> Buyers' Advice
Two Loans Or One? Will It Work?
by Benny L. Kass
Question: My sister and I plan to team up to purchase a home for our elderly parents. The purchase price of the home will be approximately $200,000. We have considered putting down $30,000 and then obtaining a mortgage for the rest ($170,000). My sister and I would be joint owners of the property. However, a friend recently told me that this is not a good idea because both my credit record and my sister's record will show a loan of $170,000. He said that my sister and I should each take the property as a tenants in common role. Under his plan, he said that my sister and I should each put down $15,000 ($30,000 total) and that we should each obtain a mortgage loan for $85,000 (one under my sister's name and one under my name). The total down payment is $30,000 and there are two $85,000 loans ($170,000 total debt). He said that under this method there would only be one $85,000 loan under each of our names so that our credit records would not be affected as much. Is my friend's advice well-founded? Answer: You have a creative friend, and it's an interesting suggestion, but unfortunately, it won't work. You have actually asked two questions: - Can you get two loans instead of one, and
- How should you and your sister take title to your parents' property?
Let's look at the two loan issue. A mortgage (also called a Deed of Trust) is a loan made by a lender to a homeowner. The lender wants security -- a guarantee -- that should you be unable to pay the entire loan in full (including interest), the lender will not lose its investment. Thus, the Deed of Trust is recorded on the land records in the county (or city) where your property is located. The purpose of recording is to put the entire world on notice of the existence of this mortgage. If, for example, when you go to sell the house, your purchaser will arrange for the title to be searched, and that mortgage will be discovered. It must be paid off so that the new buyer will get the house free and clear of any old mortgages. There is a priority on land records, which is very important in the law. A mortgage which is recorded first has a priority over any other subsequently recorded documents, expect some items -- such as certain kinds of governmental taxes -- which by statute have been given a super-priority status. You cannot record two documents on land records at the same time. If your sister's mortgage is recorded first, your mortgage will be in second position. That's the meaning of a "second deed of trust." Most mortgage lenders do not want to be in a second trust position. Why? Because should the first mortgage go into default and be foreclosed upon, the second deed of trust will be effectively eliminated. Let's take your example: The first trust is in the amount of $85,000. If the first lender forecloses on the property, and it is purchased at a foreclosure sale for only $100,000, the first trust lender will be paid in full. But the second trust holder will only get the balance remaining from the $100,000. And from my experience, by the time the lawyers, the auctioneers and the advertisements are paid, very little if any money will be left over for the second mortgage holder. This does not mean, of course, that the second trust holder has no remedies. They can still pursue the maker of the promissory note for the moneys which are owed. But if that note maker has no money -- or files for bankruptcy protection -- the second trust holder is left holding an empty bag. Your friend is correct that if you and your sister get a combined first mortgage in the amount of $170,000, both of your credit reports will show the full obligation. But I believe that should either of you want to borrow money for other purposes, you will be able to explain the situation to the new lender. When they realize that you are helping out your elderly parents, and if you would otherwise qualify for that new loan, you should not have a real problem. Taking Title: There are two ways that you and your sister can take title: - Tenants in Common: Under this approach, you and your sister own a divided interest in the property. While typically the interest is 50-50, it can be held in any percentage that you and your sister agree upon. On your death, your interest in the property will be distributed in accordance with your Last Will and Testament (which, by the way, you should have). If, for example, either or both of you are married with children, do you want your family to get your half of the property? If so, tenants in common is the best way to accomplish this.
- Joint Tenants With Right of Survivorship: Here, you and your sister own an indivisible interest in the entire property. On your death, for example, regardless of what your Will states, your sister (as joint tenant) will end up owning the entire house.
I cannot tell you which is the better route for you to take. Everyone has different needs and concerns. You should each talk to your own (separate) attorney to see what is best for both of you. I have one additional suggestion which may be of interest to you. If your parent's home is free and clear of any existing mortgage (or if the amount of any mortgage is low enough that you and your sister can pay it off), have you considered buying the house from your parents and letting them take back a mortgage? Here's how that would work. You would both buy the property and take title as you and your lawyers have decided. You would give your parents the $30,000, and you would both sign a promissory note in favor of your parents for the balance of $170,000. This note would be secured by a deed of trust and recorded among the land records. Each and every month, you and your sister would pay your parents the loan payment, based on whatever interest rate has been agreed upon when the transaction was first entered into. If your parents do not need the money, they can gift each of you up to $11,000 every year, tax free. On the other hand, if your parents need the money, they can keep your monthly payments. Why go this route? If your parents do not need the full $200,000 sales price, it is clearly less expensive to keep the loan "in house." You will not have to pay a lot of lender's charges, such as appraisal, credit check, document preparation, etc. More importantly, you are paying your parents -- rather than a stranger -- on a monthly basis. And finally, don't forget that when your parents file their income tax return for the year in which the property was sold, assuming that they have owned and lived in the house for two years before it was sold, they will not have to pay any capital gains tax. If they file a joint tax return, they can completely exclude up to $500,000 of any gain. And even should they be filing separate tax returns, they can each exclude up to $250,000 in gain. You and your sister will also get some tax benefits. The mortgage interest which you will pay -- either to your parents or to the commercial lender -- is deductible on your income tax returns. However, keep in mind that mortgage interest is only deductible if the mortgage is recorded on the land records. If you obtain a commercial mortgage, that lender will make sure that the deed of trust is properly recorded. If you decide to give a mortgage to your parents, however, please make sure that you arrange to record the mortgage as soon as possible. |
