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Circumvent rigid down-payment gift rules

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POSTED November 18, 2011 12:51 a.m.

DEAR BENNY: I live in Connecticut and my husband stays several nights a week in Massachusetts. We saw a duplex we would like to buy in Massachusetts. He would live in one part and there is already a tenant in the other part.

Because the bank is viewing this as an investment -- even though the plan is for me to move up there in about two years after I find position -- a down payment of 25 percent is required. My mother is willing to provide most of the money; however, I understand that there are issues with gifts for what is deemed investment property, even though we will be living in it.

How do banks check to see if something is a gift? How far back do they check accounts? Aside from depleting all of my accounts that do not approach the 25 percent, do we have any options as to how the gift funds could be used, if at all? --Paula

DEAR PAULA:
I discussed your question with a mortgage broker friend, Craig Strent, CEO of Apex Mortgage, in Rockville, Md.

According to Strent, “Her point about the bank not treating it as a primary residence is simply unreasonable, as she will not be occupying it within 60 days of closing as her primary residence and the lender has no way of compelling her or verifying later on that it is her primary residence.

“Just like many borrowers get the benefits of paying owner-occupied rates once they vacate a property and turn it into a rental, such is the case here in the opposite direction.”

He clearly is a lender.

In answer to the gift question, here is what he said: “Typically, underwriting will want two of the most recent statements from the borrower from the account where the down payment will come.

“Nowadays, any gift for $1,000 or more will have to be documented and sourced to verify that no new debts were incurred (that could then affect debt ratio and qualification) in connection with those deposits. With that in mind, a large deposit into the account will have to be sourced, and the gift documentation will need to be in order.

“There is a standard gift letter we use, which has a requirement for proof of ‘donor ability.’ This means that the borrower must document and prove that the funds in question did in fact originate with the giftor.

“It’s hard for most borrowers to understand why this is important, but it has to do with making sure that the transaction is, in fact, ‘arm’s length’ and the seller did not somehow do an end around the guidelines to get additional funds to the buyer to facilitate the sale. Additionally, it brings to light any liabilities that may have been incurred by the giftee in connection with receipt of the funds.”

As you can see, the “gift” must really be a gift, and not a subterfuge for a loan.

However, Strent also made a helpful suggestion: “Separately, with regard to this writer’s question, perhaps instead of the gift and all the issues that go with it, why not add the mother to the loan and to the deed, making her a full borrower, and avoiding the gift issue completely.”

Discuss this last suggestion with your tax and financial adviser. It makes sense to me.

DEAR BENNY: In a recent column there was a property owner who wanted to dispose of a plot of land that had been turned into a garden by the condo next door. You suggested a number of ways the owner could sell/donate this land. Because he’s allowing someone unrestricted access, isn’t he effectively ceding ownership? --Jim

DEAR JIM:
Excellent question. You are referring to the legal concept of “adverse possession” whereby if someone uses your land for the period of time spelled out in your state statute, that person is no longer a squatter but -- with court approval --becomes an owner.

Unfortunately, you used one magic word that defeats adverse possession, namely “allowing.”

Let me explain. In order to claim adverse possession, there are basic tests you have to meet. You have to prove that your use was:

One judge explained it as follows: “The person claiming the property by adverse possession must unfurl his flag on the land and keep it flying so that the owner may see, if he wishes, that an enemy has invaded his domain and planted the flag of conquest.”

Different states have different time periods. For example, in the places where I practice law, the Washington, D.C., has a 15-year requirement, while in Maryland it is 20 years.

But in my earlier column, as you point out, the owner is “allowing” the lot to be used as a garden by the condominium next door. This means that the use by the condo, while it may be open and notorious, is not “hostile.”

Accordingly, if the condominium wanted to claim adverse possession, it would probably lose on that one concept. Proving adverse possession is not easy, and you have to go to court to get a judge to rule. And judges do not want to take property away from anyone unless the law and the facts are very clear.

DEAR BENNY: I take issue with your response to the family that has a vacant plot in a residential Chicago neighborhood. Like that family, we have tried to sell two vacant lots, which our parents got when they bought their first house in the 1950s.

The lots, untouched for more than 50 years, now look like a miniature forest preserve, overgrown and with full-grown trees. We have paid penalties from the city, more than once, because the lots are unkempt and not fenced in.

We have tried in vain to have two different real estate agents sell them. We have offered them to adjacent neighbors. We have offered to donate them to the community through the alderman and to both Catholic Charities and Habit for Humanity. No bites!

To clean the property would cost us more than $3,000.

We continue to pay the taxes because when the latest fine was not paid in a timely fashion, the city froze my checking account until the fine was paid. Incidentally, the city froze the account with no warning. What a scramble! (As you might guess, it is hard to pay a fine when you do not have access to your own checking account!)

Your idea to stop paying the Cook County taxes makes us wonder if the county would not again freeze my checking account until taxes are current. --Susan

DEAR SUSAN: In my earlier column -- on a very similar question, ironically also in Illinois -- I suggested that if all else fails, the property owner should just not pay the real estate tax. Ultimately, depending on your own state law, the property will be sold at a real estate tax sale.

I don’t practice law in Illinois, so I can’t give you specific legal advice. However, I suspect that the county froze your account because of the fines it levied against you. I have been involved with hundreds of real estate tax sales (both from the purchaser’s point of view as well as the homeowner who wants to redeed and get his property back) and have never heard of any government freezing accounts.

As I stated in my earlier column, I do not like the idea of not paying any legitimate tax, whether on real estate or income. However, since there is a mechanism built into local governments to enable them to hold a tax sale if the real estate tax is not paid, I don’t feel so bad about my recommendation. But please talk with your attorney first.

DEAR BENNY: I am refinancing and my lender told me that I have to subordinate my home equity loan. Exactly what does that mean? --Hirsch

DEAR HIRSCH: Great question, easy answer. Currently you have a mortgage (also known as a deed of trust). That is in first-place position on the land records in the jurisdiction where your property is located. You also have a second trust (either a home equity loan or a home equity line of credit, aka HELOC), that was recorded among those same land records and is in second place.

When you pay off the first mortgage it is released from land records and the HELOC automatically slips into first place. Because your new lender wants to be (actually must be) in first-place position, you either have to pay off the HELOC or move it back into second place.

A subordination agreement does just that. But using the correct legal language, the HELOC magically falls into second place behind the new first deed of trust.

Incidentally, I do not recommend paying off your HELOC; it’s basically a checkbook in your desk drawer in case you need quick cash.

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