Deciding If Refinancing Is Beneficial – Part 1

So, your current loan has an interest rate of 7.5 percent and you think that you can now refinance your property at 6.25 percent. Should you refinance now? How does one decide when it’s time to consider refinancing, knowing one must take into account the points and other loan costs and the tax considerations? If it isn’t advisable to refinance at 6.25 percent, how much below the old interest rate must rates fall before it’s beneficial to refinance?

Although there can be different factors involved in refinancing your personal residence compared to a rental property, the discussions and analyses in this series apply to either case for most issues.

Is it advantageous to refinance when rates drop by one-percent as many “experts” claim or is some lesser reduction enough or some greater reduction required?

These days, property owners are often bombarded by advertising urging them to refinance their property or take out an equity line of credit or equity loan. The advertising is on millions of Web pages, in the newspaper, flyers delivered to your door, and mail in your mail box. The advertising often fails to provide adequate disclosures, is sometimes downright misleading and, even when adequate disclosures are provided, it’s in less than “fine” print.

When hearing from the “experts” that one-percent is the point at which to refinance, keep in mind the following two important basic points:

• First, most of these “experts” work for banks or mortgage companies and anticipate refinancing income when making the pronouncement.
• Second, knowing the rate drop alone is usually seriously inadequate for making a decision and most of those giving such advice do not take into account many of the various factors that should be considered, including some that affect each borrower differently.

In this first part of the series we’ll mention some of the basic factors related to refinancing. In future parts of the series we’ll delve into ways to perform detailed analyses that take into account some of the factors. One will not usually need to do such detailed analyses, particularly for 1 to 4 unit properties, where the amounts involved are relatively small. Furthermore, there are numerous short-cut methods that provide adequate results for such loans. Although the detailed procedures shown are not often necessary, investors in larger properties may save significant amounts by utilizing the procedures and it is instructive for investors in smaller properties to understand the issues involved.

The Basics

Factors that should be considered when deciding whether it is beneficial to refinance include the following:

• The real total cost of the potential refinancing including your time and that of any others involved.
• Expected future rates and costs compared to at present.
• Your current marginal income tax bracket and what it is expected to be over the term of the loan.
• Whether or not you want to pull out cash.
• How long you plan to own the property.
• Whether or not you might want to do a Section 1031 exchange in the near future.
• Long-term goals and objectives, such as:
  • Whether you prefer high leverage for maximum return on investment or low leverage for more cash flow.
  • Whether you want to pay off the loan by a particular date because of retirement plans or for other reasons.

Discussions can be divided into two parts – the short-term and the long-term. For the short-term, we’re usually most interested in knowing how long it takes for the reduced interest rate to pay the costs of refinancing, including the time and trouble required to obtain the new loan. This is particularly important when the property might be sold in the near future, as there is usually no advantage to reducing interest costs for less time than it takes to recoup the costs of refinancing. For the long-term, we’re usually more interested in knowing the effect over a period of many years. It can often be of benefit to pay some additional cost up front in order to obtain significant savings over a number of years.

In order to do analyses similar to those that follow, one must be able to determine the values of various loan parameters for various points in the lives of loans having various interest rates and terms. This can be done by direct calculation, by utilizing printed amortization tables, or by using various computer calculators. The last method is the easiest and calculators are available on many Web sites.

Over the past half-century, real estate long-term loan interest rates have varied widely, from a low of around 4 percent, even lower for owner-occupied single-family residences, to a high of about 18 percent, even higher for less than prime properties. Although for much of the past decade rates have been lower, we will use rates in the 7 to 8 percent range in most of our examples because this is probably close to the average of rates for typical residential and commercial rental properties over the five decades.

Loan Type Considerations

There are basically two types of interest rates – fixed and adjustable (ARMs). Although we think that advantages and disadvantages of each of the two types are known to most readers, we will briefly review the two types.

Fixed Rate

A fixed rate mortgage is one in which the interest remains the same for the term of the loan. It could be a short-term interest-only loan with the entire principle due at the end of the term (a balloon note) or an amortizing long-term loan where each payment includes the interest due and some amount on the principal.

It is impossible for a lender to predict where interest rates will be 10, 20 or 30 years from now, so lenders are likely to quote higher interest rates for a fixed rate long-term mortgage to offset the risk to the lender.

While various other costs can vary among lenders, the variances of those items are insignificant compared to the two most important issues in a fixed rate loan – points and interest rate.

Points and interest rate are intertwined. Accordingly, it is possible to minimize the points with a higher interest rate or reduce the interest rate by paying more points (buy down the interest rate). The benefit of one or the other depends on the borrower’s cash availability and the expected period of the loan.

The payment amount for an amortized fixed interest loan is the same for each period, usually one month.

Adjustable Rate Mortgages (ARMs)

Adjustable Rate Mortgages (ARMs) have interest rates that are tied to some kind of financial index. This results in mortgage interest rates that can vary over a specified range. A portion of the long-term rate risk is transferred to the buyer so the lender is willing to accept lower initial interest rates on the loan. Usually, mortgage payments are adjusted as well, but not for all types of ARMs. In any event, the due date of the loan usually remains the same, meaning the loan is not fully amortized for all types.

The various indices used include U.S. Treasury Bills (T-bills), Certificates of Deposit (CDs), London Interbank Offered Rate Index (LIBOR), and Eleventh District Cost of Funds Index (COFI). Each of these indexes has different ranges and rates of potential movement and vary with different aspects of the economy and world events.

Because the lender’s risk is less, interest rates are lower for ARMs than for fixed rate mortgages.

There are essentially infinite potential varieties of ARMs, with more features and options, and a number of additional terms than associated with fixed rate loans. The initial interest rate of the mortgage is known as the “start rate”, applicable for a specific period determined by the terms of the mortgage. The period of time that the rate is fixed can range from one month to several years. Once this initial period expires, the interest rate can begin to vary. The interest rate will rise, fall, or remain the same depending on the long-term rate to which it is tied. The overall change is usually limited annually, and over the life of the loan, by a cap. Typically the annual payment increase cap is several points over the index.

Some adjustable rate mortgages have an annual interest rate adjustment cap instead of a payment cap. That sets a limit on the maximum amount of interest rate adjustment. For example, if the loan has a 2% annual interest rate cap, a loan with a start rate of 8% can then only grow to 10% at the beginning of the second year.

ARMs typically have a lifetime interest rate cap as well, which sets the absolute maximum interest rate allowed for the mortgage. If the financial index to which the interest rate is tied reaches the cap, the mortgage basically becomes a fixed-rate mortgage until the financial index drops enough for the mortgage interest rate to drop below the rate cap. There is usually a minimum interest rate required by the lender as well.

When the interest rate changes without like changes in monthly payments, it is possible for the loan amount to actually increase as the deficit in the payment amount is added to the principal. This is known as negative amortization.

Competition among lenders has resulted in a great many real estate financing options. The fixed-rate mortgage is fairly straightforward and the conservative selection for both borrowers and lenders. Nothing should change during the 15 to 30 year term, except for the property taxes and insurance amount that may be collected in the payment.

ARMs can vary in many different ways and lenders offer a number of different options to deal with changes in the interest rate index. In addition to an annual rate adjustment, some lenders offer a fixed rate for a specified period of time, like five to seven years. At the end of that initial period the rate can vary annually.

Unlike fixed rate mortgages, most ARMs are assumable. That can be a benefit to your future buyer. However, assumption usually requires financial qualification and can also require payment of fees. It is often more desirable to obtain a new loan rather than to assume an existing one.

Choosing between a fixed and variable/adjustable rate mortgage can be difficult and depends on both your expectations for the future of interest rates and your investment comfort level. If security and predictability are most important to you, then the security of a fixed payment long-term loan will be attractive. If you expect to sell within the next five years or are willing to gamble that interest rates will go down or at least remain stable, the variable/adjustable rate mortgage could be a much better deal.

In order to keep the complexity of the analyses that will be studied in future parts manageable, those analyses will only consider fixed interest rates. However, analysis for a variable rate loan is easily performed by breaking the period of time for which an analysis is desired into smaller periods during which the rate is constant.

Question

I did my quarterly safety inspection on a unit last week, the first for this tenant, and found that the tenant has an unusual amount of junk throughout the unit – my newest tenant appears to be a “hoarder.” I couldn’t see the floor in many areas of the unit. What if anything can be done about a tenant that has so much junk? I am particularly concerned about flammable items near the wall gas heaters. Also, they have ants that are probably because of food items left out and we cannot call in the pest control because of all the stuff.

Answer

First, I congratulate you on doing regular inspections of your units, as too few landlords do so. Hopefully, your inspections are for more than safety related, as inspections can also catch unreported maintenance problems that, if not corrected, can become costly (e.g., leaky plumbing). Regular inspections can also uncover lease violations and other potential problems (e.g., unknown pets and prohibited smoking, even illegal activities).

You can certainly require that a tenant maintain his unit in a safe and healthy condition. If it is your opinion that the “clutter” creates a dangerous situation you can serve a notice to correct. If you have a clause in your lease agreement that deals with the way the unit must be maintained (a common clause in a good document), refer to the specific clause as well as general safety principles. If there is no clause in the lease, refer to general principles. Many states include such issues in their landlord-tenant statutes and some local governments have their own requirements.

However, keeping both legal and landlord-tenant relations in mind, be absolutely sure, before pursuing any action, that the clutter really represents a true safety hazard or other problem rather than housekeeping practice that is beneath your standards. A tenant who pays the rent on time and causes no other problems except having a cluttered apartment interior that really doesn’t bother anyone except you is far preferable to a neat-freak tenant who is always late with the rent or is selling drugs from the unit. Other than if the clutter created a true danger to my property, I would not hassle an otherwise acceptable tenant.

You might consider seeing if the fire department for the location will do an inspection of your units in order to have an official opinion one way or the other regarding the issue. Fire departments will often do such voluntary inspections free of charge with no penalties for violations found. Some insurance companies will provide a similar service. Such inspections provide additional liability protection for a landlord as well as provide ammunition for pursuing your complaint regarding housekeeping.

Regarding the ants, even if the clutter does not represent a safety issue you would have the right to require that the floors be cleared of clutter on the day when pest control treatment is scheduled. You should provide written notice of the treatment the number of days in advance required by your lease agreement or state law, whichever is greater. If the pest control person must make a separate special trip because the stuff prevent treating the unit, you could probably bill them for it. Failure to cooperate might provide grounds for eviction, but it might depend on the judge. However, keep in mind that such actions will not likely improve landlord-tenant relations.

If you decide to serve the tenant with a notice, LandlordOnline.com has one available titled “Warning Notice To Resident Re: Housekeeping.”

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Question 2

I am a relatively new landlord who has not previously experienced the issue of my question.

A tenant gave notice more than a week ago via my cell phone message service that she would vacate the unit by the end of her lease this past Sunday. It is now Friday, 5 days later, and she has not yet turned in the keys and does not return phone calls or respond to messages left at her work place. Looking through a window I can see that there is still some of her furniture and other things in the unit. What must I do before entering the unit and what do I do with things left there?

Answer 2

You did not provide the name of the state for your rental property, so I can only answer in generalities.

The most basic issue is whether or not possession has been returned to you. This in turn depends on the intent of the tenant, clauses in your lease agreement, the law of the state, and what events have occurred that might indicate the tenant did not plan to return to the property.

Events that prove that the tenant intended to return possession to the landlord can include (1) termination of the lease term where the lease agreement does not provide for automatic renewal or the tenant did not meet the conditions stated in the lease agreement for staying beyond the term end, (2) and what the tenant stated when giving notice of intent to have vacated, with the latter being provable, and (3) return of the keys and other such items such as garage door openers.

Some states have statutes that specify procedures the landlord should follow when not certain that the tenant has abandoned the rental premises. This may include posting of a notice on the property for a certain period before taking possession.

When you can remove personal property left by the tenant and what you can or must do with the property depends on the intent of the tenant, perhaps the clauses in your lease agreement, and the specific laws of your particular state. Laws related to abandoned property vary considerable among states. A landlord should not be in a hurry to donate, sell or otherwise dispose of any items without knowing the relevant laws of the particular state.

At one extreme, a state does not have a specific law regarding abandoned property. At the other extreme, a state has a statute spelling out detailed procedures for dealing with abandoned property that must be followed even when the lease has expired, all personal property except for a few items has been removed, and the tenant is almost certainly no longer occupying the premises. These procedures often include the requirement of putting the belongings in secure storage, providing notices to the tenant in accordance with that state’s law, holding a public sale of the abandoned property, and providing an accounting of the sale proceeds to the tenant, along with giving the tenant any funds in excess of what the tenant owed the landlord for rent and damages.

Some states do allow a landlord to keep or sell abandoned property if the tenant owes the landlord money. This is known as an automatic lien on the tenant’s possessions. The landlord should keep in mind that he may be seizing possessions that may not be paid for and the merchant for those items has a superior lien ahead of any lien interest the landlord may have.

In order to reduce the uncertainly regarding items left on the premises in spite of the above discussion, it is of benefit to include a lease clause stating that any items left on the premises beyond the date of termination of tenancy shall be considered abandoned and may be disposed of as the landlord sees fit without contact with the tenant. Abandoned property laws of many states might have priority over such lease clauses, but such clauses can still have value before some judges. Even if that isn’t certain, the clauses will likely discourage tenants from pursuing the matter to begin with.

Information regarding both possession and abandoned property for your state can likely be easily found by searching the Internet. However, I advise that you both (1) view multiple search results and (2) consider as most reliable those Web sites of the state governments (usually a consumer protection or specific landlord-tenant law related site) and/or landlord or tenant association sites.

However, if the landlord is uncertain regarding the issues he/she should consider consulting a competent attorney who is knowledgeable and experienced in the particular subjects of possession and/or abandoned property laws.

Lease Agreements – Part 11

Some Miscellaneous Issues                         

This final part of our Lease Agreements series will provide brief discussions regarding several miscellaneous issues.

Rent Control

Only a small number of jurisdictions (usually cities) have any form of rent control and rent control laws vary significantly among those jurisdictions. Rent control was arguably established to prevent or stabilize increased rent. It may affect how a landlord manages his property compared to non-stabilized jurisdiction; as examples, regarding the handling of security deposits and evictions. If your property is located in a rent control jurisdiction, be sure to read and thoroughly understand the law of that jurisdiction.

If a property is located in an area that has, or is considering rent control, the purchase price of the property must reflect the impact rent control has on income, additional management requirements, and the economic feasibility of maintaining or improving the property.

Section 8

Participation in Section 8 (Housing Choice Voucher Program – HCVP) can affect your lease terms. While participation in Section 8 is voluntary in most jurisdictions, some jurisdictions currently do not give landlords the right to refuse Section 8 applicants and it is likely that this trend will continue in the future.

If the selected rental unit is approved, the housing subsidy is paid directly to the landlord by the local Public Housing Authority (PHA) that administers Section 8 funding on behalf of the participating family. The family is responsible to pay any difference between the actual rent charged by the landlord and the amount subsidized by the Section 8 program.

There can be no difference in the amount of security deposit requested from an assisted family than from a non-assisted family. State landlord tenant statutes regarding security deposits are applicable to Section 8 tenants.

The lease agreement signed by the landlord and the participant family should have standard practices listed for damage charges beyond normal wear and tear. If the landlord determines after the family has vacated the rental unit that damages by the family have occurred, those damages may be compensated from the security deposit held by the landlord and the landlord may attempt collection for any amount that exceed the deposit.

The lease agreement between the landlord and the participant family must be for a term of one year and must be in written form. HUD’s Tenancy Addendum must be attached to the lease agreement. At the end of the lease, the landlord may renew the lease for a new one year term or offer a lease for a different specified time period.

Evictions, collections, and other issues are the responsibility of the landlord just as they are for any other tenant.

For detailed discussions regarding the Section 8 issues see our “9 Steps to Understanding Section 8” Mini Training Guide.

Co-Signer/Guarantor

While the terms co-signer and guarantor are often used interchangeably, they are significantly different.

A co-signer is the same as a signer, being simply a signer on the lease agreement. Accordingly, the co-signer may have all the same rights as a tenant who resides in the subject unit unless the agreement states otherwise. Accordingly, it is extremely important that all co-signers for a lease agreement be served all notices that are served on those signers who are occupying the unit. If a co-signer of proven identity does not sign the lease agreement in person (e.g., the out-of-state parent of a college student) it is very important that the signature be notarized in order to avoid the possibility of forgery.

A guarantor is someone who assumes certain financial liabilities for a lease, but does not actually sign the lease agreement and, accordingly, has no rights to the premises. There are basically two different types of guarantees, broad and narrow. The broad form of guaranty makes the guarantor liable for all financial matters including rents and damages. The narrow form limits the guarantor’s liability to the rent.

Agreements can be written to cover only an initial lease term or to include future extensions and renewals. The agreement should include any assignee of the lease during the term of the original guaranty.

Each co-signer and/or each guarantor should be screened in the same way and required to meet the same standards as any tenant.

Landlords in community property states should try to have both husband and wife execute a co-signer or guaranty agreement in order to be certain of binding both spouses. It is best to have both signatures whether or not this is an issue in a particular state because it eliminates potential disputes regarding liability for a lease. The same recommendation applies whether the co-signor or guarantor is guaranteeing a commercial lease for a limited liability entity or parents are guaranteeing a residential lease for a student child.

If a lease is modified in any way during the guaranty period, the co-signer/guarantor should be required to sign a new document related to the modified lease.

Security Deposits

Most states have requirements related to security deposits, including:

• The      maximum amount that can be required,
• Interest      that must be paid on the deposit,
• Where      the deposit must be kept,
• What      can be deducted from the deposit,
• When      the deposit must be returned and/or an accounting of amounts not returned      provided, and/or
• Penalties that may be      imposed against landlords who do not comply with return and/or accounting.

Maximum Amount – A majority of (but not all) states limit the amount of security deposit a landlord can require. In states that specify a maximum, the amount typically varies from one to two times the monthly rent. Some states allow higher amounts for furnished units and/or for waterbeds. Some states specifically do not allow landlords to collect greater amounts by calling the additional amounts cleaning or redecorating deposits or fees. Some states allow for an additional amount as a pet deposit, while most states do not consider this issue. If the state’s law is not clear on such issues, it is usually safest to consider the maximum as including everything except the first month’s rent.

Interest – There is a wide variety of specifications for calculating interest among states that require payment of interest on deposit. Some states specify a fixed rate; others tie the rate to an index. Some states require payment of interest only after a certain length of tenancy, for example, one year. Many states require annual or other periodic payments of accrued interest.

Depository – While some states allow conversion or commingling of security deposits, many do not and many of those specify where deposit funds must be kept, including the type and/or location of institutions in which funds may be deposited. Some states require that information regarding location be provided to the tenant.

Deductions – Most states specify the items for which funds can be deducted from deposits. Most, perhaps all prohibit deductions for normal wear and tear.

Return/Accounting – Most states require that landlords return the security deposit and/or a detail accounting for any portion not returned and to do so within a certain period following departure of a tenant, whether the departure was voluntary or non-voluntary. The period varies from 10 days to 60 days among the states.

Penalties – Many states impose significant financial penalties on landlords who do not perform in accordance with the law if the ex-tenant pursues the matter in court. Penalties in various states include loss of the right to keep any part of the deposit and double or treble damages payable to the ex-tenant plus Court costs and attorney fees.

Record Keeping

Landlords need to keep records on all applicants, current tenants, and past tenants. This obviously applies to lease agreements. The time required varies because the time allowed for filing of a suit varies among states. It can depend on a specific state statute or by the general statute of limitations laws applicable to the potential cause of action. The length of time typically varies from 2 to 5 years among the states.

For property managers, who are regulated by a state licensing agency, the records which must retained and the period of time for which various records must be retained are defined by state statutes and/or regulatory agency regulations and the periods may be different than for landlords managing their own properties.

Sources of Lease Agreements

It sometimes appears that there are almost as many lease agreement formats as there are landlords. When deciding which lease agreement to use, you must consider (1) does it provide all the clauses necessary to adequately protect you and your particular property, (2) does it meet all federal, state, and local laws, (3) is it iron-clad enough to provide sufficient protection without being so tight that no applicant will sign it, and is it available in a digital format that can be edited by the landlord?

Adequacy of a lease is best decided by knowing what should be in a good lease. Knowing this comes from experience and from knowledge gained from study of the subject, for example, by having read this article and the first 10 parts of this series and from other educational materials found on LandlordOnline.com.

The adequacy of a particular lease agreement can be determined by (1) checking it against the current version of your state’s statutes, (2) obtaining it from a reliable vendor who warrants that the lease was vetted by a competent attorney such as LandlordOnline.com, or (3) having it vetted by your own competent law attorney.

Lease agreements are available from a variety of sources including:

• Office supply stores
• Property management companies
• Landlord associations
• Trade associations
• State Association of Realtors
• Legal forms vendors
• Custom-made by landlord’s attorney
• Created      by the landlord

The adequacy and legality of forms vary significantly among the sources. For most landlords, the most convenient and best source of forms will be from a qualified forms vendor that provides state-specific versions that are vetted by attorneys. Attorney-approved state-specific lease agreements are available from LandlordOnline.com. However, as for any “off-the-shelf” document, modification of a lease agreement is often required to make it adequate for a specific property. The Word version of a lease agreement for any state can be modified as desired by addition of clauses relevant to specific properties or desired by the landlord for any other legal reason.

Keep in mind that, no matter where the form comes from, it is the landlord who bears final responsibility for using a form meeting the legal requirements of the specific state and providing the terms that are adequate for the particular properties for which it is used. Accordingly, it is advisable for a landlord to always (1) read through the landlord-tenant law of his state, making notes about important issues; (2) be knowledgeable about important issues such as maximum security deposit and when a deposit of a terminating tenant must be returned and/or accounted for; and (3) keep abreast of changes in the laws. Unless the lease agreement is provided by a reliable source, a landlord should personally check it against his state’s law or have it checked by a competent landlord-tenant law attorney.