Real Estate in Steamboat

As popular as tax-free exchanges have become to investors and second-home buyers, facilitators are still facing the basic questions that were asked two decades ago.

The Federation of Exchange Accommodators (FEA) is a national trade organization formed in 1989 to represent qualified intermediaries (QIs) and their primary legal and tax advisors who are directly involved in Section 1031 exchanges, sometimes known as Starker exchanges. At the recent FEA mid-year conference in Washington, D.C., attendees shared common challenges they faced regarding the 1031 exchange industry. Vacation homes topped the list, even though the Internal Revenue Code is clear on the rules that differentiate a vacation or second home from investment property.

“Some business magazines and some Web sites have been giving information to consumers that is not correct,” said Tom Oldfield, a Tacoma, Wash., attorney and partner in Olympic Exchange Accommodators who attended the D.C. conference. “It seems many taxpayers believe they can exchange a vacation home at any time and that’s just not the case.”

Section 1031 of the IRS code allows that a property held either for business or investment can be exchanged tax-free for another “like kind” property of equal or great value if the exchange adheres to specific guidelines.

So, is your vacation home an investment property that can be exchanged or a second residence that would face a tax liability if it is sold? It usually comes down to how many personal days you use the property for vacation. If your vacation home is an investment property, the rule is that personal days must not exceed the greater of 14 days or 10 percent of rental days.

“Some people rent out their vacation home some years and don’t have any personal use,” Oldfield said. “Others rarely rent it out and use it solely for their family and friends. If you want to use the vacation home in a tax-deferred exchange, it must be used as a rental at least for the entire previous year and rented out at fair market value.”

Homeowners can flip-flop the status of the vacation home each year. For example, let’s say the cabin was used as a second residence in 2006 when you didn’t rent it out at all and it was used only for family weekends and reunions. However, in 2007 a college professor from the nearby community college rented the place for three academic quarters and the cabin became an investment property, thereby changing the tax status.

If you are planning to execute a 1031 tax-free exchange, make sure your vacation home held investment status for at least the previous year before attempting an exchange. While there are no absolute rules as to how long the property should be held as an investment, accountants suggest that the property show up as a rental on at least two consecutive tax returns.

“The consecutive part is what has been missing in some newspaper and magazine reports,” Oldfield said. “Some taxpayers have been led to believe that once the cabin has been used as an investment property that it can be used in an exchange at any time. If it reverts back to a second home in the year before the exchange, it would no longer be investment property and thus not eligible for the exchange.”

Income derived from renting out a second home or primary residence for a term of 14 days or fewer does not have to be reported to the IRS and does not change the tax status of the home. It’s only when you exceed the 14-day limit that a change occurs. The short-term rental (fewer than 14 days) happens all the time at pro golf tournaments where players or officials rent out fairway homes for the week or 10 days surrounding a big tournament. It’s a great way for homeowners to pocket tax-free cash.

Another popular tax strategy, especially for retirees, is to convert the second home to a primary residence. For example, let’s say a couple retires and sells the longtime family home, pocketing $500,000 tax-free from its sale. The couple moves into their vacation home, making it their primary residence. Two years later, they can sell the place, move into an in-city apartment and pocket up $500,000 tax-free again because it had become their primary residence.

Vacation homes can definitely help with your financial picture, however, make sure you are clear on the status before you attempt to trade or sell.

To get even more valuable advice from Tom, visit his Second Home Center.

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Copyright 2007 Tom Kelly

Editor’s note: Robert Bruss is temporarily away. The following column from Bruss’ “Best of” collection first appeared Sunday, March 19, 2006.

DEAR BOB: My fiance and I are splitting after a 10-year relationship. During this time, we bought two single-family houses and one duplex. When we started acquiring these properties, my credit was poor due to a bankruptcy, so all the property is in her name. I am worried that nothing is in my name. What should I do to protect myself and my interest in these properties, which have greatly appreciated in market value? –Dan C.

DEAR DAN: Please consult the best real estate attorney in town. Unless you have some type of written agreement, you might find it very difficult to prove an oral agreement to co-own the properties and split the profits upon sale. Now is the time to determine your exact legal rights in the properties, if any.

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It might be necessary to bring a legal action for a “declaratory judgment” asking the court to determine your legal rights. Your real estate attorney will probably recommend recording a “lis pendens” against the property titles to prevent their sale or refinance pending the outcome of the lawsuit.

Hopefully, you will be able to work out a fair settlement so legal action does not become necessary. Your situation is a classic example why it is so important to put everything in writing, especially because the Statute of Frauds requires written agreements for real estate contracts.

DETERMINING BASIS IN PROPERTY GIFT FROM DEAD DONOR ISN’T EASY

DEAR BOB: About 15 years ago, my dad deeded a vacant lot to me. He then built a modest house on that lot and I have rented it to my aunt ever since. My dad died about five years and my aunt died recently so I have decided to sell the property. How do I determine my basis and my capital gains? –Amy P.

DEAR AMY: It may be possible to determine from public records your late father’s purchase price for the lot. However, the amount spent to build the house on the lot will be more difficult, unless there was a construction loan or mortgage used to pay the cost. Fortunately, the Internal Revenue Service allows owners in situations like yours to make reasonable cost estimates.

From the adjusted-cost basis, I presume you deducted depreciation during the years you rented the house to your aunt. When you sell the house, this depreciation deduction will be taxed at the special 25 percent federal “recapture” tax rate. For full details, please consult your tax adviser.

IS A BROKER “TRANSACTION FEE” LEGAL?

DEAR BOB: As a home seller who paid my listing broker a 5 percent sales commission (split equally with the buyer’s broker who obtained the buyer), I was very upset when, at the closing, my broker demanded I pay a $395 “administration fee.” She said this is “standard” now. Because I wanted to get the sale closed, I stupidly agreed to pay. However, when I re-read my listing contract, I didn’t see anything about a $395 administration fee. I later talked with several other realty agents I know and they said they don’t charge such fees on top of a sales commission. Is this junk fee legal? –Brian K.

DEAR BRIAN: Real estate brokerage owners are well compensated from sales commissions. If you did not agree to pay the $395 administration junk fee, on top of your sales commission, as part of the listing contract, you should not have to pay.

I suggest you send a written demand letter to the broker insisting the $395 be refunded within 10 business days. If you fail to receive the $395, I would take the broker to local small claims court for breach of contract and fraud because you were not obligated to pay.

The new Robert Bruss special report, “How to Sell Your House or Condo for Top Dollar With or Without a Real Estate Agent,” is now available for $5 from Robert Bruss, 251 Park Road, Burlingame, Calif., 94010, or by credit card at 1-800-736-1736 or instant Internet delivery at www.bobbruss.com. Questions for this column are welcome at either address.

(For more information on Bob Bruss publications, visit his Real Estate Center).

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Copyright 2007 Inman News

Editor’s note: Robert Bruss is temporarily away. The following column from Bruss’ “Best of” collection first appeared Sunday, March 19, 2006.

If you or your parents are nearing retirement age and are considering a move to a new location, “50 Fabulous Places to Retire in America, Third Edition” by Arthur and Mary Griffith is a great place to start your quest. The authors list their top 50 favorite retirement spots, followed by six pages to explain the pros and cons of each town.

As you might expect, the list is weighted toward the Sunbelt. But, surprisingly, three of the best-rated retirement havens are in Alaska. One is in Minnesota, and two are in Montana. The authors don’t say these are inexpensive places to retire; just that they are “fabulous.”

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At the end of the book, after describing all the 50 locations plus nine “honorable mention” towns, the authors finally reveal where they retired. I’ll give you some hints: median home price $112,400; population 5,332; closest big city 200 miles away; lots of privacy and scenery; great fishing and hunting; and a nickname, “The End of the Road.”

The reports for each retirement town follow a repetitive formula that includes the cost of living, climate, medical care, available housing and costs, recreation, services just for seniors, education resources, and transportation. Having visited most of the places described, I found the reports for each town remarkably complete, even including “nice-to-know” information, such as community special events and state car-registration rules.

For retirees who want to keep busy with full- or part-time employment, or perhaps start a business, each town description includes “earning a living” resources. Especially valuable are the latest unemployment statistics and growth information. There is also extensive real estate information for both house and condo buyers, as well as prospective renters.

If the book has a fault, it is that much of the statistical information is from 2003 and 2004, rather than more up-to-date 2005 information.

A strange feature of the book is the authors recommend a local real estate agent for most, but not all, towns. Readers can’t help but wonder how the individual realty agent was selected and whether there are any “referral fees” involved. A disclaimer explanation would have been useful.

But this isn’t a “chamber of commerce” book that reveals only favorable information about the 50 towns. The authors don’t hesitate to disclose negative information. Each town description includes crime-rate information, including whether the crime rate per 100,000 population is above or below the national average.

For example, a few weeks ago I visited Raleigh, N.C., which I thought was a very friendly, affordable and interesting city with lots of diversity. However, I was shocked to learn this “fabulous place” has a crime rate far above the national average and the violent crime rate is extremely high.

In addition to the 50 descriptions of each retirement town, there are three fascinating short chapters with lots of valuable information and suggestions for retirees. They are titled “Facts, Numbers, and Tips”; “Friendly Internet Websites”; and “Moving is: Worse than a Root Canal, but More Fun Than a Water Slide.”

After having visited all 50 fabulous retirement locations, you are probably wondering where retirement location experts Arthur and Mary Griffith live. The book cover shows a color photo of them enjoying an obviously summer day near Homer, Alaska, where they live on (unpaved) North Fork Road. On my scale of one to 10, this well-researched book earns a solid 10.

“50 Fabulous Places to Retire in America, Third Edition,” by Arthur and Mary Griffith (Career Press, Franklin Lakes, NJ), 2006, $24.99, 340 pages plus CD-ROM; available in stock or by special order at local bookstores, public libraries, and www.amazon.com.

(For more information on Bob Bruss publications, visit his Real Estate Center).

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Copyright 2007 Inman News

Dear Barry,

I have not had a good night’s sleep since reading a recent article about asbestos. We’ve lived in our home for 30 years and have “popcorn” ceilings. I remember when we hung our swag lamp we could see fibers falling when we drilled holes. After all these years, is it too late to have the “popcorn” removed or are we already doomed? Some companies offer asbestos testing if you send them a sample, but is it safe for us to remove the sample ourselves? –Peggy

Dear Peggy,

You are not doomed. The belief that small or periodic exposure to asbestos fibers poses a major health risk has no factual basis. The connection between asbestos exposure and respiratory disease involves those who worked with asbestos materials on a daily basis, as manufacturers or installers. Large exposures to airborne asbestos fibers can cause lung cancer and other severe respiratory diseases, such as mesothelioma. But the mere presence of asbestos ceiling texture is not a cause for worry or alarm. The drilling of holes in acoustic ceilings should be avoided unless proper precautions are taken, but the fact that you once made a few holes in your ceiling should not be remembered as a moment when your fate was sealed.

Asbestos is a mineral fiber, commonly found in certain rock formations. It has been used in numerous manufactured materials for more than 100 years. Common asbestos-containing products include automobile brake linings, fire-proofing in high-rise buildings, air-duct insulation, and a long list of residential building materials such as floor tiles, asphalt roof shingles, drywall joint compound, and acoustic ceiling texture (commonly known as “popcorn” ceilings).

The national asbestos panic, which reached its peak in the late 1980s, was spawned and nurtured by sensational news reports, frivolous lawsuits and bureaucratic excessiveness. Fortunes were spent on asbestos removal, and many home buyers canceled purchase contracts at the mere mention of asbestos.

In the early 1970s, the gradual elimination of asbestos from many products was begun, but there was never an absolute ban on asbestos products. In the case of textured ceilings, the manufacture of asbestos containing acoustic material was prohibited in 1978, but the sale and installation of existing supplies were allowed to continue. Therefore, many homes that were built through the mid-1980s do have asbestos ceilings. This point should be noted by many remodeling contractors. Asbestos ceilings are often removed in ways that are illegal and potentially hazardous because of misinformation among tradespeople.

To determine if your ceilings contain asbestos, testing by a certified lab is necessary. You can hire a qualified professional to take the samples, or you can take them yourself. If you gather you own samples, precautions should be taken to avoid the release of airborne fibers. The material should be wetted, and a HEPA-type facemask (available at hardware stores) should be worn. A minimum of three samples should be taken from various rooms because asbestos content in acoustic ceilings may not be uniformly distributed.

If the lab report confirms that you have asbestos, removal is not necessary. What matters is that you avoid damage to the material. A common approach is to encapsulate the surface with paint. Many homeowners, however, prefer removal simply for cosmetic enhancement. Those who elect removal should have the work done by a licensed asbestos abatement contractor.

To write to Barry Stone, please visit him on the Web at www.housedetective.com.

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Copyright 2007 Barry Stone

Editor’s note: Robert Bruss is temporarily away. The following column from Bruss’ “Best of” collection first appeared Sunday, March 19, 2006.

DEAR BOB: I will be getting married soon. My fiancé and I will be buying a home together and selling our current residences for capital gains exceeding the $250,000 exemptions for each. If we put ourselves on each other’s title, and file a joint tax return, can we take advantage of the $500,000 married exemption per property and avoid capital gains tax? If so, can we use the $500,000 exemption twice in the same tax year since both properties will be sold in 2006? –Wilamena P.

DEAR WILAMENA: Adding your name to the residence title owned by your fiancé, or vice versa, won’t change anything.

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The reason is, to increase the principal residence sale tax exemption from $250,000 for a single owner to $500,000 for a married couple filing a joint tax return, both spouses must occupy the home at least 24 of the 60 months before its sale.

You can each sell your principal residences in the same tax year and claim up to $250,000 tax-free home-sale profit on each sale, thanks to Internal Revenue Code 121.

That’s presuming you each owned and occupied your home at least 24 of the 60 months before its sale. But you will owe capital gains tax, currently at the 15 percent maximum federal tax rate, plus state tax, on the capital gain exceeding $250,000. For full details, please consult your tax adviser.

UPSTAIRS CONDO OWNER’S NOISE IS A PRIVATE NUISANCE

DEAR BOB: I own a ground-floor condo, which I rent to a tenant. The resident owners of the unit above replaced their flooring with hardwood floors. My new tenant says the noise from the floors is intolerable and he wants to move out. With this noise problem, I am about to lose my tenant and I doubt I can even sell the condo if I disclose this noise problem to a buyer. I talked with the homeowner’s association. They advised that this is a problem between my neighbor and me. If I can’t work things out with my neighbor, do I have any recourse? This noisy floor is ruining my rental property. –Matthew D.

DEAR MATTHEW: The situation you describe is legally known as a “private nuisance” because it only affects one property owner. If it affected many owners, it would be a “public nuisance.”

If you can’t resolve the noise problem on a friendly basis with the inconsiderate upstairs neighbor, you may need to retain a real estate attorney to bring a private nuisance abatement lawsuit and sue for monetary damages.

NEIGHBOR LIABLE FOR DIVERTING WATER ONTO LOWER PROPERTY

DEAR BOB: About two years ago, my neighbor and I built a common cinderblock fence on our property line. She made additional improvements to her driveway on her side of the fence. Then she discovered her garage flooded with heavy rains. She rectified the problem by having the fence contractor punch a hole in the bottom of our fence to let the water drain into my yard. Now that part of my yard becomes a swamp when it rains. When I approached her about this problem she created, she said that is the natural way the water would run. She refuses to do anything. Is she right? Is her flooding my problem to fix? I am tempted to have the contractor come back to plug up that hole. –Katalin S.

DEAR KATALIN: The general rule is a lower property owner must accept the natural flow of water from an upper property owner. However, the upper owner cannot divert or channel water unto the lower property without liability.

Because you and your neighbor jointly built the cinderblock fence, it appears the rules of natural water flow no longer apply to your situation. Now your upper neighbor appears to be illegally directing or channeling the water onto your property.

Please consult a local real estate attorney to determine if “self-help” is appropriate by blocking that fence hole that directs water toward your property. Or perhaps you should file a lawsuit against your uncooperative neighbor to abate the private nuisance that she has created.

HOW LONG BEFORE OWNER-OCCUPANT CAN CLAIM $250,000 TAX BREAK?

DEAR BOB: After my rental property is converted to my principal residence, how long must I live in my house to qualify for the $250,000 tax-free from the sale? Some friends say two years, but others say five years. –Kimberly T.

DEAR KIMBERLY: If you acquired the rental residence in an Internal Revenue Code 1031 tax-deferred exchange, you must own the property at least 60 months before you can sell it and qualify for the Internal Revenue Code 121 principal residence sale tax exemption up to $250,000 (up to $500,000 for a qualified married couple filing a joint tax return.

Whether you acquired the rental house in a tax-deferred exchange or as a purchase, you must own and occupy it at least 24 of the 60 months before its sale to qualify for the IRC 121 exemption. For full details, please consult your tax adviser.

IS “BED-AND-BREAKFAST INN” A GOOD REALTY INVESTMENT?

DEAR BOB: My wife and I are thinking about selling our home, taking that $500,000 principal-residence-sale exemption you often discuss, and buying a small “bed and breakfast inn” where we have stayed many times. It has five bedrooms, plus an owner’s cottage in the back. Is this type of property a good investment? –Dan W.

DEAR DAN: A bed-and-breakfast inn is both a business and a real estate investment. Do you realize you will also be buying yourselves seven-day-a-week jobs? Please consider yourself fortunate if you earn much profit and if you eventually profitably resell.

I have some friends who owned a nice bed-and-breakfast inn in a resort area. The wife talked her husband into buying it. Only after moving in did they realize it was a full-time job (although they were able to hire outside help to give them a day off each week).

Due to a family situation a few years later they decided to sell. After the sale closed, the husband told me that was the happiest day of his life.

WHAT IF CO-SIGNER DEFAULTS ON HOME MORTGAGE?

DEAR BOB: A few years ago, my husband’s brother talked him into co-signing on a mortgage so the brother could buy a condominium. My husband had good credit and his brother did not. Since then, his brother has been in and out of jail, doesn’t work steadily, and my husband often has to pay all or part of the mortgage payments to prevent it from going into default. My husband wants his brother to sell the condo (which can be sold at a net profit of at least $75,000) but he refuses to sell. What can my husband do to get out of this mess? –Vivian R.

DEAR VIVIAN: Presuming he is a title co-owner, your husband can bring a partition lawsuit to force the sale of the property with the sales proceeds divided between the co-owners. He will need a real estate attorney to handle the legal details.

But before filing a partition lawsuit, if I were your husband I would sit down with the brother, explain the facts, and suggest they voluntarily agree to sell the condo without the costs of a partition lawsuit.

IS A “YIELD SPREAD PREMIUM” LEGAL?

DEAR BOB: I recently refinanced my home mortgage. I had to pay the mortgage broker a two-point loan fee. But at the closing settlement, the statement I received said there was a “yield spread premium” to the mortgage broker of $1,785. When I asked what this was for, I was told the lender paid my mortgage broker $1,785 on top of my two-point loan fee. Is this legal? –Miriam A.

DEAR MIRIAM: Yes. A “yield spread premium” fee is a legal kickback from the mortgage lender to your mortgage broker for producing a home loan with an interest rate higher than the lender requires.

For example, suppose the lender requires a 6 percent mortgage interest rate but you agreed with the mortgage broker to pay 6.25 percent interest. In addition to saying “thank you” to the mortgage broker, the lender paid a “yield spread premium” kickback fee to the mortgage broker.

When this occurs, often due to a decline in the mortgage market, many mortgage brokers will decrease the loan fee paid by the borrower. If you ask, perhaps your mortgage broker will refund part of the loan fee you paid him.

The new Robert Bruss special report, “How to Sell Your House or Condo for Top Dollar With or Without a Real Estate Agent,” is now available for $5 from Robert Bruss, 251 Park Road, Burlingame, Calif., 94010, or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com. Questions for this column are welcome at either address.

(For more information on Bob Bruss publications, visit his Real Estate Center).

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Copyright 2007 Inman News

Recently buyers who were in contract to purchase a home in Oakland, Calif., asked the seller to credit them money in escrow. The money was to be applied toward repairs that were recommended in the course of the buyers’ inspections.

The sellers were offended. They had agreed to sell for significantly less than their asking price. They weren’t inclined to make any further concessions. So they turned down the buyers’ request and told their agent to put the house back on the market. The buyers, realizing that they were buying the house at a fair price, removed their inspection contingency and the sale went through.

Most residential home purchase contracts include an inspection contingency for the buyers to inspect the property. It’s not uncommon for items to surface during the inspections that were previously unknown to both the buyer and seller.

Depending on how the contract is written, the buyers may be able to simply withdraw from the contract without penalty if they no longer want to buy the property. But if the buyers want to pursue the sale even in light of the inspection findings, there are several options.

If the defects are minor, they might simply remove their inspection contingency without asking the sellers to repair or pay for the defects. Or they could ask for a price reduction and agree to purchase the property “as is” with respect to the defects. Or they could ask the sellers to repair the problems. Or they could ask for a monetary credit at closing to offset some or all of the repair costs.

There are pros and cons to the various options, depending on the situation. Before making a request of the sellers, it’s wise to assess your chance of a success. For example, if there is a backup offer for more than the price you agreed to pay, the seller might be just as happy to see you move on to another house, which would free him up to sell at a higher price.

Sellers who are willing to negotiate on inspection issues might be more receptive to a price reduction or a credit at closing, rather than having to make repairs, particularly if they are moving out of the area.

HOUSE HUNTING TIP: From the buyers’ perspective, it’s usually better to ask for a lower price than a credit, especially if your property taxes will be based on the purchase price and if you have plenty of cash to pay for the repairs. A credit works well for buyers who are cash-strapped. The credit offsets some of the buyers’ closing costs and thereby frees up cash for repairs.

Before you ask for either a price reduction or a credit — particularly if the amount is large — be sure to talk with your mortgage broker or loan agent. A large price reduction could be a red flag to a lender who might want to see inspection reports. This could cause the terms of the transaction to be modified if the lender then required that work be done before closing. In this case, the close of escrow might have to be delayed, which could raise problems for both the buyer and seller.

Lenders also have limits on how much money a seller can credit a buyer at closing. On a mortgage for 100 percent of the purchase price, lenders usually limit the amount of a credit to 3 percent of the purchase price. On loans for 90 percent or less of the purchase price, the limit is often increased to 6 percent.

THE CLOSING: However, in either case, the amount of the credit cannot be more than the actual amount of the buyer’s nonrecurring closing costs — those costs paid by the buyer one time only at closing.

Dian Hymer is author of “House Hunting, The Take-Along Workbook for Home Buyers” and “Starting Out, The Complete Home Buyer’s Guide,” Chronicle Books.

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Copyright 2007 Dian Hymer

Extensive payment problems among subprime mortgage borrowers, along with the failure of a number of subprime lenders, have been major news topics in recent months. Speculation about the causes of the defaults has been widespread. That is the topic of this article.

Future articles will consider why so many lenders have failed, the impact of the crisis on the current availability of credit to prospective new subprime borrowers, and what — if anything — government should do. The final article will discuss whether the subprime market could and should be replaced, and, if so, by what.

Ending of Price Appreciation: The immediate cause of turmoil in the subprime market was the end of house-price appreciation. Property values in most areas stopped rising in 2006, and in many areas they have since declined. This has led to a rise in delinquencies and defaults on what I call “appreciation-dependent mortgages” — those that worked for borrowers only if their properties appreciated. A large proportion — but not all — of such mortgages were subprime.

Speculative Purchases: Some houses were purchased with 100 percent loans by borrowers hoping to turn a quick profit from future appreciation. These loans were made for the full amount of the purchase price or appraised value — no down payment was required.

Home buyers taking these loans had negative equity the day they closed, in the sense that if they were forced to resell immediately, the transactions costs — which can be 5 percent or more — would have to be paid out of their pockets. The buyers looked to appreciation to cover the costs and make a profit.

When the appreciation doesn’t materialize, even if the payments remain affordable, the financial incentive to make them is substantially weakened. Most do continue to pay because they want to remain in the house and they don’t want to ruin their credit, but some fold their cards and walk away. The result is a foreclosure.

Speculative Refinances: A presumption that their houses would appreciate also infected the refinance decisions of many borrowers. A question house purchasers asked me in 2004-05 with distressing frequency was “How long do I have to wait (after purchase) before I can refinance to take cash out?” Some of these borrowers were influenced by a new breed of financial planners and mortgage brokers who promote the view that unused equity should be used for investment — in common stock, property or annuities.

Some homeowners used the growing equity in their homes as a way to live beyond their means. They would build up credit card debt, then consolidate the debt into their mortgage through a cash-out refinance. The consolidation — by extending the term of the credit card debt, reducing the rate and making the interest tax-deductible — would reduce the borrower’s total monthly payment. They could then start building up their credit card debt all over again.

This process could continue only so long as their houses appreciated. As soon as appreciation stopped, they were stuck with total debt service costs that might be unmanageable or with negative equity in their house, or perhaps both.

Unaffordable Mortgages: The most commonly used mortgage in the subprime market is the 2/28 ARM. This is an adjustable-rate mortgage on which the rate is fixed for two years, and is then reset to equal the value of a rate index at that time, plus a margin.

Because subprime margins are high, the rate on most 2/28s will rise sharply at the two-year mark, even if market rates do not change during the period. This means that while the loan is affordable to the borrower at the initial rate, it may not be affordable after two years when the rate is reset.

If the house has appreciated, this is not usually a problem because the borrower can refinance — if necessary, into another 2/28. While these loans carry refinance costs and typically have prepayment penalties, the costs and penalty can be included in the balance of the new loan if the borrower has sufficient equity.

The borrower who does not have the equity needed to refinance, however, is stuck with the higher payment on the existing 2/28 that may be unaffordable.

The upshot is that many consumers made purchase and refinance decisions based on the premise that their houses would appreciate, as they had for many years. When appreciation abruptly stopped, both their incentive to make their payments and their ability to do so was sharply reduced. While it wasn’t only subprime borrowers who fell into this trap, these borrowers had the least capacity to extricate themselves.

This raises an obvious question: Why was the mortgage lending industry willing to make loans that were workable for the borrowers only if their properties appreciated? This will be discussed next week.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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Copyright 2007 Jack Guttentag

Rates are up, decisively: mortgages are 6.375 percent, taken by the 10-year T-note blowout from five weeks in the four-sixties to 4.77 percent, very much at risk for further increases.

The end of the standoff between the recession-coming and all-OK camps was a three-act play, beginning with an exchange between former Fed Chair Alan Greenspan and Bill Gross, PIMCO’s bond impresario. Gross confessed that he had been wrong as a recession camper, and Greenspan described the three-year interest-rate outlook: “higher.”

Act II was a whispering affair, a conference of central bankers devoted to new-age financial-market risks. The net result of kabuki speeches: central bankers everywhere are aware that there is an ocean of cash sloshing around the world, creating mini-bubbles and suppressing reasonable assessment of risk in markets. These pinstripers cannot determine any better than the rest of us whether the cash is the result of the world getting rich on multilateral trade, or nouveau financial gadgets blinding everyone to real risk — but either way, there is no chance that the Fed will cut its rate while the system is already awash in liquidity.

Act III was yesterday’s news of a sustained drop in new applications for unemployment insurance to a 14-month low. Whatever damage housing is doing to the economy is still contained.

This whole psychology has changed very fast. I get the sense from the central bankers that they are uneasy, feeling behind — not behind some old-fashioned inflation curve, but that financial innovation has diminished central bank command of the financial system. The global economy displays every sign of unprecedented health, which does reduce many risks, but simultaneously introduces new ones, contraction giving way to exuberance. The near-total absence of risk premia — for time, credit, liquidity or correction — cannot last, yet Gross, the biggest bond manager extant, has publicly acknowledged his exhaustion with betting on restored premia.

Does that mean that risk just fell another notch, or increased?

We’re still learning about Fed Chair Ben Bernanke, and it’s a slow process because he doesn’t say much. So, listen harder.

Bernanke spoke on Tuesday about the issue of risk, and the kids’ fooling around with the financial chemistry set. His adopted rhetorical style is to list all the issues — in this case, all the potentially troublesome explosives — to let us know that he is paying attention, but offered not a single phrase of conclusion.

He was more forthcoming in his speech yesterday on subprime mortgages. He made it clear that he has no interest in a regulatory effort to intercept future abuses: “… Disclosure is the first line of defense. …” He is wrong, of course: disclosure won’t do a thing to stop my clients yesterday, who, despite two excellent government-sector jobs, are drowning in debt, have withdrawn and blown their retirement funds, and are absolutely determined to buy with nothing down a house that they cannot afford. Only tough-minded, regulation-based underwriting will defend that line.

He did not mention the Fed’s blood-and-thunder, formal supervisory guidance of September 2006, tightening standards for interest-only and negative-amortization loans, nor the fact that no entity anywhere has come into compliance. Withdrawn? Suspended? Forgotten?

Offensive to me, on page four of the subprime remarks Bernanke adopted the Wall Street line that mortgage misbehavior was the work of originating firms. Sure. Those poor, innocent investment bankers had no idea what they were buying. He is right that markets are “self-correcting” now, and it will be a while before the IBs and the rating agencies again conspire to ignore suicidal mortgage risk just because they can re-sell freshly painted derivative trash at fat prices.

However, if Bernanke does not grasp the role of Street suction in this mortgage episode — runaway IB demand for bad product — then I have very little faith that he has correctly measured other risks inherent to the nouveau sausage machines.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.

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What’s your opinion? Send your Letter to the Editor to opinion@inman.com.

Copyright 2007 Lou Barnes

Editor’s note: Robert Bruss is temporarily away. The following column from Bruss’ “Best of” collection first appeared Sunday, March 26, 2006.

Thanks to abnormally low mortgage interest rates, home sellers had an extremely favorable “seller’s market” for the last few years. That means there were more qualified home buyers in the market than there were homes available for sale.

Homes often sold in just a few days or weeks. Typical home sale prices appreciated 10 percent or more annually for the last few years in many communities. Since 2000, the average U.S. home has doubled in market value, according to the National Association of Realtors.

Purchase Bob Bruss reports online.

But the 2006 home sales market pace has rapidly slowed down in most communities, mostly due to rising mortgage interest rates, according to home industry economists. The volume of home sales is down. But home sales prices are holding steady in most communities.

The result for this year’s peak spring home sales season appears to be a “buyer’s market.” That means there are more houses and condominiums available for sale than there are qualified home buyers.

As a result, home buyers can be more selective and negotiate harder even though mortgage interest rates remain remarkably affordable in the 6 percent interest range. To help home buyers negotiate their best possible sales price and terms, here are the five key questions home sellers and their real estate agents hope buyers don’t ask:

1.) WHY ARE YOU SELLING THIS LOVELY HOME?

Having bought and sold dozens of houses and condominiums for both personal use and as investments, this is my favorite and most revealing question to ask of home sellers and their listing agents.

Even if the home is run-down and shabby, I always try to use that word “lovely” to see if the seller and/or the listing agent have a sense of humor.

The primary reasons the home buyer needs to know why the seller is selling are to (1) tailor a purchase offer that will meet the seller’s needs, and (2) determine if the seller is highly motivated to sell.

To illustrate, if you learn the sellers are moving to a retirement residence, perhaps they will carry back a first or second mortgage, thus creating superb secured income earning around 6 percent for them and easy financing for you as the buyer. Or, maybe you learn the sellers are in foreclosure so the buyer needs to act fast to close the purchase before the foreclosure auction.

Unless the buyer asks, the listing agent is unlikely to volunteer the reason for selling. Occasionally, the buyer will be rebuffed.

For example, I recall I once asked this key question and the nasty listing agent said, “It’s none of your business.” Later, I learned the sellers were retiring to move to Palm Springs, Calif., and they would have been perfect candidates for a seller-financed mortgage.

2.) HOW MUCH DID THE SELLER PAY FOR THIS HOME?

In most communities, this information is a public record, which the buyer’s agent can easily obtain. The reason smart home buyers insist on knowing this vital information is it shows how much negotiation room the seller has.

A key follow-up question is, “What is the current mortgage balance and are there any other liens against the home, such as a second mortgage or home equity loan, judgment liens, and mechanics’ liens?”

The answer from the seller or the listing agent shows how much cash the seller absolutely must receive. If you learn the home is free and clear with no encumbrances, you just struck gold because the seller can then be flexible as to price and terms.

As a seller, when a home buyer asks me what I paid for the property, I politely reply, “I got a bargain purchase price when this was a run-down shack before I renovated it so my purchase price is irrelevant to today’s market value.”

If a smart home buyer, and his or her buyer’s agent, discover the seller paid a low purchase price many years ago, that means the seller has lots of room to negotiate. However, if you find out the seller bought the house in the last year or two with a large mortgage or two, the seller might not have much negotiation flexibility.

3.) WHAT DEFECTS DOES THE HOME HAVE AND HAVE THERE BEEN ANY RECENT PROFESSIONAL HOME INSPECTIONS?

In most states, home sellers must now provide buyers with written home sale disclosures revealing any material facts that affect the home’s market value or desirability.

Smart listing agents obtain the seller’s written disclosures at the time of listing and have it easily available to prospective buyers. Then buyers won’t be surprised later by discovering the home has major problems that were already disclosed by the seller.

Home sellers, at the suggestion of their listing agents, often have customary professional inspections completed before the home is put on the market. Then the seller can either have any defects repaired, or at least can make the buyer aware of them before the purchase offer is made.

Of course, after the seller accepts the buyer’s purchase offer in writing, the buyer should always hire his or her own professional inspector just to double-check the seller’s inspector. If the buyer’s inspector discovers any undisclosed defects, then negotiations can be reopened if the buyer included a professional inspection contingency clause in the sales contract.

A good source of quality home inspectors is the American Society of Home Inspectors. To find local ASHI members, go to www.ashi.org or phone 1-800-743-2744.

4.) WHAT PROBLEMS HAVE YOU HAD WITH THIS HOME?

An open-end question like this will remind the home seller of any problems that, hopefully, have been corrected.

For example, when I first moved to my current home I quickly discovered I couldn’t have a decent garden because the deer would eat virtually everything. So I constructed fences to solve that problem. A few years later, the wood shingle roof began to leak but new leaks kept reappearing after a roofer made repairs. About 20 years ago, I had a new metal “lifetime” roof installed and I have had no further roof problems.

In most states, court decisions and statutes do not require home sellers to reveal past problems that have been corrected. But it is still important for buyers to know if those past problems might again become future problems.

5.) WHAT IS THE QUALITY OF THE PUBLIC SCHOOLS?

If you don’t have school-age children, it’s easy to forget this important question. But top quality schools contribute to home values and future market value appreciation. Families prefer to buy in communities with superb public schools and are willing to pay extra for the privilege.

However, in many big cities where the public schools are poor quality, families who buy a house or condo there realize the low school quality contributes little or nothing toward residence values.

Because most home sellers do not have accurate information on public school quality, the buyer’s agent should provide their home buyer with the latest school quality statistics, usually based on standard test scores and high school graduation rates.

Most real estate brokerages have access to the Internet resource www.schoolmatch.com, which tracks over 14,000 public school districts. Over 7 million parents accessed School Match services last year. A related Internet resource is www.houseappreciation.com, which rates the top 32 percent of communities based on their school quality and home value appreciation since 1994.

SUMMARY: Home buyers should always ask the five key questions sellers and their listing agents hope you don’t ask. The answers help eliminate undesirable homes and maximize the home buyer’s negotiation information. More details are in my special report, “The 10 Most Important Questions Home Sellers Hope Their Buyers Don’t Ask,” available for $5 from Robert Bruss, 251 Park Road, Burlingame, Calif., 94010, or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com.

(For more information on Bob Bruss publications, visit his Real Estate Center).

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What’s your opinion? Send your Letter to the Editor to opinion@inman.com.

Copyright 2007 Inman News

Although Mother’s Day has passed, it’s never too late to get Moms who love do-it-yourself projects some cool new tools. These tools are available at most home centers and hardware stores, or through on-line retailers, and the prices shown are approximate:

Werner Aluminum Work Platform ($39.95): This sturdy, well-built folding work platform is ideal for a variety of home improvement projects, particularly painting. The platform itself is almost 40 inches long and 12 inches wide, with a working height of 20 9/16 inches. It allows you to work comfortably along walls and windows, and at about 12 pounds it’s a lot easier to move around than a ladder. The legs fold up for easy storage, and lock firmly in place for use. Nonmarring rubber feet keep the bench firmly in place while protecting the floor from damage.

Ryobi Cordless Stapler ($39.95) and Random Orbit Sander ($44.95): These two tools are part of Ryobi’s lineup of One + 18-volt cordless tools, a very nice system they’ve developed that allows you to save some money by purchasing the tools separately from the charger and battery (which are universal and interchangeable for all the One + tools).

While heavier than a conventional staple gun, the cordless stapler eliminates the hand and wrist fatigue that comes with squeezing a manual trigger over and over. The gun has an easy-load staple magazine that accepts staples in lengths from 1/4 inch to 9/16 inch, with a convenient window to let you know when you’re running low on staples. The gun has a comfortable, nonslip handle, and the top-mounted adjustment knob allows you to control the depth of the staple to match the application.

The cordless random orbit sander, which accepts standard hook-and-loop sanding disks, is ergonomically designed to fit comfortably in your hand while freeing you up from the hassles of a cord. The top-mounted battery helps balance the tool, and the rubberized gripping area gives you a nonslip hold in any working position. With the random-orbit motion of the sanding head, Ryobi’s sander is great for everything from finishing wood to refinishing furniture, and even sanding drywall.

Stanley IntelliLaser Pro Stud Finder and Laser Line Level ($69.99): Here’s a great two-laser set that can really be a huge help on a variety of home improvement tasks. The main laser can project a sharp, clear laser line for up to 20 feet, and the built-in plumb and level vials guide you to an accurate setup. The tool doubles as a stud sensor, and features an easy-to-read backlit LCD screen and an audible tone that lets you know when you’ve found a stud. The stud finder works with 1/2-inch- to 1 1/2-inch-thick materials.

Included in the kit is a second laser that also projects a 20-foot line. You can use it in conjunction with the main laser tool to set up perfect laser cross lines for everything from hanging pictures and shelves to getting perfect layouts for floor tiles. Eight removable adhesive tabs are also included for temporary wall mounting.

Dremel Glue Gun ($24.99): For a wide variety of craft and home improvement projects, hot glue guns are a great choice, and this one from Dremel offers high quality and a great lineup of features. There’s an on/off switch that eliminates the need to unplug the tool between uses, separate LED lights to let you know when the tool is on and when it’s ready for use, and dual temperature settings for use with all standard glue sticks. It has a handy “kick stand” that keeps the gun stable when you set it down, and a soft trigger and built-in work light for ease of use. Dremel has developed an Anti-Drip nozzle to help keep your project and your work area free of unwanted drips, and the gun comes complete with three interchangeable nozzles.

Black & Decker Simple-Start ($49.99): Don’t let Mom risk being stranded somewhere, like on the way back from the home center with all her project supplies. Black & Decker’s Simple Start is a small, portable car charger that plugs into the 12-volt power outlet and boosts the battery power to get her restarted and back on the road. No need to lift the hood or break out the jumper cables — just plug it in, wait a few minutes, and restart the car. It has a built-in work light, recharges from regular household power or from the car’s 12-volt system, and can even be used to recharge a cell phone battery.

Remodeling and repair questions? E-mail Paul at paul2887@hughes.net.

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What’s your opinion? Send your Letter to the Editor to opinion@inman.com.

Copyright 2007 Inman News