Refinancing Camouflages Cash Flow Woes

Bruce Wiliams
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Posted: Apr 05, 2012 12:01 AM

DEAR BRUCE: About four years ago, a major bank called us about refinancing our mortgage. We agreed, and the bank qualified us for a loan of $1,960 per month. We are on a fixed income -- pension and Social Security for my husband and me -- for a total of about $4,200 per month.

The bank qualified us by "grossing up" our Social Security benefits, which added about $800 to our income. The irony is, we don't have income taxes taken out, and that $800 is an illusion. The bank did not offer escrow with the loan, so we are responsible for taxes and insurance.

Three years ago we did a three-year modification, reducing our payment to $1,390 per month. Still, no escrow for taxes.

Today we are behind three years in our property taxes, our house payment is going back to $1,960 and we are in a mess. We've talked to a bankruptcy lawyer, who recommends Chapter 13 with a payback of three years. I am worried about our house payment, which is about 44 percent of our income. Is bankruptcy our best option, or should we try to work with the bank for a solution to the house payment and back taxes? -- D.G., via email

DEAR D.G.: I am having a problem with a couple of things.

First, when the bank would not establish an escrow account, which is no big deal, why did you not open your own escrow account? This would be a separate account where every month you would deposit money to pay your homeowners insurance and real estate taxes. That would have accomplished the same thing as a bank escrow account. You put yourself into this problem by not taking the responsibility to do that.

In manipulating the mortgage to reduce your monthly payment, you had the advantage of paying less but did not look ahead to when your mortgage would have to return to its previous rate. You've tried to finance your way to solvency through a back door, and that just isn't in the cards. I'm not trying to pick on you, but those are obvious mistakes you made that you don't want to make again.

In considering bankruptcy, you have to discuss what option would be best for you. A Chapter 7 bankruptcy is absolute: The house gets sold and almost all of your debts are discharged. Chapter 13, which you state is what your attorney recommends, is simply a reorganization that gives you time to get back on your feet. While neither is really desirable in terms of credit, Chapter 13 would allow you some breathing room.

I don't think trying to refinance with the bank to get yourself out of debt is the way to go. That whole business right now is so screwed up, I would stay away from it if I possibly could.

Another question to you: Is it absolutely necessary for you to maintain the home you are in now? If not, is the market in your part of the world starting to recover? In other words, if you could sell the house and use the equity you have to buy a much smaller place or get into the rental market, that might be a viable solution for you. Make sure you go over all of your options with your attorney.

DEAR BRUCE: My husband and I are in our mid-50s, with a combined gross salary of $65,000. We both are employed full time. We own our house and are raising our 13-year-old daughter, who will hopefully be college-bound in the future.

My mother, age 90, entered a nursing home in September (stroke). Her cash will be depleted in midsummer. She is "life tenant" in her house, so the house is still an asset. Hence, the house will have to be sold to provide money for care until we can apply for Medicaid for her in the state of Virginia.

My husband and I have approximately $260,000 in various retirement accounts. I have three adult brothers, and I venture to say that I am the one with the most "saved" money. Some of the money was invested in an IRA to be used for college.

Would it be unwise to spend some of this money for my mother's nursing home care so we don't have to sell her house? The bill currently averages $5,000 a month. I realize there will be penalties for early withdrawal of any of it, but I'm having guilt issues with this and just need some advice. We don't need her house -- we feel pretty certain she will not be able to return there -- but for sentimental reasons, we hate to see it sold. --C.D., via email

DEAR C.D.: There are a couple of things you've failed to explain. How did your mom become a "life tenant" in the house and why? Is there a mortgage on the house?

Sentimentality acknowledged, and given the likelihood that your brothers will not have the money to contribute to your mother's care, it's going to fall on you. In reality, you don't have any legal obligation to support her. She is in an institution, and it's very unlikely she will be asked to leave because of a lack of funds; that's what Medicaid supposedly cures.

As to keeping her house in the family, what are you going to do with it? It may or may not produce enough income as a rental to pay for itself. While I can understand sentimentality, cooler heads will have to be involved in making a decision regarding the house.

Maybe your brothers would agree to sign off on any interest they have in the house, which would give you money that you could recapture upon sale of the house and spend on your mother. I don't have any great quarrel with that. I certainly would get good solid legal advice to be certain that you would be first in line. You mentioned that the bill for the nursing home is $60,000 a year. How much is the house worth, and how soon would proceeds from a sale be exhausted? These are all things to consider before making a final decision.

You also have your daughter's education hanging over you. My regular readers know that I believe you have an obligation to get your daughter through high school with proper morals, etc. You have no obligation, legal or moral, to impoverish yourself and spend retirement funds on her college education.

Although your assets are substantial -- to the point where getting loans may be difficult -- I certainly would apply for all of the college aid possible. But under no circumstances would I take money out of the retirement accounts to finance a college education.

(Send questions to bruce@brucewilliams.com or to Smart Money, P.O. Box 2095, Elfers, FL 34680. Questions of general interest will be answered in future columns. Owing to the volume of mail, personal replies cannot be provided.)