Functional, Stylistic and Economic Obsolescence
Functional Obsolescence, with regards to real estate, occurs when there is a loss of building utility. This can occur with a home that is too lavish or improved for a neighborhood, or on the other end of the spectrum, a home that is much smaller or under-improved for an area. Functional obsolescence can also occur when a property no longer meets the basic needs and wants of a certain society; such as a 2 bedroom, 1 bathroom home or a home heated with coal. Functional obsolescence can be curable or incurable depending on how difficult it is to overcome the obsolescence.
Stylistic Obsolescence is a home which does not conform stylistically to the neighborhood or incorporates some sort of material that is no longer manufactured or utilized. It can be a contemporary home in a traditional neighborhood or a home with a EIFS exterior that is no longer used. Stylistic obsolescence is almost always curable, but it is not always economically feasible to do so.
Economic Obsolescence is rarely curable. This occurs normally with older properties and is usually out of the control of the owner. Economic obsolescence can occur when commercial zoning encroaches onto residential or when a road widening diminishes the front yard of a home.
It’s important to understand obsolescence and the effect it can have on the value of your property. In some cases, especially with stylistic obsolescence, it may take a third party to inform you of the status (just like when you wear your favorite skinny tie and leisure suit).
What does it mean to buy a property “subject to?”
“Subject to” (as it relates to real estate) refers to a method of purchasing a property while leaving the seller’s existing mortgage(s) in place.
The seller deeds the property to the buyer, who agrees to make the existing mortgage payments on the property. In most cases, the seller is not released from liability on the mortgage. In some cases, the agreement may also include the provision that the buyer either sell or refinance the property within a certain period of time.
What is the main benefit? The seller’s costs to sell are usually very small with this type of transaction. It’s also easy to sell this way as the buyer does not need to qualify for a mortgage and incur a high cost for closing on the property.
The main negative? Most mortgages contain a due on sale clause. This allows the lender to call the note if there is a transfer of title on the property. If the lender is made aware of the sale, they could require payment in full and the original owner (the seller) is liable party.
A Second Home … What Qualifies?
As the economy has wreaked havoc on the second home market, some buyers are seeing an opportunity to own something they might not otherwise be able to afford. Others are finding themselves “stuck” with 2 properties and not being able to sell one.
The IRS allows for up to 2 residences for a taxpayer to deduct mortgage interest. Also of note is what qualifies as a second home:
- House
- Townhouse
- Condominium
- Boat
- RV
- Mobile home
- Trailer
The requirement states that the second home must have a sleeping space, toilet and a place to cook. In addition, the second home must be at least 50 miles from the primary residence. (Note about the 50 mile rule - say you commute 45 miles to work each day, a second home could be a “crash pad” near your employer but 50 miles from your home).
Can you rent your second home and still take the mortgage interest and property tax deductions? Yes! As long as you use it for 14 days or 10% of the time it is rented, whichever is greater. Another benefit: if you rent your second home out for 15 days or less and for fair market value, the rental income is not taxable.
Of course, speak to a qualified accountant to answer any questions or concerns you may have regarding a second home.
What is a Negative Amortization Mortgage?
Negative amortization occurs when the payment made by the borrower does not cover the amount of the interest incurred. The difference is added to the loan amount.
Traditionally, negative amortization loans have been used by lenders to allow for a lower monthly mortgage payment in the beginning of the loan period.
So, why would someone want this type of loan? Well, it may be an option for a couple where one person is presently employed and the other is in school, graduating in a year or so and will be employed, bringing the household income substantially higher.
In the 1980′s when interest rates very very high, negative amortization loans offered borrowers the ability to keep their payments low and ride the market hoping that in a few years, they could refinance into a lower interest rate.
In our current market of low mortgage interest rates and lenders having stricter lending guidelines, negative amortization loans are very rare; however, there are still some lenders offering the product.
The Due On Sale Clause
The Due on Sale Clause, or Acceleration Clause, is a clause in a mortgage which states that if there is any transfer of ownership or interest in a property, the mortgage can be called and immediately due to the lender. With the exception of VA and FHA mortgages (which are generally assumable by a qualifying party), almost all mortgages have a due on sale clause.
Keep in mind that generally, this clause is a contractual option by the lender. This means that the lender may or may not decide to call the loan due once notified of a transfer in title or ownership interest. If the loan cannot be paid, the lender has the option of beginning foreclosure proceedings.
A “sale” is not the only thing that can trigger the due on sale clause. Sometimes, a long term lease, lease-purchase agreement, or even a quit-claim deed can trigger the clause.
The reality is, in today’s market, a lender would be nuts to call a loan when the payments are being made in full and on time. And usually, they don’t. That being said, we do live in a world where nutty things are done….
Depending on applicable state laws, it may be possible to purchase a property “subject to” the existing mortgage by creating a land trust when transferring title. Obviously, it is highly recommended that one consult with a qualified attorney before entering into such a transfer.
