Will refinance lessen homeowner's real estate tax deduction?

Benefits of lower interest rate, no mortgage insurance go undetected
By: Robert J. Bruss: Inman News
DEAR BOB: I own a townhouse condo that I bought in 1993 with a 6.5 percent interest rate, 30-year FHA mortgage. My monthly FHA mortgage insurance fee is $47. My purchase price was $130,000. Today, the condo is worth around $380,000. I have never seriously considered refinancing, although my lender periodically sends me advertisements about no-closing-cost refinances for 15 or 30 years. The interest rate would be slightly lower than my current interest rate for 15 years with a slightly higher monthly payment, but I would avoid that unnecessary $47 FHA fee. One of the reasons I am holding back is because I would be paying less interest, thus having less to deduct on my income tax. However, I would be taking about five years off the mortgage. Is such a refinance a good idea? - Susan P.

DEAR SUSAN: Let me get this straight. You have not refinanced to save interest and shorten the life of your mortgage by about five years because you enjoy paying higher interest, that non-deductible $47 FHA fee, and deducting the interest on your tax returns.

It makes no financial sense to pay higher mortgage interest just to get the itemized homeowner's interest tax deduction.

To illustrate, if you are in the 28 percent federal income tax bracket, plus state taxes, for every $100 mortgage interest you pay, you get a $28 income tax saving. Wouldn't it be better to slightly reduce your interest rate, get rid of that $47 non-deductible FHA insurance fee, and shorten the mortgage term? I think you know the answer.

HOW MUCH LIABILITY INSURANCE IS ENOUGH?

DEAR BOB: You recently suggested homeowners carry $300,000 liability coverage, plus a $2 or $3 million umbrella liability insurance policy. This seems very high to me. My homeowner's insurance policy currently has $100,000 liability coverage and I don't have any umbrella liability insurance policy. Do you think I need more liability coverage? -Martha W.

DEAR MARTHA: The answer depends on your assets, your home equity, and your potential liability risk. Accidents happen no matter how careful you might be. I won't bore you with all the possible negligence liability that might cause injury to others around your home.

If someone is severely injured, and if you are liable, your current $100,000 liability isn't much coverage if you get sued. Adding an extra $100,000 or $200,000 liability coverage on your homeowner's insurance policy shouldn't cost very much.

More important, if you are wealthy and have substantial assets, a $2 or $3 million umbrella insurance policy is very cheap protection. It also offers additional insurance coverage, such as for your negligence in an auto accident. Please consult your insurance agent for details.

WHY IT IS USUALLY BETTER TO INHERIT THAN RECEIVE REALTY GIFT DEED

DEAR BOB: Several years ago, upon the advice of our attorney, we added our four children to the title to our home and adjoining land. But after reading your frequent advice that it is usually best to inherit real estate via a living trust to get the stepped-up basis on the date of death, we're wondering if we did the right thing. The attorney has since died. Why do you say it is better to inherit real estate than to receive it as a gift before death? - Betty and Ernie G.

DEAR BETTY AND ERNIE: I hate to disagree with a fellow attorney, but depending on how title is held with your four children there might not be any stepped-up basis benefits.

Also, holding title with six people on the title is almost certain to lead to eventual problems if you want to sell but one of the co-owners refuses to sell. Or what will you do if one of the co-owners becomes incapacitated, such as with a severe stroke or Alzheimer's disease?

Holding title to your property in your living trust would have been so much easier and your heirs would get the stepped-up basis benefits. A living trust lets you maintain control. By gifting part of your title to your children, you gave up full control.

I suggest you consult a new attorney about possible title changes.

More details are in my special report, "24 Key Questions: Living Trusts Reveal How to Avoid Probate Costs and Delays," available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet PDF delivery at www.bobbruss.com. Questions for this column are welcome at either address.