Trouble looms if mortgage exceeds value of the house Lots of folks concerned, including the IRS

Nation's Housing

August 16, 1998|By Kenneth R. Harney

MORTGAGE loans that exceed the value of the homes securing them are attracting new, critical attention at the IRS, on Capitol Hill, and in at least one district attorney's office.

The issue in all three places is the same: Homeowners taking out mortgages with balances higher than their property values -- a hot, multibillion-dollar financing concept for the past two years -- may be taking illegal tax write-offs on portions of their interest payments. Those homeowners may be misinformed about federal law limiting interest deductions, or they may be actively misled by their lender or loan broker.

Either way, homeowners -- and the lenders who encourage them to claim excess write-offs -- need to cut it out.

At the IRS, plans are under way to create a new method for tagging or identifying homeowners who have mortgages that exceed their home values.

Federal tax officials are drafting a revised "Form 1098," the familiar "mortgage interest statement" sent annually by all mortgage lenders to each home loan borrower, with a mandatory copy to the IRS.

The current form details the amount of mortgage interest the lender has collected from the borrower during the prior year. That amount is generally deductible at federal tax time for homeowners who itemize.

The copy of the form sent by the lender to the IRS enables tax auditors to electronically cross-check interest deductions on individual tax returns.

If your Form 1098 says your mortgage interest paid during the year was $4,000, and your tax return claims $6,000, the IRS can spot that difference in an audit.

The revised Form 1098 would include a new box for lenders to check if they believe a borrower has a "high loan-to-value" (high-LTV) loan, where the total amount of mortgage debt exceeds the fair market value of the property.

In instructions to lenders filling out the new draft Form 1098, the IRS asks them to check the box if the "total of all debt [including the debt to you] secured by the home exceeds the [fair market value]," or if "the [fair market value] of the home is not available, u nless the total of all debt secured by the home clearly does not exceed the [fair market value.]"

Under long-standing federal tax rules, mortgage interest deductions are limited to interest on loan amounts up to -- but no greater than -- the market value of the home when the loan was closed.

That means that homeowners taking out popular "125 percent loan-to-value" mortgages to consolidate consumer debts are prohibited from writing off the interest on loan amounts above the value of their homes.

Aggressively pitched on TV and in direct mail by sports celebrities, high-LTV mortgages have gone from nowhere a few years ago to a $12 billion to $15 billion per year boom product, according to industry estimates.

Federal tax officials believe that many homeowners don't understand the limitation on mortgage deductions, and are converting huge amounts of nondeductible auto and credit card debt into ostensibly deductible mortgage debt.

For example, a homeowner with a $100,000 loan on a $115,000 house who also has $25,000 in nondeductible auto and credit card debt might apply for and get a high-LTV second mortgage of $40,000.

The interest on the second mortgage, however, is only partially deductible -- just $15,000 of the $40,000. The interest on the remainder -- $25,000 -- is nondeductible because it's above the $115,000 value of the property.

An IRS official confirms the check-the-box effort is under way on Form 1098, but says it's doubtful that the form can be ready and distributed in time for the coming tax year.

After that, though, borrowers and lenders with high-LTV loans can expect heightened IRS tax scrutiny. Homeowners will be tagged for special attention by the very lenders who gave them their loans.

Two other developments on the high-LTV mortgage front:

* Concerned about potentially misleading marketing practices, Sen. Jack Reed, a Rhode Island Democrat, has drafted legislative language requiring lenders offering high-LTV mortgages to disclose in all advertising, and at the time of borrower application, that interest payments on loan balances above the home value are not deductible. Reed's language is in the form of an amendment to the Truth-in-Lending Act that could be attached to a bill moving to the Senate floor this year.

* In California, the Santa Clara County district attorney has sued one of the major national lenders of high-LTV mortgage money for alleged deceptive marketing practices, including misrepresentations on federal tax deductions.

The suit charges Irvine, Calif.-based DiTech Funding Corp. with false or misleading advertising on its interest rates, loan fees, prepayment penalties and closing costs, as well as on the tax deductibility of interest payments. DiTech's vice president and general counsel, Daniel Baren, says the company denies all the allegations in the suit.

Kenneth R. Harney is a syndicated columnist. Send letters care of the Washington Post Writers Group, 1150 15th St. N.W., Washington D.C. 20071.

Pub Date: 8/16/98

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