DEAR BENNY: My mother was under contract to buy a foreclosed house from the bank. Before closing, she had the house inspected. During the time the house was being inspected, the heat and water system was shut off (I guess the former owners weren’t paying their water and gas bill). The inspector documented in his report that the heater and water were not inspected and further stated that when it is turned on we should consult a contractor to check that everything is in order. My mother signed off and purchased the house. When the water was turned back on, she discovered that one pipe was leaking and the heater was not working.
These are health hazards, and my mother must fix everything. Who is responsible: the bank for not turning on the heat and water system so that everything could be inspected properly or my mother for insisting that the utilities be in working order before the inspection? We did not know our rights because we were dealing with a foreclosure property. –O.K.
DEAR O.K.: I am afraid that your mother will have to fix these problems at her expense. And the advice that I will provide below applies whether you are buying a foreclosed house, an older property or even a brand-new one.
I am a strong believer that anyone who buys a house must have an independent housing inspector thoroughly evaluate the house and provide you with a written report. Your purchase and sales contract must contain an "inspection contingency" — which means that you have XX number of days in which to have the property inspected. If you advise the seller that there are problems with the house within the time limit spelled out in the contract, the contract will either be null and void (and your earnest money deposit returned to you) or the seller will agree to make the necessary corrections (or give you a cash credit at settlement).
Actually, I prefer the cash credit. All too often, home buyers plan to make modifications or renovations to their new home, and the repairs that the seller may make will have to be undone. And besides, all too often, a seller forced to pay for repairs will hire an unlicensed contractor who may not do a good repair job.
Before the inspection takes place, you must insist that all utilities be in working order, so they can be properly inspected. Your mother’s mistake was to go to settlement without carefully inspecting the entire house, and once she is the title owner, she assumes the obligations to pay for these repairs.
Many states have "seller disclosure" requirements. If your mother had not bought a foreclosure home, she may have an argument that the seller indicated the plumbing and heating system were in working order, and since they clearly were not, the seller has misrepresented the condition of the property. However, to my knowledge, banks that sell foreclosed homes are normally not legally required to provide such a disclosure.
Your mother made yet another mistake: She should have inspected the property the morning that settlement (escrow) took place. I advise all of my home-buying clients to include the right to a "pre-settlement inspection" in the sales contract. This final inspection must take place the morning of settlement — not the day before — and never at night when you cannot see everything in the house.
DEAR BENNY: In this depressed real estate market, we are buying the house next-door to us. We believe we are getting a great price, as it needs a lot of cosmetic fixing up inside. We are borrowing against assets, so we can pay cash for the house to avoid having to take out a construction loan. We will be trying to get the best rate on a standard home mortgage once the home is fixed up in a month’s time.
Can each member of a couple own their own "primary residence" in order to get an owner-occupied mortgage rate? Or does it need to be called a "second home" or an "investment property." It won’t be currently rented at the time we finance, and we have no idea how long it would take to rent it in this market.
We are trying to avoid the increased interest rates if this would be an "investment property." –Misty
DEAR MISTY: You have raised a couple of issues that have to be reviewed.
1. Tax Consequences: If you pay all cash for the new house, and then get a mortgage at a later date, you may not be able to deduct all of the mortgage interest on your tax returns. There is in tax law the concept of "acquisition indebtedness." This is the debt that you have when you buy, construct or substantially improve your house. If you buy the second property and pay all cash, your acquisition indebtedness is zero. When you later get a mortgage on the house, you will be able to deduct interest only on the first $100,000 of your new loan, plus the amount that you spent to "substantially improve" that property. You have to make the call as to whether your improvements were "substantial."
2. Two primary residences: If you and your husband actually live in separate houses, file separate tax returns (in which case the $100,000 limit discussed about would be cut in half), have driver’s licenses reflecting the separate addresses, and have mail delivered separately to each of you, then I would think you can both claim different residences. However, unless you really want to go through with this — or if you are in the process of splitting up — I question whether it really is worth going through this exercise. True, you may be saving a little money by getting a principal-residence loan instead of an investment loan. But you indicated that you may — in the future — rent out the house. So is it truly your "primary residence"? I don’t recommend that you go down this slippery path.
If you have enough equity in your current home, why not try to refinance that home and pull out enough money to assist in the purchase of the new one? Mortgage lenders are currently nervous about making "cash out" loans, but if you can find one, then you will get a loan on the basis of a principal residence. You still will be subject to the interest limitations based on acquisition indebtedness.
DEAR BENNY: As a retired couple we have moved to Florida, built our own home on property we purchased. Everything was paid for in full — no outstanding loan. Because our past homes have always had a mortgage, there was title insurance that someone had purchased. Should we have some kind of title insurance? How can we prove that we own this home free and clear? –Nancy
DEAR NANCY: I don’t think you have to be concerned. But, if you are worried about this, there are some steps that you can easily take to relieve your anxiety.
First, do you have the file when you first purchased the land? When you went to closing (called escrow in the western states) you may have paid for title insurance, even though you were not getting a mortgage loan. If you do not have your file, see if the attorney or title company that conducted your settlement still has the file.
I would also get a title rundown. Ask that company (or attorney) to order a title search on your property. It should not cost you more than a couple of hundred dollars. That title report will disclose three important issues: (1) who owns the property; (2) whether there any outstanding loans showing up on title; and (3) whether there any liens or other "clouds" on title that could impact on you.
Your attorney can advise you once you get the title report.
DEAR BENNY: I currently hold a second deed of trust on a piece of property. I am to be paid off by July of 2009. What would happen when the second deed of trust is due and they are unable to pay me off but they continue to make payments on the first deed of trust? I know that in the second position I have to be ready to take over the first if they stop making their payments on that note. –Art
DEAR ART: A second trust means what it says: You are in second place behind the first mortgage. (Although there are differences between a mortgage and a deed of trust, for this answer they mean the same.)
If your borrower stops paying on the second or does not pay the balance when it comes due, you have to carefully review the terms and conditions of that trust document. In most cases, you have the right to foreclose upon the property, but as you suggest, that may mean that you will have to deal with the lender that is in first-trust position.
I suggest that you discuss this with your attorney and with the lender that holds the first trust. The lender may be willing to allow you to foreclose and assume the obligations of the first. That lender has the absolute right to make a decision based on all the facts, including whether there is any equity in the property.
Here’s another approach you may want to consider, especially if your borrower has any other assets or a steady income: When you lent the money to your borrower (or took back a second trust when you sold it to him), the borrower also signed a promissory note. You now have two alternatives: You can foreclose on the deed of trust or you can sue your borrower on that note.
Your attorney can guide you as to which route to take.
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 benny@inman.com.
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