How Adjustable-Rate Mortgages Differ

QUESTION: Our adjustable mortgage payment has recently been increased due to rising interest rates. But despite our higher monthly payment, the amount that is actually allocated to the repayment of our loan principal has decreased. Is this common with adjustable mortgages?--M. A. A.

ANSWER: It can be; it all depends on the type of adjustable-rate mortgage you have and the conditions governing it. According to our advisers, some adjustable-rate mortgages limit the amount that monthly charges can be raised. So if interest rates rise steeply, it is possible that the required increase in your monthly payment would be greater than your mortgage agreement allows.

What happens? Your lender gets the money--or at least some of it--but it’s shifted from the principal repayment portion of the monthly payment to the interest side. In an extreme case of rising interest rates and an adjustable-rate mortgage with a ceiling on allowable increases, you could end up with a large balloon payment or payments in the final years of the mortgage to catch up with the principal repayment.

Even more dramatic would be “negative amortization.” Here, instead of paying off some of the principal each month--even a slight amount--you actually end up owing a greater amount because your monthly payments do not cover the full costs of the interest charges accrued by your loan.

The bottom line? Read the terms of your loan carefully to see what you sign and how the loan will be administered over its full life. Even though you may think you will sell your house well before the 30-year mortgage runs its full course, you can never be sure.

IRS Allows Discount on Family Rentals

Q: We wish to rent a house to our son for an amount less than what we are currently receiving for this unit. However, our tax consultant says we will be taxed as though we had received the amount we had previously gotten. Is this true, or can we charge our son a reasonable rental price based on the fact that the house is next door to ours and that our son will eventually be required to care of us as we become older?--N. C. F.

A: Relax, say our advisers. You may rent the house to your son at a discount so long as the rent you do charge is “reasonable.”

What does that mean? Well, our advisers say the Internal Revenue Service scrutinizes such deals carefully. A 20% discount below prevailing rental rates is generally considered reasonable. Above that, they say, and you court questions, although you can’t be sure that the IRS would challenge an arrangement with a discount greater than 20%.

Why does the IRS accept a discount for rentals to family members at all? It’s a good question. Our advisers say it is generally accepted that renting to a family member poses less risk than renting to a total stranger, a factor that takes some of the uncertainity out of being a landlord.

Do Homework Before Investing Abroad

Q: Can you tell me if interest earned from a foreign bank account is taxable? I know it has to be reported, but I’m not sure if it’s taxable each year or if it’s taxable only when it is withdrawn.--A. G.

A: If you are a resident of the United States, the interest is probably taxable, whether or not you actually withdraw the money. However, this subject is quite complicated and fraught with ambiguity, intrigue and intense interest by the IRS.

The actual application of U.S. tax laws on this interest depends on where your foreign bank account is located and the exact terms of the treaties between the U.S. and the foreign country. Offshore bank accounts are a well-known tax dodge, and the IRS is aware of them. You would be advised to research applicable agreements thoroughly before making any offshore deposits.

Another Point on IRA Withdrawals

Q: I am 68 years old and plan to retire soon. My individual retirement account now allows me to reinvest any capital gains and dividends in additional shares of stock. But what if I should direct that these distributions be paid directly to me, rather than reinvested in new shares? Would the payments I receive be treated as withdrawals from the account?--H. F. B.

A: Yes, the Internal Revenue Service considers such payments account withdrawals. And as such, they are subject to taxation. However, because you are already over age 59 1/2--the minimum age at which withdrawals from individual retirement accounts can be made--no early withdrawal penalty is assessed.

If you had not yet reached age 59 1/2, these distributions would be subject to taxation as well as a 10% penalty for early withdrawal from your individual retirement account.

Personal Expenses Can’t Be Deducted

Q: I rent out my house at the beach during the summer. During these months, I have to rent an apartment in which to live. Because my home mortgage is fully paid, I have no monthly housing expenses during the year except the rent I pay on the apartment during the summer. May I deduct my apartment rent as a business expense to offset some of the income I receive from renting my beach house out?--A. M. W.

A: No. The Internal Revenue Service does not allow taxpayers to deduct personal expenses as a business cost. It’s just that simple.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.