-in-law, he followed the advice you all chorus. He was 88 years old and paying a mortgage. Well, the house went into foreclosure when we had to choose to either pay the mortgage or pay for his nursing home. With his severe dementia and being bed-ridden, his house became one more huge burden on my already stressed spouse. His entire "deduction" was less than a few thousand off his taxes. But, the cost to us was unbearable. So he lost everything by keeping up that deduction.
We are still dealing with the foreclosure almost two years later. If he had paid it off, we could have sold it for any amount and been done with it. My own mother, under the advice of a real estate banker, kept a huge line of credit mortgage on her home. Because my dad died, my mother is so burdened with the payments that she is about to walk away from her home of 35 years. Gee, maybe she should be glad she saved 28 percent on her deductions. All those thousands of dollars down a hole.
How do you all justify that logic? I have listened to it all my life and never understood it. Especially after living just the opposite and doing so much better. –Michele
DEAR MICHELE: Thank you for your very interesting observations and comments. You clearly have your life and your financial situation in good hands.
I am not sure that I have ever categorically written "don’t pay off your mortgage." My message to readers (and clients) over the years is that everyone has different circumstances and different financial situations, and you have to tailor your plans accordingly.
In your case, you obviously did well and appear to be well off. But I have represented (and heard from) too many people who are not as well off as you. They live from day to day, worrying about where they will get the money to pay their mortgage, their real estate tax and their home insurance. They are the people who end up "house rich and cash poor."
Let’s say you have $100,000 in your savings — not including retirement plans. Let’s also say that your mortgage is $100,000. If you pay it off, you have no savings left for that important rainy day. If you keep the savings, you at least are guaranteed to have sufficient money to make the monthly mortgage and pay the real estate tax should you lose your job or encounter other financial casualties.
However, I have also strongly recommended that homeowners should (if at all possible) start making additional payments on a monthly basis toward their mortgage. If you make the equivalent of one additional month’s payment per year, you will reduce a 30-year loan down to approximately 22 years.
And while I agree that saving 28 cents by way of a tax deduction doesn’t compensate for paying 72 cents’ interest every month, I still believe that under my recommendation, 28 cents’ saving is still a saving.
One final point: With interest rates so low nowadays (hovering in the very low 3 percent), why pay it off? One client recently told me, "I have such a low mortgage interest rate now that I will use my own savings for other investments."
And, regardless of whether your home is free and clear or burdened with a mortgage, I strongly recommend that everyone obtain a home equity line of credit (HELOC). Typically, banks do not charge for setting this up, and you pay interest only on the moneys you actually borrow. It is a comfortable feeling to have that checkbook in your desk drawer just in case you need quick cash.
DEAR BENNY: My mom no longer wants the responsibility of homeownership. She no longer wants her 3,000-square-foot home and is willing to give it to me, as a gift, if I move in and care for her. If she transfers the title into my name, how will this impact my taxes? Or her taxes? Can she gift it to me for $1? –Anne
DEAR ANNE: You really have to discuss your situation with your own tax adviser, but let me provide you with a general response. Your mother can gift the property to you for zero dollars. However, there are taxable consequences for both of you.
Your mom has the right to gift you up to $13,000 this year completely tax-free. It has been reported that this will increase to $14,000 next year. Any gift over that amount must be reported to the IRS. So, for example, if the house is valued at $200,000, your mom has to advise the IRS of a gift of $187,000. This year the total gift exemption is $5.12 million. While your mother will not have to pay any tax on the gift, it will reduce the total exemption by the amount she reports to the IRS.
I seriously doubt this will be a real problem for your mother, unless she is a millionaire.
You, on the other hand, may have a tax problem. The tax basis of the donor (your mom) becomes your tax basis. So if your mom bought the property for $50,000 years ago and gifts it to you, your basis for tax purposes is $50,000 (I am ignoring any improvements she may have made since some improvements will increase basis.).
The house, in our example, is now worth $400,000. If you go to sell it, you may have to pay a large capital gains tax based on the difference between the $50,000 basis and the $400,000 selling price, less closing costs such as a real estate commission. This can be a large amount of money
Of course, if you will have lived and owned the property for two out of the five years before it is sold, you can exclude up to $250,000 of gain, or up to $500,000 if you are married and file a joint return with your spouse.
In general, I don’t think it’s a good idea for your mom to gift her property. If your mother really wants out, why not arrange to buy it from her for a price that is close to market value — less any real estate commission that does not have to be paid. Your mother can then cancel up to $13,000 of monthly payments each year ($14,000 next year) so in effect you will have gotten that gift.
Your mother may have to pay some capital gains tax, unless she can prove that she has owned and lived in the property for the two years before sale. In that case, she can exclude the gain as outlined earlier.
Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to firstname.lastname@example.org.
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