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NOT the same 'pay off house' question
Old 06-18-2008, 08:06 AM   #1
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NOT the same 'pay off house' question

To pay off or not to pay off has been discussed at length on this board, and I am not looking for the 'feels great', not good economic sense debate. Here is the situation:

Texas Property Tax:
In Texas, 65 and over, homesteaded property, can defer their property tax. The deferred tax must be paid within 180 days after death by your estate and there is an 8% simple interest, not compounded, tacked on.

However, most lenders will not allow this option as it places a lean ahead of theirs, so it is necessary to pay off the house in order to defer the taxes. The debt passes to the estate. If the value of the home is not equal to the taxes owed, and the estate has no other assets, it is the county/city/states problem. i.e. they get the home.

For my neighborhood, the tax, after exemptions, is between 2.1 and 2.5 percent of the values on the home. We pay about $7,000 a year on the note, and $7,500 on the taxes. We would have to withdraw $115,000 from IRAs to pay it off.

I think it makes since to pay off the home with a 5.78% note, and defer the taxes. The longer we live the less the effective rate on the taxes, and both my wifes parents lived past 95 and her brother is already pushing 80. Say in 30 years we need a hundred thousand or so to fix up the home. I could go to the county/city/school and ask for some money back, or I could go to the bank and take it out. I am sure the county/city/school would be understanding... right!

To me this seems like a no brainier, yet there are not many people that do it. I tried to create a spread sheet based on a 20 year life to see what compounded interest rate I would have to get on the savings to equal the simple rate. I came up with 6%, however, I am not sure it is right.

So any opinions? Any other over 65 Texans doing this?
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Old 06-18-2008, 08:16 AM   #2
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So... you pay $115,000 and your expenses go down by $14,500 per year?

The hit would come to your estate on your death. Unless that is a big factor in your planning, I'd go for it.
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Old 06-18-2008, 02:20 PM   #3
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Quote:
Originally Posted by Rustic23 View Post
Any other over 65 Texans doing this?
Well, you've certainly found a motivation to maintain the will to live! I can already see Montgomery Burns rubbing his hands and cackling with glee...

A couple questions: This is second-to-die, right? In other words, if the house was owned in your name and you died, what would happen to your spouse? Or if both of you were on the title as joint tenancy with right of survivorship, would the state step into the execution of your estate and demand payment before your spouse could inherit?

If the "kids" decide that dear ol' Mom & Dad have to move into a full-care facility, what happens to the house? Can it be sold? Is the gain on the sale of the house still exempt from $500K federal cap gains taxes? Does Texas also exempt $500K from state cap gains taxes?

How does the tax lien compare to a reverse mortgage? You're saving money by not paying taxes while a reverse mortgage sends you a check every month that you could use to pay your taxes. You win either way, but I guess the question would be about the size of the lead you had at the finish line.

I'd be a little nervous about owing a big tax bill to a state with the power to tax its voters, especially when their marketing consultants & lobbyists could portray you as a vulture feasting on the rest of the state's honest taxpayers. At least when you owe a lien to a bank you have some means of litigious appeal, but you may not have the time (or the sentience) to duke it out with the state.
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Old 06-18-2008, 03:11 PM   #4
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The deferred tax must be paid within 180 days after death by your estate and there is an 8% simple interest, not compounded, tacked on.
What if you don't die, but need to sell the house to go into an extended care place? I suspect that the state will collect the accumulated tax at that point. So instead of passing the tax off onto your heirs, you are borrowing money from the state at 8%.
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Old 06-18-2008, 05:37 PM   #5
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I suspect reverse mortgage rates are below 8% today. So you'ld be better off borrowing and locking the rate. Might all change in the future. But who's to say the state won't up the 8% too.
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Old 06-18-2008, 11:47 PM   #6
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Second to die. Yes. Wife can live as long as she wants and can defer taxes.

You can pay the taxes anytime you want. You would owe the tax plus the 8%. If you needed the cash and had to sell the home you would have to pay the taxes.

The 8% is simple not compound. I figure in a 20 year period the compound interest you would have to earn is a little over 6% to equal the 8% simple figure. As the period increases the interest you have to earn decreases. I think it is just north of 4% at 30 years.

I have not thought through the reverse mortgage. We have the cash to pay the taxes. While the guys on TV make it sound like a gift from heaven, the high up front fees of a reverse mortgage do not appeal to me. I'm not sure of this, but I don't think Scott Burns is very high on them either. Several other notables have made statements to stay away or use them as a last resort.

Texas has no Cap Gaines tax. If the house is sold I would guess it would still qualify for the federal exemption. It is still your house. I could see a case that if you moved into a long term care facility and 'did not live in the home' the feds might have a case to come after the Gaines. However in that case the home would need to be sold before those thresholds were crossed. If the home was worth less than the taxes you would let the county foreclose and it would not be an issue. They could come back against you for the taxes, but it would be real bad publicity for the elected official to dun a couple of old geysers on their death bed, and I'm not sure I would worry about it at that point.

My thoughts were to compare two people. One defers the other does not. Say 20 years later they both need cash. One has to take out a loan or a reverse mortgage, if they can, the other has to go to the bank. (assuming you save the money rather than spend it) Also it the money is invested in stocks and bonds, the probability it will grow more than the interest due.
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Old 06-19-2008, 12:34 AM   #7
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Sounds like you've thought through all the fine print.

Quote:
Originally Posted by Rustic23 View Post
I'm not sure of this, but I don't think Scott Burns is very high on them either. Several other notables have made statements to stay away or use them as a last resort.
Burns is indeed not a fan. But most advisers see it as the only way to tap home equity, short of moving into a group home or with a relative. No downside (unless the heirs hold a grudge) and the deal just gets better as people live longer.

Quote:
Originally Posted by Rustic23 View Post
... the other has to go to the bank. (assuming you save the money rather than spend it) Also it the money is invested in stocks and bonds, the probability it will grow more than the interest due.
I guess the key to this plan (or, for the vast majority of people, the flaw) is that the money saved on taxes has to actually be saved/invested. And it's probably best done somewhere that Texas couldn't easily attach or freeze those assets.

Now I'm going to have to see what Hawaii law says...
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Old 06-19-2008, 07:48 AM   #8
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Biggest catch is the 180 days to pay off upon death. If your heirs do not make this deadline then all fees and penalties apply. In Texas that is borders, not it is, usurious!
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Old 06-19-2008, 03:12 PM   #9
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You don't mention how you calculated the effective interest rate, but don't forget that while the interest on that first year you deferred is compounding away, the rate on that last year is the full 8%. So if you defer for 30 years you only need to make a 4.2% return to pay off that first year, but you need to make an 8% return to pay off the last year, and this averages out to a blended IRR of 4.8%. Given this, and assuming your 4.8% would have to be after tax, I think this is not worthwhile. Only a small upside and a fairly significant downside.

The benefit of this plan would be if you knew you weren't going to sell the house and didn't care about your estate. Then it's free money.
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Old 06-19-2008, 10:06 PM   #10
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I ran a spreadsheet for 20 years. I used the formula for the first year of Tax*.08*20+Tax. That gives you $18,200 for the first year on a $7,000 tax. The rest are figured the same way with each year one year less. There is no compounding as there is never interest paid on interest. I then took the sum of the 20 years and put it in my HP-19b calculator with the total as the FV, with the Tax as the Pmt, 20 years and ask for the interest rate. That gives me the 'compound' interest rate to achieve that FV with steady payment. Now there are some flaws as the Tax will go up during the 20 years. However, I live in a county that freezes the County and School Tax for those over 65. Our Utility District is about to pay off it's bonds and their tax should drop drastically so there should be little if any increase in Tax.

You are right, the rate to pay off the last year is 8%. I never figured the rate for the 1st year.
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Old 06-19-2008, 10:58 PM   #11
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Because we haven't made this discussion complicated enough yet, here's a new way to tap home equity:

Tapping home equity for no-debt cash | Money | Reuters

Quote:
They've lived in the house for 24 years, come close to paying off the mortgage, and watched its value go up from $160,000 to almost $700,000. That was equity they wanted to tap to pay off the family cars and buy some new equipment for Dan's physical therapy practice. But they didn't want to get into a costly reverse mortgage.
Instead, [they] signed up for a relatively new product called a Rex Agreement.
It gave them $117,000 in cash to spend however they wanted, and they owe no payments until they sell the house. At that time, they'll owe Rex & Co. the $117,000 plus half of the appreciation in their home's worth between the time they signed the agreement and the time they sell the house. If the house goes down in value, Rex & Co. will eat half of that loss as well. Since they signed the agreement last October, prices in their neighborhood have dropped. So far, it's been a good deal...
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