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At the end of the day, divorce is a financial transaction wrapped in complex human emotions. Part of the divorce lawyer’s mission is to try to gently unwrap the emotion so that each party can walk away from a failed relationship with assets that make sense.

Custody of children is the most difficult part of the problem. Each parent tends to see him or herself as the “better” or “more stable” parent. But custody disputes are often meshed with disputes over housing. Almost every parent would agree that the children are the innocent victims of divorce. But things get messy when parents start asking: “Well, why should the children have to move? Isn’t that just adding to the turmoil?”

In an absolute sense, the answer is yes. But our world has very few absolutes and as we shall demonstrate, the market can hurt you badly while you are trying to do what you think is “right by the kids.”

In happier times (2003) our client and his wife bought a home for $300,000. Now things are not so happy and the question becomes how do we unbundle the family assets in the most efficient manner. For the sake of simplicity, let’s assume a 50/50 split of the assets even though there is no presumption of any asset split in a Pennsylvania divorce matter. When they bought the house, like most folks, they took a 30 year mortgage for $270,000. In 2015, with houses in the neighborhood selling for $490,000, they decided they would take advantage of lower rates and refinance to a fifteen year mortgage. The new re-fi debt was then $215,000.

Today, as we all know, home values have “popped” and the market surveys indicate the house is worth an additional $60,000. Part of the reason for the “pop” is that rates declined a lot. Our couple would have refinanced at about 3.77% in 2015. By July 2020 rates had declined to 3%.  They bottomed in January 2021 at 2.74%. They climbed back a bit toward the end of 2021 ending in December at 3.1%.

Friday’s Wall Street Journal (4/1) reports that “Mortgage Rates Leap to Highest Since 2018.” The article reports that mortgage bankers say they are seeing no let up in applications. Realtors are reporting that in most markets the inventory is painfully thin. But Freddie Mac  reported on Thursday that the average rate for the 30 year conventional fixed mortgage was 4.67%. So, what was 3.1% in December is now 4.67%. Now that’s inflation. In December, gas was $3.40. Today, I see $4.29. If gas prices paralleled mortgage rates, a gallon would be $5.10.

Now let’s get back to our couple in their now $550,000 home. The mortgage is about $130,000. Most counties in Pennsylvania take 7% from the fair market value to adjust for a six percent sales commission and a 1% transfer tax. On $550,000 that’s a $38,000 adjustment. Subtract that together with the $130,000 balance and the “equity” in the home is $382,000. If one party buys the other out at 50/50, the buying party will assume the $130,000 mortgage balance and pay the other party half the $382,000 equity. That payoff is $191,000.

In our case, it is clear that there are only two options. Only one party has the income to shoulder the $130,000 mortgage and the $191,000 needed to pay off the other spouse. Four months ago, we would have told that spouse to refinance the entire house over 15 or 30 years and get a new 3.1% mortgage for $321,000. Today, just ninety days later, it makes no sense to pay off a 3.77% mortgage and roll that $130,000 into a 4.67% mortgage. So, we are advising the client to keep the old mortgage and add a $191,000 home equity to buy-out his spouse’s interest.

Now let’s look at this in terms we all understand. What’s the monthly “nut?” In the end we buy houses based on affordability and the hope/expectation of appreciation over time. If our client had done the transaction in December, he would have borrowed $321,000 over 30 years at 3.1%. His mortgage and interest payment would have been $1,371 a month. Today, his best option is to keep his 3.77% 15 year mortgage at $1565 per month and add the $191,000 as a home equity loan. That loan at today’s rates will be $987 a month for thirty years. For the next eight years he will pay $2,552 a month. His redemption will come when the 15 year is paid off in 2030 and he will be left with $987 a month for 22 more years.

There’s a child and no doubt the couple would like to help that child with college. But during those golden college years, the mortgage is $1,000 a month higher than it is today. It could have been $194 cheaper if we could roll the clock back to late 2021.

There’s other risks to discuss. Home price deflation. We have had it before. In the late 1990s and in 2009-2010 during the great deflation. Houses weren’t moving and bottom feeders were offering low ball bids. There is another force at work as well. In our matter, the house is on a 4 acre lot. It’s 3,500 square feet. When it was built in 1998 it was the quintessential upscale house. But 4 acres? And while 3,500 square feet remains popular the trend seems to be headed down for the first time in terms of how much space people want. Last, but not least, is what can be termed “buyer’s affordability.” Assume a year from now 30 year mortgages are 5.5% and our client is transferred or otherwise needs to sell (to contribute to college, for example). If he puts the property out at $550,000 and his buyer does a 30 year finance of 95% at 5.5%, that buyer is going to pay $3,000 a month + $700 in real estate taxes. So, toss in some casualty insurance and the prospective buyer is in for a coupon that says pay almost $4,000 a month for housing. Then mow your 4 acre yard. The point is that our client missed out on a chance to buy out the spouse and keep housing costs with taxes and insurance close to $2,000. The person he sells to will have to pay double that amount. That buyer may be saying he won’t go above $500,000 because he can’t afford that monthly payment and the client will have to eat a $50,000 loss.

It’s emotional. Yes, it would be nice to keep the children in the house they grew up in. But the joy of that same bedroom is tempered by the sad countenance of a parent who can’t really afford or is losing hard money keeping that bedroom. As a former client who moved more than a dozen times during her childhood put it; “It’s never easy to move, but you get used to it.”

 

 

The January issue of Family Lawyer Magazine published an article about the rise of the gig economy and what it means for divorce. I have been thinking about that and the subject came back to mind when Saturday’s Wall Street Journal published an article, “The Post Paycheck Economy.”

In pre 1984 days, collection of child support was hit or miss with a lot of “miss.” In those days there was no wage attachment. The only real remedy was contempt, and the only viable contempt tool was to toss the obligor in the clink. That often did the trick, but it was messy and cumbersome. Wage attachment was the “ticket” to efficient support collection. Counties can also ding credit reports and even freeze and seize bank accounts, but most are reluctant to do so.

As we (hopefully) emerge from the pandemic of 2020-2021 it’s time to realize that lots about our economy has changed. Yes, people did have remote jobs before 2020 but when I was chatting with a person in my firm who recruits staff positions, she reported that today one of the first questions posed during job placement interviews is “where” work is located. The people employed at this firm will remain W-2 employees for the foreseeable future, but many employers today are finding sound reasons to outsource jobs to independent contractors. As the Journal observed many jobs which were historically performed in offices don’t seem to need that “in office” element, especially when telecommunications allow people to meet collaboratively while sitting at home.

Gig employment presents child support collection problems from the outset. There is no wage to attach. This is not new. Self-employment has always been with us, but it is now becoming more prevalent. It’s a problem for the obligor as well. Some get paid up front for contract work. Others get paid upon conclusion. So, the obligor now must budget to pay from lump sum receipts rather than the pay as you go aspect of fortnightly or bi-monthly paychecks. And, as all of us in the support collection business know, things like housing, transportation, insurance and other needs often tend to take a seat ahead of money for the unworthy ex or the ungrateful children.

For years the General Assembly has dabbled with the concept of charging interest on overdue child support. There has been opposition to this because as sums due for support rise because of interest charges, collection rates do not correspond and matching federal entitlements paid to states for efficient collection of support would go down. In sum, less money from the feds to promote collection of support. Calculating and applying interest is also another impediment although not a big one. So far, Pennsylvania has resisted interest on overdue support, but that may need to change as wage attachment collections yield to less reliable mail in or electronic payments from the people owing the support.

Meanwhile, for those on the receiving end, word that the obligor has gone “gig” has to be a frightening one. Rent or mortgages not paid by the 10th of the month come with substantial penalties as do payments for cars and credit cards. Most people with these obligations take timely payment seriously, but when an obligor is faced with a choice between being late on the rent and incurring a certain penalty or deferring domestic obligations free of charge, the choice is made easy.

If, as, when, the percentage of payments coming through wage attachment begins to decline significantly there will be a corresponding drop in federal payments to states in support of the collection system. To this writer’s mind, the imposition of interest on arrears does little to encourage prompt payment. But the mortgage industry has taught us well that the threat to see a 5% penalty (e.g., $50 on a $1,000 payment that is late) does seem to have a curing effect on tardiness. The point is that the late payment problems exists; it is probably going to be a exacerbated as wage attachments decline in relation to total payments and it is in the interest of the system and the people supported by it to address the problem now with a change in the law.

Divorce lawyers are not real estate agents and we are not mortgage brokers. But in any given year we move a lot of residential real estate as splitting couples either cash out or buy one another out of the old homestead.

The Wall Street Journal reported on January 21 that residential home sales reached a 15 year high in 2021 and that demand is expected to remain great well into 2022. That is, unless the Federal Reserve and the lending markets decide to poop the party. And indications are that this may be underway.

In early 2008 mortgage rates hovered around 6% for conventional 30 year financing. The residential realty market was crazed and lenders were closing on deals without any income verification of substance. Then the market cracked, first with Bear Stearns failing (3/2008) and then Lehman Brothers (9/2008). In an effort to juice the economy the Federal Reserve dropped its discount rate (loans to banks) to zero trying to keep the economy alive. It worked and we eluded what could have been an economic collapse by Spring, 2009. But, because we love cheap money, the Fed never took the analgesic away, even after the economy soared. When the market was in free fall, the S&P 500 was at 940 but you still paid 5% for a mortgage. Today the S&P 500 is at 4,400 but a 30 year mortgage only costs 3.6%. So, you can afford a big fancy house because rates are so low. And that is what is driving the market today.

The biggest winners have been the people with houses in the $300-500,000 range. Some have seen their homes increase by $100,000 or more in the past 24 months. How does this affect the divorce world.? Let’s assume a 50/50 split of a house with $400,000 worth of equity. If I represent the spouse who wants to keep the house he/she needs to refinance and give the departing spouse $200,000. That number would have been $150,000 two years ago but who cares? I’m refinancing at 3.6%. Life is good.

Well, maybe. Here’s the problem that interest rates and real estate taxes can cause. I pay off the ex and now I still owe 400,000. $200,000 of that was my old mortgage and $200,000 is the blood money I paid the ex to keep the house. The good news is that any prospective increase is all mine now because I bought the ex out of her interest.

Alas, there is the problem. What really drives real estate prices is affordability. As interest rates rise, fewer and fewer people can afford your house. And when they can’t afford your house, they will pay/bid less for it.

A year ago, residential mortgage rates on a 30 year fixed basis were 2.83%. Today they are 3.59%. As a home buyer, a 30 year mortgage for $400,000 that would cost $2,327 a month in January 2021 now has the same buyer paying $2,516 for the same package. That’s $189 a month more for the next 30 years. But let’s assume mortgages go back to a normal 6%. That same $400,000 mortgage will cost $3,169 a month. A buyer can address $189 a month by cutting the cable cord. But $843 a month for 30 years is real money. $300,000 more over 30 years.

It doesn’t stop there. Spouses who sell to each other may or may not draw the attention of the local county, township and school district authorities. If you buy the home that was being taxed on a $350,000 value and you pay $500,000, you should expect that the $5,000 real estate tax bill will go to $7,150. That’s another $150 a month. When you go to sell, that’s the world your prospective buyers may face.

Here’s what divorce lawyers are facing. One spouse wants to keep the house. It means a re-fi and an increase in debt. It may also mean a visit from the local tax authorities. These problems may seem minor if you are adding $200,000 of buyout debt at 3.6% over 30 years. But the real question is whether you can still get the value you are paying today to keep your home in a market where interest rates are rising and crowding buyers out of the market.

It’s not an easy choice. You can always sell but then where do you live? Even if you downsize to a cheaper home you are still paying a premium. In fact the cheaper homes have had the biggest increases in value.

We like to end this kind of essay with the “right choice” answer. Unfortunately, there really isn’t one. But if you are keeping the old homestead for emotional reasons, you need to ask yourself, what are the real prospects to retain home value or see it increase when you are doing a transaction in what is undeniably a “hot” market.

Imbedded in this is forecasting the return you get on an investment, whether a house or the “market”. Money in real estate is money not invested in equities. As the investment community likes to tell us in the small print; past performance is not an indicator of future results. But in this writer’s suburban Philadelphia neighborhood the past 13 years has brought a 34% increase in home values while an S&P index fund garnered 10x that return (368%) in the same period.

It is said that desperate times call for desperate measures.  Many people out there today are facing some financial headwinds that were not reasonably foreseeable a few months ago.  Today they have businesses to operate or even daily bills to pay while afflicted with cash shortages.

The reverse mortgage or more properly the Home Equity Conversion Mortgage (HECM) has been around for a while.  In an age of low interest rates it has seemed like a device which merited attention.  Many of today’s divorces involve folks who qualify by age (you must be 62) and have significant equity trapped in a home, which is not appreciating as it did in the past.  As we have noted, the current financial crisis has caused increased interest in this product.

The problem has always been that most conventional mortgage brokers stay away from reverse mortgage products.  If you search for a reverse mortgage on the internet you will be scooped up by dozens of websites that instantly want your name, address, home value and current mortgage information.  That is concerning in its own right.  Then, over the weekend, I heard the inevitable horror story of a family that “lost the family home” to what seemed like a good way to supplement household income.  If you want to hear the entire story it ran on May 16, 2020 and can be found at a Public Radio Exchange (PRX) website.

As an attorney, I found the PRX episode titled “Homewreckers” to be a pretty poorly executed and highly prejudiced piece of journalism with the current U.S. Treasury Secretary loudly depicted as the villain.  The point of this article is to talk about practical pitfalls rather than public policy.  Suffice to say that the lending industry is not always honorable.  But, I also have some problems with people who took things like no doc mortgages claiming to be the victims. Now, allow me to try to cast off my prejudices and stick to the facts I have researched.

There are a lot of different programs out there.  And, as noted, trusty human reverse mortgage lenders don’t seem to be widely available.  So, you may have to go fishing on the internet and risk being hounded by pop-up advertising each time you check messages or the news.  Once you find something that sounds like a plan, the key is to ask to see what the loan documents look like and insist that a copy be made available for you to print. DO NOT let these people come to your house.  Yes, the lender is going to need someone to appraise your home’s value after you understand the transaction from top to bottom.  The only other reason you need to be visited is to hotbox you into signing a deal you may soon wish you had not. The PRX story, although highly prejudiced, does identify in explicit detail some things that can go wrong.

Let’s say you see a reverse mortgage you like in terms of what the loan will amount to and how it operates.  My general impression is that some of these lenders are interested in getting title to your house rather than making a simple loan against the equity you have in it.  That’s why you need to see the actual documents you will sign and take them to a real estate lawyer who will represent you and not the lender.  Never, ever, ever, sign a loan of this kind without a lawyer or relying upon a lawyer you are not paying.  This is not a friendly business.  Some people see that programs are FHA approved and believe that protects them.  It may or may no,t but it is your job to protect your home equity not a government agency.

Among the games I have read and heard about in the PRX story are the following:

  1. Appraisal games. It would appear you can be “low balled” on the appraisal for the loan so that you cannot borrow as much as you would like.  You can also be “high balled”, to encourage you to borrow more than you really need to borrow.  Do some research on your own to see what your property is worth and it may be worthwhile to get your own appraisal.
  2. You need to be at least 62. You will need to pay your real estate taxes, condo assessments and/or repair bills on time.  Your failure to do that for any reason is a default of the mortgage and can produce foreclosure.  Most people are deathly frightened of foreclosure and with good reason, but there seems to be some evidence that aggressive lenders threaten foreclosure to intimidate the homeowner into doing what they want.  Most conventional mortgage lenders view these defaults as their headache.  It seems that some of the reverse mortgage lenders are more willing to get in your face and threaten to take your property.
  3. Make certain the lawyer you confer with tells you in detail what happens if you don’t or can’t live in the house any longer. These loans appear to have covenants on your part that you will remain in the house.  That’s normal in conventional financing.  But realize that if you are 62 or older, age and infirmity may deprive you of your well thought-out plan to stay.  If you have to move out you may be forced to sell against your wishes.  If your plan was to give the house to your kids, be aware that this reverse mortgage gets in the way.  This may be a useful place to sit down with your children and have a frank conversation about the house.  In the story reported on PRX, a family member had been recruited to come live with Mom and Pop.  Pop died and Mom needed to move to assisted living.  The family member ended up homeless because she had no rights under the reverse mortgage.  Realize that in fairness to the lenders, they need to see the house sold to get back the money they lent you on this mortgage.  Understand as well that sometimes life insurance or other assets the borrower owns may be used to pay off the debt due the lender on the reverse mortgage.  You should have a clear understanding of what occurs if you die before the house is sold.  You might have a $300,000 house but owe the reverse mortgage lender $150,000.  Can the lender insist you sell to anyone offering more than the amount you owe?  Do you have the right to make the lender wait for years and mess with your now empty house while your heirs unreasonably insist the house is worth $300,000?  The person who will be your executor needs to know how the estate’s right to sell at the highest price corresponds with the lender’s right to get his loan money back.
  4. The fees associated with doing this financing appear to be higher than conventional financing. So, get that in writing.  Your $150,000 loan from home equity may be only $125,000 depending on the fees, usually charged up front.  Realize that many of these fees may be negotiated or waived if the lender wants to close the loan.  On the other hand, no one is lending to you for free.  These deals also involve your having to purchase private mortgage insurance.  You should find out the annual percentage rate (APR) on any financing because the stated interest may look low, but the “fees” paid at closing drive it much higher.
  5. Don’t outsmart yourself. This is what happened to all of those folks who took out home equity loans (HELOC) in 2005-2007 to dump money into the stock market.  It worked well until it didn’t.  Borrowing money to gamble is never a sound plan.

In short, proceed cautiously and lawyer up.  Yes, every lender uses standard forms.  They are written by the lender, for the lender.

This was a summer where prenuptials arrived in profusion, and what made it interesting is that just about all of them involved folks who were either beginning or in the middle of their earning careers. Most prenuptials involve couples who already have kids from former marriages and money they want to preserve for those kids. But we also see prenups for young people who have wealth already transmitted from their parents; parents who want that wealth to stay on their child’s side of the column even after a marriage occurs.

When going through this process with young folks or even people who are in their forties, lawyers ask lots of questions that can be uncomfortable. No one ever really asks a couple how they want to live their financial lives together and yet as McKenzie Frankel, a financial planner in Wayne, PA has observed, a lot of relationships would work far better if those questions were addressed. When it comes to how we manage family and money our expectations are often hard baked into our personalities by our own life experiences. Millennials can be especially interesting to work with because many of them are raised to eschew family and money stereotypes (e.g., mothers stay at home and dad’s do the financial stuff).

I read the Money Personality Quiz developed by Frankel and her partner Joslyn Ewart with interest, but I also considered some far more basic questions that young people in love should be asking each other. I also believe that the answers to some of these questions might be worth incorporating into agreements. Permit me to try my hand at my own “personality quiz:”

  • How important is it to your relationship that you have children, with a “0” reflecting no interest in raising a family and “5” indicating that it was indispensable to agreeing to marriage?
  • Indicate the optimum number of children you would want to have with your intended spouse.
  • Indicate the outer limit of the number of children you think you would want to have.
  • If fertility becomes an issue for either of you, would you be prepared to incur the expense and physical challenges which fertility treatments may involve?
  • If fertility is an issue, indicate your receptivity to adoption and whether there are limits to how far you were willing to adjust to the alternative options adoption may require.
  • If you had a child who suffered physical, intellectual or emotional limitations that prevent one of you from being able to work outside the home, how would you decide which of you would make that financial sacrifice and how would that sacrifice be compensated if the marriage were to dissolve?
  • If your child(ren) had no limitations but you decided that one of you did not want to return to work in order to devote energy to full time parenting, how should that be compensated if the marriage were to dissolve? How should you reduce or limit your lifestyle/expenses once the decision is made and the household income is reduced?
  • If you both had jobs earning equal amounts of money and one of you was offered employment that would require relocation to another city, how much more compensation would the spouse offered the job have to receive before you would agree to move, especially if no substitute job was immediately available in the new market.
  • How important is it to you that your child have the benefit of private school when a reasonable public school is available?
  • Do you see it as your responsibility to provide children with either vocational or academic training after they have completed high school? In a day (today) when a four year public school undergrad degree costs $80,000 and a private school $160,000, what should be your contribution and how do you want to finance the parent portion (e.g., savings or when it comes)?
  • In a day when the average social security benefit for a retiree is about $17,000 a year and the maximum benefit, if you contribute the maximum ($8,000 per annum) and defer to age 70, is $44,000 a year, what kind of retirement income do you hope to have and when do you intend to start financing that via savings? Can you agree now that a portion of your earnings go into some form of retirement and that you would continue that percentage?
  • How important is it to you that you own your home rather than rent a dwelling, “0” being of no consequence and “5” being an absolute necessity?
  • If you earned $30,000 per annum what do you consider a reasonable amount for a monthly auto payment excluding any trade in value (i.e., “0” down)? If your income doubled, would your expectations change and by how much?
  • Is there a level of income where you would prefer to devote additional energy to non-income producing endeavors like charitable work, creative work or occupations which sometimes pay lots of money but typically are low on the income ladder (e.g., acting, writing etc.)?
  • Between 1 and 5, rank your future spouse’s financial stability in terms of their approach to money. If your intended could earn $100,000 but would likely spend more than he earned, that’s a low rank. If your spouse would earn $30,000 but be more likely to still have money for savings he/she is more toward a 5.
  • What is your intended spouse’s current credit rating and what does the credit history look like? Shakespeare said it best: Past is prologue. And it’s a delicate subject, but have tax returns for recent years been filed?
  • Hobbies and collectibles are often a tell-tale signs of financial distress. Gambling, sports or clothing addictions and “collections” (whether cars, handbags, guns or memorabilia) can often take even solid wage earners over the edge. The latter expense often masquerades as an “investment.” We have worked with clients who have tried this. Very few profit from their efforts and many owe large sums on what they do own.
  • What’s the child support situation? Don’t be surprised to find out that a prospective mate who otherwise seems an honorable person owes tens of thousands in back support. There can be many explanations for this and some may be more reflective of neglect than malice but it won’t make any difference, when the $10,000 bonus you deposited to the joint bank account for a trip to Orlando is seized to pay his past due support.
  • Criminal background. This can be a painful look but today Pennsylvania has data online about prior criminal history. It does not include juvenile offenses (which occur before age 18), but any adult bad behavior tends to linger. Make certain you are looking at the right name and verify if possible with a birthdate and/or a social security number. You may be planning a driving honeymoon while your future bride is juggling her second DUI arrest.

So there are two stories here. Know the past of the person you love and talk about the future and how to address it. And while you are discussing the future you may want to think about an agreement that protects you with some promises that could be legally enforceable.

When you marry you usually take on obligations of support for each other. The property you acquire (except by gift) is divisible in divorce. The debt is as well. Most people file joint tax returns which means that any monkey business with the return affects both monkeys even though only one monkey was cooking the books. And except for credit card debt, lots of consumer debt including mortgages are “joint and several.” That’s legalese for “you’re on the hook for the mortgage even though you consistently gave him cash to make the payment.” He just had other priorities.

The author has plenty of real life stories to back up the scary things he just described. What makes the stories tragic is that they were actually avoidable if someone had asked some of the questions before. We have all heard the stories about people online creating an avatar; an identity that does not reflect who they really are. Don’t allow a love-based fantasy to ruin your otherwise stable reality.

Lots of electronic ink has been spilled this week on winners and losers coming out of the Tax Reform Act passed on December 20.  Much of this is fairly speculative but some is simply common sense.

If you are a homeowner, take a look at last year’s bill for real estate taxes, then calculate what the foreseen or unforeseen buyer of your house will pay as a mortgage if he or she finances at 4.0-4.5%.  Realize that, until today, real estate taxes and mortgage interest were entirely deductible subject to “phase out” as adjusted gross income grew higher and higher.  For your purposes, assume no phase out by your imaginary “buyer”.   Now take that number and cap it at $10,000, knowing that this is the maximum you can deduct for real estate taxes and state and local income taxes combined.  If you are looking to buy a home for $1,200,000 in Pennsylvania you have to be earning $250,000 a year and the state and local taxes on that income alone will consume your capped deduction of $10,000 for all forms of tax (again, income and property tax).  So your $15,000 a year in school and municipal taxes is effectively lost as a deduction.  Then we have a new cap on deductions for home mortgages.  That cap is $750,000.  If you put 20% down on your $1,200,000 mansion you will still have a $960,000 mortgage.  Only the interest on $750,000 is deductible.  Thus 22% of your mortgage interest payment will be non-deductible, i.e., paid with after tax income along with your real estate taxes.  If you borrowed at 4.5% your $43,000 in annual deductions for mortgage interest is now capped out at $33,700 and your $15,000 in school/municipal taxes was consumed by your deduction for state and local income taxes.  Surprise!  You have $24,000 in deductions lost to tax reform.  With the new rates this income is effectively taxed at 24% (the old rate was 28%).  The new house is about $500 a month more because of the new tax reform.

The fact is that smart buyers will look at this and conclude that what was once fully deductible is now mostly not.  Will they adjust their offer accordingly? $500 a month is not deal killing in its own right given the numbers we are using, but realize as well that big fancy homes are not selling like they used to because younger buyers have grown up in a world where houses are not appreciating by leaps and bounds.  So if you own a high end house, either in terms of what the mortgage debt will be or the real estate taxes will consume, realize that this tax package is making your house pricier than it was just a day ago.

This last year seemed to be the year for buyers in the $500,000 and lower sellers.  They sold homes quickly and often for premiums.  New home buyers seem scared by big debt and their credit histories often include lots of consumer and student debt.  So they often can’t afford the big house even though they might want to own it.  They also tend towards new construction because they perceive it as less problematic. Sellers may view the buyers as short sighted but they are sellers and not buyers.

Bottom line.  Big, expensive, older homes just took a hit.  They were already on the ropes because they were perceived to be high maintenance.  Now they have the added disadvantage of being more expensive because of the limits on deductions the new tax law provides. As we have said many times, real estate is not the investment we experienced in the 1960s, 1970s, 1980s or 1990s.  This is truly a new day.

In recent years much has been written about the “marriage penalty” when it comes to federal income tax. As a group known as the Tax Foundation states it “An unmarried couple with equal incomes that earn a combined $300,000 would have a total tax bill of $83,232.50 ($64,374.50 from the individual income tax and an additional $18,858.00 from the payroll tax).  If they were to get married, they would be hit by a marriage penalty of $3,806.50.  The penalty has declined in significance over recent years but it still exists.

A year ago the US Court of Appeals for the 9th Circuit (i.e., the west coast) decided Voss v. Commissioner.  Voss and his life partner Sophy owned a house together on which there was a jumbo mortgage exceeding $1,000,000.  Section 163(h)(3) of the Internal Revenue Code limits home mortgage interest deductions to those attributable to not more than $1,000,000 in mortgage debt if used for acquisition and $100,000 of home equity loans.  The purpose of this law was to capitate home mortgage deductions for the wealthy and, in the case of the home equity cap to discourage people borrowing against home equity to fund activities unrelated to savings.

Personal interest is generally nondeductible. The government allows interest on qualified residences to be deducted with qualified residences being up to two taxpayer’s homes, each being used as a residence.  The statute also states that individuals filing separately are limited to $500,000 each and $50,000 in the case of a home equity loan.

Taxpayer Voss and his partner Charles Sophy who are registered domestic partners under California law. And, together they own two homes with mortgages for which they are jointly liable.  For the tax year involved, their mortgages and home equity debt were about $2.7 million and were recorded on their primary residence in Beverly Hills.  They filed income tax returns separately for the tax years involved and each claimed averaging about $90,000 per annum.  The IRS reviewed the returns and assessed tax premised on the conclusion that any interest associated with debt above $1.1 million ($1 million acquisition and 100,000 home equity) was not deductible.  Messrs. Voss and Sophy filed in Tax Court asserting that the $1,100,000 limitations were not calculated per “residence” but per tax taxpayer.  The Tax Court agreed with the IRS and upheld the limitation on interest to $1.1 million.  But in a decision premised upon the express language found in Section 163 (h)(3) the US Court of Appeals held that the limitation is per taxpayer.  The Court notes that this is probably not what the Congress intended but it is what the statute says and, as such, the clear language trumps legislative intent.

The decision was rendered on August 7, 2015 and undoubtedly, the IRS has hoped that the Congress would adopt a technical amendment to correct this. But, that amendment has not been adopted and on August 1, 2016 the IRS issued something called an AOD (Action of Decision: 2016-2) stating that it accedes to this approach to home interest deductibility until Congress adopts a statute saying otherwise.  So big mortgage deductions for couples not filing jointly are there to be had until Congress finds the time and energy to close the door.

Voss v. Commissioner    796 F3d 1051 (9th Cir. 2015)

This is not a money management blog but what we increasingly find is that many divorce clients simply “trusted” that their resources would be sufficient to carry them through retirement. The great awakening comes when they discover they are now splitting what looked like a comfortable retirement and that their ability to make up for lost time has been lost amidst the sands of time.

So today, lawyers need to help clients be creative, and based on an article in the March 22 Wall Street Journal, there is reason to take a second look at a device invented a few years ago called the reverse mortgage. When first introduced, they were disparaged as a kind of sleight of hand trick. The number of them issued spiked just after the Great Recession but then eased off as the economy (or at least the stock markets) recovered.

A reverse mortgage is what it sounds like. You have equity in a home that is essentially a trapped asset. A reverse mortgage involves your pledge of that equity to a lender who gives you your own trapped money. The true economist would dismiss this as absurd. If you need cash out of your home, don’t pay anyone fees or anything else to tap it; just sell, downsize and take the cash from the settlement proceeds. That’s why economics is called the dismal science.

The problem with today’s older divorced couples is that they want everything to stay the same. Sure, it’s only you living in the house that once held three or four. But you like it, you like the neighborhood, and besides, moving means dealing with 30 years of accumulated things that you call treasures and your child dismiss as “crap” when they come for Thanksgiving.

I typically advise clients that they should at least consider downsizing. The response is the same. A longing look like I told them they need to put the dog down unless his health improves and either a testy “Maybe next year” or even more challenging “Must I?” In the end, we assess matters and give clients options. No pets have met their demise on my watch but I have told several clients that unless they reduce their housing costs in the near term, they may need to consider a shorter life.

Reverse mortgages can be a way to ease the pain. At their worst, people borrow them to speculate. This is pure foolishness. But the mortgage in reverse can be a very effective tool, especially to cover late life rainy days. The best example is a sustained down market. If you are retired and drawing $4000 a month while getting $2,000 in social security, when the market tumbled, your $4,000 is coming out of a measurable smaller pool. If you had $300,000 in retirement and drew $3,000 a month in January, 2008 you had  100 months of retirement assuming no increase in value and no inflation. Your draw was 1%. By late Fall, your $300,000 was now $150,000 which mean your pool had halved and your draws were 2% a month.  The market quickly shot back up to 11,000 but if the trough had been sustained and you didn’t halve your expenses, you were burning retirement fast.

If you had a line of credit associated with a reverse mortgage, you could have reduced the impact on your portfolio by drawing on your home equity. Then you would have had more on hand to ride the market back to some form of equilibrium even though your home equity would have been reduced. There was a time when home prices could be said to keep pace with the market. But that is not a recent trend. A tract home in the Philadelphia region with 3,000 square feet  sold in July, 2008 for $400,000. Six years later it sold for $420,000 and it today draws estimates for $410-425,000.  Had you known in Fall, 2008, you could have borrowed $100,000 in home equity; stuck it in a Dow index fund and today your $100,000 would be worth $251,000. But, alas, that would require speculation.

But there are good times to draw on home equity. You sit, happily in your crap filled house burning through $3,000 a month of retirement. The roofer tells you “It’s time for me to get $20,000.” That roof can come out of home equity much more readily than an investment portfolio because the house is not really gaining value.

Now for some of the trickier strategies; tricky but solid if done in the right way. You are on a fixed income. You have $300,000 in equity but $200,000 in mortgage debt. The monthly mortgage of $200,000 plus $600 a month in real estate taxes is really crimping your ability to see the grandkids. Why not take a reverse mortgage on the equity to service the real mortgage you owe. This cuts expenses while leaving your investment portfolio intact. Yes, your real estate portfolio is going to decline but that wealth right now is trapped in housing and not really increasing.

Another strategy. We are told that if you delay drawing on Social Security from ordinary retirement to age 70, the monthly benefit payable rises by 7% a year. That’s a pretty solid return and it’s guaranteed unless you conk out along the way. But, you may look at the pension and retirement money you now have and say, I can’t really make it to 70 without tapping my social security. Why not consider a reverse mortgage to fund the “gap” of payments you might otherwise get if you applied early or at normal retirement age.

Your employer lays you off in December 2015. Because you are not a kid it is going to take time to find a job, which means that your 2016 income will be low. Financial planners will suggest that the off-year is a prime time to convert a traditional IRA to a Roth because your income will be low. But you do still have to pay the tax on the conversion. Why not take that out of a reverse mortgage to cover the taxes.

Typically, reverse mortgage payments come without tax because the payment is not income but a reduction in home equity. You are effectively getting your own money. Federal regulations now make it so that a steep decline in home equity such that the amount you took out exceeds the equity does not open the door to liability on your part. So this is now a tool and not a toy. It can be abused but it has options that can make your retirement far more comfortable.

So it’s break up time and you can’t wait to “move on” in not just the emotional but the physical sense of the word.  Even though you and your spouse can’t agree on much of anything, you both agree that it is time to sell your burdensome house and find more comfortable digs of less grandeur.  This should be easy, right?  Just ring up the realtor and make the appointment to sign the listing agreement.

Before you sign that agreement, especially if you are the financially disadvantaged spouse (i.e., you make far less or control far less) GET SOMEONE TO FIND OUT WHAT YOU OWE.  There are many exceptions to the rule, but the rule is that you can’t sell a house until you can pay off the mortgages associated with it.  Oh, you can agree to sell your house for whatever the price but to actually “close” on the transaction and convey title to the willing buyers you will need to pay off the mortgages and any other liens (e.g., tax liens, judgments etc) that may have arisen while you owned the place.

To some this would seem academic but in the rush to buy every piece of real estate in America between 2000 and 2008, the consuming public signed lots of funky mortgage paper including home equity lines of credit that nestled on top of conventional mortgages.  People also refinanced their real estate many times to cover many expenses unrelated to home acquisition and ownership.  They paid auto loans, college tuitions and consumer debt.  When they come in to meet us, they often can’t recall whether or not the loan was a mortgage, what else might have secured their debt or even what the money was used for.

Most experienced realtors actually try to do a quick lien search before taking a listing to make certain the proceeds will be sufficient to pay their commission and otherwise “clear title”.  But you must either ask the realtor or ask a lawyer to make certain that you know what debt you owe for which your house is collateral.  This is not something to wait for.  First you may find that while the house will close and the debt can be paid, you will have nothing left to put down on a new house.  Second, if your willing buyer agrees to pay your price and then invests time, effort and money into getting ready to move in only to find out that you really can’t clear the title hurdle, that buyer may be looking for a lawyer to sue you for listing and selling a property you should have known you could not successfully sell.

There are ways to negotiate around some of these problems but no transaction where debt exceeds contract price is a safe transaction.  The key however is to find out first what debt really is recorded against the property and then list for sale.

 

A panel decision of the Pennsylvania Superior Court on December 23, 2014 informs us that despite recent decisions refusing statute of limitation defenses in actions to enforce property settlement agreements, the defense still lives.  It comes down to the nature of the obligation for which enforcement is sought.

We start with the older cases.  In a 2006 decision Crispo v. Crispo,  909 A.2d 308 (Pa. Super, 2006) the parties concluded their property agreement in 1995.  In 2004 Wife sued to enforce the agreement and after a hearing at which Husband asserted the statute of limitations as a defense held him in contempt subject to purge upon obtaining life insurance in the amount of $300,000.00 paying a Sears charge in the amount of $2,048.49 and a MasterCard bill in the amount of $4,662.76 plus the sum of $22,500 to Appellee.  The agreement had called upon husband to maintain the life insurance until his children reached 22 and to pay off Wife’s credit card debt.  It also required him to pay the $22,500 for his interest in a business he owned.  Under the terms of the agreement the lump sum was due in 1997.  He appealed stating that the credit card and cash payment provisions were beyond the four year statute of limitations.

In Crispo, the Superior Court held that these were continuing obligations and therefore not subject to the statute of limitations.  The authority cited for this proposition was a Monroe County Common Pleas case.  Jenkins v. Jenkins, 2004 WL 3406186 (Pa.Com.Pl. Oct. 25, 2004), 71 Pa. D. & C. 4th 205.  According to the case decided on by the Superior Court on December 23, 2014 if an agreement does not contain a specific deadline, the contract is continuing. K.A.R. v. T.G.L. 2014 Pa. Super. 285.

In 2009, the Superior Court decided Miller v. Miller, 983 A.2d 736 (Pa. Super. 2009).  That was an agreement to continue to pay mortgage payments associated with a marital residence.  In November, 2005, Wife sued to recover payments she made because Husband had not.  He asserted that statute of limitations with respect to any amounts due for more than four years. Again, the Superior Court held this was a continuing contract because there was no deadline for payments nor was the amount specified.

Last month’s ruling has a decidedly different flavor.  Husband and wife formed an agreement in August, 2003 related to payment to Wife of certain sums defined by formula if and when Husband’s stock or warrants in his business were sold.  In March, 2011 Wife sued to enforce the agreement alleging that Husband sold a portion of the stock in January, 2004.  In 2004 and 2005 husband did make payments to Wife of $450,000 for her business interest but he retained part of the business and morphed it twice before selling it without additional compensation to her. Husband answered that she was beyond the statute of limitations on the 2004 transaction and that the portion of the business that she claimed he retained in the 2004 sale was “completely distinct.”

As one might expect from reading this far, Wife asserted this was a continuing contract.  She cited Crispo and Miller.

The trial court found that husband sold all of his stock in the business in January 2004.  Thus, that was the date Wife was entitled to her payments.  It turned out that in addition to the sales piece of the transaction husband received something the court deemed a “stay” bonus for remaining with the acquiring purchaser of his business.  So this contract that called for a fixed payment in January, 2004 and the statute ran in January 2008 per 42 Pa.C.S. 5528(a)(8).  Wife argued that she had stayed the statute by filing a writ of summons in 2005.  Apparently this was done because she was already unhappy with the payments she had received.  The Superior Court held that filing a civil action does not preserve claims brought under 23 Pa.C.S. 3105 to enforce agreements.  She argued that she did not discover the claim until she secured copies of tax returns filed in 2011 and 2012.  The response of the court is that husband did provide closing binders for the 2004 sale within a year of the transaction and that even back then she was asserting in writing that she was still due money.  The Superior Court opined that for purposes of the discovery rule the statute would have run from the date the closing binders were delivered, a date one year after the sales transaction.  Wife’s argument that they were negotiating during this time was dismissed under the well established principle that negotiations do not stay a statute of limitation.

The Court held that this was not a continuing contract and said this case is distinguishable from Crispo and Miller.

At one level, this writer is happy to see the statute of limitations brought back to a field where we are told time and again that contract law governs.  But, this ruling does not really reconcile with either Crispo or Miller.  In this case, the Superior Court cites Crispo for the proposition that even in the case of continuing contracts, “the statute of limitations will run either from the time the breach occurs or when the contract is terminated.”  It further states that a continuing contract is one with no definite time for payment or where there are several separate contracts.”

So let’s get the chains out and measure these cases.  In Crispo, the parties divided their credit card debt and each agreed to pay some.  Husband did not pay.  Wife knew that Husband didn’t pay as the opinion states that she began making the payments he had due under the agreement on his behalf.  So, clearly he defaulted and just as clearly, she knew it.  Using what I will call the Crispo standard, the breach occurred for statute of limitation purposes the moment she knew that he had not paid.  As for the $22,500 amount to be paid for the business interest it was to be deferred to 2001 unless Husband filed a petition to modify support in which case the payment was due on filing of the modification.  Again the opinion states that in 1997 Husband decided to seek modification of support.  Under the contract this made the $22,500 due immediately.  Her enforcement claim was filed in 2004, seven years after the default.  Despite what the opinion says, these are not continuing obligations.  They are clear defaults known to the innocent party.

Miller is much the same.  Per the contract, Husband was to pay the mortgage.  He did not.  Wife knew this because she began paying the mortgage herself.  So we have a breach and it is known to the innocent party.  The argument that there was no deadline for the payments just doesn’t hold water.  Promissory notes associated with mortgages are pretty clear about what is required and when.

There are facts buried in the K.A.R. opinion from which one gets the impression that the Plaintiff did not get a fair shake from her settlement agreement.  But, the facts are equally clear that she knew her spouse had sold the business because she got $450,000 in payments and a settlement binder from the transaction within twelve months of the closing on the business sale.  The facts also show that she was not happy about the amount she got and was vocal about it.  So imposition of the four year statute of limitations made perfect sense.  But, it would have made perfect sense in Crispo and Miller as well.  It just didn’t turn out that way.

Viva la K.A.R.  If property settlement agreements in divorce are contracts, it would seem that the laws affecting contracts, including statutes of limitation, should be invoked as well.