Taking Care of Mom and Dad: Calculating and Using Equity

The equity that your parents have in real estate or other assets is simply the appraised present value minus any mortgages or liens attached. Once you've calculated this number, you may want to consider the various ways to react.

If your parents don't have any equity -- or have negative equity -- the news is bad but your choices are simple.

This situation usually stems from heavy borrowing: Your parents have a mortgage and perhaps a second or third mortgage or an equity credit line that, taken together, add up to more than the current value of the real estate. With aggressive lenders promoting mortgages and lines of credit of up to 125 percent of a home's value, some people can owe more on their real estate than the assets are worth.

This situation can also come from numerous tax liens or court judgments placed against the value of the real estate.

Most lenders -- even aggressive ones -- won't make 125 percent loans to people over 60 years old. But, in some areas, there are lenders that will...and, in some cases, your parents may have been carrying the heavy debt for years.

If your parents' real estate has little or no equity value, the best solution is probably to sell. In this situation, the property is merely serving as security for the loans your parents have taken. Even if they are paying their monthly obligations from earnings or other income, they could probably use that income better to build some savings or pay for their costs of the daily living.

If the loans against the real estate are significantly larger than its market value -- in other words, if the property has negative equity (or is "underwater" in real estate parlance) -- a sale will not resolve the debts completely. In this situation, some people are tempted to keep making payments and let the lenders try to settle their accounts after their parents have passed away. This approach only works if your parents have no other assets in their estate...and it doesn't always work even in that case.

Some people may think about simply walking away from the over-leveraged real estate -- if it's the only asset they have and they are having trouble keeping up the payments. This may make some sense, from a tactical point of view. However, the lenders are likely to sell the property in foreclosure and then file legal proceedings against the borrowers personally.

If an older person doesn't have any assets -- other than Social Security payments and some form of pension benefit -- he or she may be judgment proof. This means that creditors have nothing to seize as security for debts...and little prospect for forcing the person to make regular payments. In most situations, courts will not allow creditors to seize or claim Social Security and monthly pension benefits.

The first priority for older people is to keep their finances as liquid as possible. Real estate is not liquid. In many ways, owning it becomes an increasing luxury for people as they get older.

Of course, many people remain emotionally attached to real estate. You may hear your parents talk about keeping "the house where we raised our family" or "the home we built." If they have enough money and income elsewhere to keep these assets, they can afford this affection.

If not, you may want to think about buying the house from them. This kind of transaction can take several forms:

• If the existing mortgages allow, you may be able to assume the loans and have your parents transfer the title to the property to you;
• You can simply buy the property from them; or
• You can help them set up a trust in which you and they share ownership and/or control of the property.

The analysis and suggestions we offer in this chapter apply to residential real estate. They don't apply to income or investment properties. Real estate that generates rental income should be treated like any other fixed-income investment when you evaluate your parents' financial situation. (See Chapter 8 for tips on handling these assets.)