Should You Purchase
At a Fire-Sale Price?

Question: My wife and I were a day or two away from making an offer on a house when it caught on fire. Our initial reaction was to forget about ever living there, but now we are thinking it actually might be a good opportunity. Nothing was damaged that can't be repaired and a lot of the repairs, especially flooring, will be for items we would have wanted to eventually replace anyway. Enough of the house was spared that we could actually live there while repairs are being made.

What is the best way to approach such a scenario? Should we let the sellers know we are interested but let them deal with making a bulk of the repairs? Should we try to buy "as is" at a discount, let the sellers keep the insurance settlement and make the repairs ourselves as we want them? Or is there another possibility we haven't considered?

We also have no idea how financing and insurance would work for people buying a damaged home to be repaired. The owners had already vacated, and are retired and living two hours away. My wife and I own a house nearby and aren’t in a rush to move, although we would have to sell our house before we could close on a new mortgage.

Answer: While it seems that dealing with a fire-damaged house should be easy, it is actually one of the hardest deals to handle. There are many reasons, not the least of which include the following:

• Insurance claims -- The current owner will certainly be making these and, hopefully they can be settled quickly. But perhaps not. Sometimes there's a dispute with the insurance company over costs and coverage. It could drag on for months, if not years.

• Liability -- Why did the house burn down? Is someone or some company responsible? Is there a criminal inquiry being conducted? What about lawsuits over liability? Again, this could drag on for quite some time.

• Rebuilding -- In the old days, insurance companies would often simply pay off the owner and be done with it. But today, many instead want to return the home to its original condition. This could involve finding contractors and doing construction work for the owners or the insurance company, along with potential delays.

• Financing -- This is going to be difficult if not impossible for you in the home's current condition. Most lenders won't want to lend on a property that needs repair work until that work is done. A construction loan may be the only kind of financing available, if you buy the house. Here money is paid out only as work is completed.

If you have a chance to buy this property in its current condition, make every effort to investigate all of the above thoroughly. And use an attorney to help determine if there are other issues. Finally, be sure to pay only a fire-sale price.

On the other hand, if you are willing to wait until the current owners clean up the mess, rebuild and can offer clear title with no claims, it should be a simple purchase. But, that could be a long time.

The Pros and Cons of Interest-Only Loans

Question: I am interested in obtaining an interest-only loan for purchasing a home. Every time I hear about interest-only loans they always appear to have an adjustable rate that changes every five years. Isn't there a fixed rate interest-only mortgage? I do not see the correlation between interest-only and whether or not the rate can be fixed?

Answer: The rationale that most home buyers have for wanting an interest-only loan is to cut down on their mortgage payment. They reason, quite correctly, that by paying only interest they will have a lower monthly payment. (After all, they aren’t paying any money each month to retire the mortgage.) Further, if prices go up, their equity will still grow, even if the loan isn’t paid down.

There are problems, however. To begin, the amount that goes to equity return in a mortgage in the first years is fairly small; you are paying mostly interest. For example, in a 30-year fully amortized (principal fully paid back) mortgage of $200,000 at 6%, your payment is about $1,200. On an interest-only loan that amount is $1,000. Yes, the difference is $200 and if that is what makes the difference between getting in, or not being able to afford the property, it may be worthwhile to go for interest-only, at least short term.

On the other hand, as the loan goes out further in time, which is apparently what you are looking for, the difference between an interest-only and an amortized loan favors the latter. By year No. 30 in a fully paid off loan such as the one described above, you will have paid about $232,000 in interest alone, but will owe no more on the mortgage. On the other hand, at the termination of the same loan but at interest-only, you will still owe the full borrowed amount, in our case $200,000. In addition, over the 30 years you will have paid a whopping $360,000 in interest. That is around $128,000 more in interest.

It is easy to see why most people, if they opt for an interest-only loan, want a short-term one. Most anticipate converting to an amortized loan in the near future. That is why most lenders offer three- and five-year interest-only convertible mortgages.

As for why you have found lots of adjustable- rather than fixed-rate interest-only loans, it is mainly to protect lenders against the risks of any upsurge in the market interest rate. Most lenders would prefer to issue only adjustable-rate loans and never offer fixed, if they could get away with it. However, the public demands fixed-rate mortgages, so they are available. If you still want a long-term fixed-rate interest-only loan, be assured that they are out there. To find one, you will just have to look more closely.

-- Mr. Irwin has more than 25 years' experience as a Los Angeles-area real-estate broker. He is the author of more than two dozen books about real estate and is recognized as one of the most knowledgeable writers in the real-estate field. Mr. Irwin's most recent books are "How to Get Started in Real Estate Investing" and "How to Buy a Home When You Can't Afford It" (McGraw-Hill, 2002).

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