Our Home Is Underwater – What Should We Do?
March 15th, 2012
Reader Question: Monty, we have a family member who paid $119,000 for their home in 2005. They owe $114,000 on the mortgage with a monthly PITI payment of $890.00. Here, is the problem. They are divorcing, and his wife has moved out of the house. A local agent has estimated the home will sell today for between $75,000 and $90,000. Our son cannot afford the monthly payment with his current job situation. He is asking for advice. We do not know what to tell him. We do not have room for he and his 2 children to move in with us. What should he do? Sharon and Mike D. – Lancaster, PA
Monty’s Answer: Sharon and Mike , Thank you for writing. I do not know enough about your son and his overall job and financial situation to proffer advice. Even if I did know I would not make a choice for him. I can suggest a plan to him where he tackles the problem in an orderly fashion. I can also point out benefits and drawbacks of the options I am aware of, but ultimately, your son must make the call. It sounds as though you want to help him figure it out. The challenge for him is to ascertain two items; 1. Is the information he has to make the decision accurate? 2.Does he have all the information he needs to make the decision?
Where Do I Start?
The first action I would take is to get a second opinion of value. Your son can investigate the multiple alternatives below simultaneously to gather information. While the first agent’s approach with a range of value is correct, your son should confirm it is the correct range. When he has a second opinion he can scrutinize the comparables of each appraisal to help verify the value directionally.
There are a number of other considerations in preparing to make the decision. It is likely there will be more than one option and more than one decision to make. To give you a sense or example of other considerations: Who has title to the home? Who is the mortgagee? Is the current job situation you describe short term? Is a reconciliation a possibility? Does he like living in the house? What will it cost him elsewhere to replace his lifestyle if he moved?
Then, I would use the “Look Up Tool” of both Freddie Mac and Fannie Mae below to determine which of them, if either, own your loan:
Here are some alternatives to foreclosure from Freddie Mac.
It is possible neither of them do own the loan, but combined a variety of sources estimate they own about 50% of all residential mortgages in the United States. I would also learn if the lender practices the “Cash For Keys” concept. There are lenders with troubled loans that will reduce the costly foreclosure process by paying the borrower to vacate early and leave the home in broom clean condition.
Armed with this information, I would now start to think about the options that make the most sense based on my circumstances.
If the first real estate agent is accurate, the negative equity is between $30,000 and $44,000. He would have to come to the closing with that amount of money if he sold the home today. Most people do not have the option to bring that kind of money to a closing. This is what being “underwater” in a home really means. What if the second real estate agent’s opinion suggests the home will sell between $85,000 and $100,000? And has better comparables to justify that opinion? If he can sell the house at the top end of the second real estate agent’s range the problem is considerably smaller than first anticipated.
Here, are some possible alternatives to investigate. I have ranked them first attempting to keep him in the home. That option disappears on option 4 and beyond.
1. The Home Affordable Refinance Program. This is a refinance program that has been modified so all the details are still emerging. You must be current with your mortgage payment to be considered. The big advantage of this option (it is called HARP) is that it appears Freddie and Fannie want to allow more families to qualify so the requirements have been relaxed. News reports vary but suggest only about 900,000 people have qualified for this program to date. He stays in his home. My first call would be to his lender.
2. Home Affordable Modification Program. This is a loan modification program called HAMP. Like HARP, this program has also been recently modified to bring more homeowners into the program. In this program you must be delinquent or in “imminent default” mode in your mortgage payment. It must be considered if alternate 1 above does not work because there are consumers qualifying for it. Your son stays in his home.
3. Ride It Out. You mentioned in your letter your son cannot afford the payments. Could he could afford the payments if he had a boarder? The critical question here is the market rent a person would pay to move into the house. You can check this out in a variety of ways. The local newspaper, online services and residential property management firms may be helpful. If the market seems cooperative and he is open to the idea, then it comes down to finding a person who can pay that meets his requirements for a boarder. While it requires a lifestyle change and work, the trade-off is your son stays in his home.
4. Rent It Out. This is the same tactic as alternative 3 above except it requires your son to move out. This is not an alternative for everyone because being a landlord requires some unique skills, training and business acumen. The unintended consequences of becoming an untrained landlord include non-payment of rent, expensive eviction costs and property damage. It can seriously ruin your day. The key, if your son is willing(and able), is the rental market values. The rent should not only cover expenses; it should incorporate income to pay a return on investment. It should also include compensation for his time and a small reserve for future vacancies if the market will allow it. I would look for a real estate company that manages rental homes for additional advice.
5. Short Sale. This alternative requires lender approval in advance to sell the home. Assuming the first real estate agent is correct with the value estimate, your son would need lender approval to accept a loan payoff of $84,000 instead of $114,000 on a $90,000 sale. The difference between $84,000 and $90,000 pays the real estate agent and the seller closing costs. Your son walks away from the home losing any equity he invested originally and the lender writes off the loan loss. While these arrangements have gained a reputation for lenders changing the agreements or the rules when an offer is produced, many of them have become more cooperative over time. It is worth the time invested to learn of your lenders posture on this alternative. Lastly, seek tax advice if the lender is cooperative as in many cases there are certain tax consequences with this alternative.
6. Foreclosure. In this alternative, your son walks away from home and defaults on the mortgage loan. The idea of waiting for the market to recover is not in the cards because he has examined all of the options above. This alternative is a more difficult one because it will affect his credit. He will have to find another place and move out of the home. He may not be able to buy another home for some time. People have been known to halt the mortgage payments, but stay in the house. They take advantage of what they see as free rent during the time required to complete a foreclosure. He should seek legal advice from an attorney who has strong experience with foreclosures before executing this alternative.
7. Bankruptcy. Insolvency is a condition that most people avoid. The law varies from state to state and in recent years the idea of debt restructuring is more common than in the past. There is sometimes a stigma associated with bankruptcy that lingers for years. The benefit of bankruptcy is that it would give your son a new start, but it is a new start at a high price. It can affect one’s ability to land a job. His credit will be affected for 7 years. He may lose his credit cards. There are other inconveniences involved in bankruptcy and this action should be avoided if at all possible. Bankruptcy is walking away from all your obligations, not just your home. Make certain your son meets with a trusted advisor or attorney when gathering information on this alternative.
There Is Much To Consider
So, Sharon and Mike, there you have it. I suspect it is easy to see why this decision requires collecting a variety of information and speaking with a number of people involved in this part of real estate. The correction or collapse in the mortgage industry remains a fluid situation with changes and rule making to improve the process constantly evolving. Each of the alternatives on the list above has different qualifications to meet. Different lenders establish criteria and apply philosophies to suit their business practices. It is no wonder some confusion and conflicts exists with information flowing into the marketplace.
I hope this information is useful to both your son and yourselves in dealing with your family’s housing situation. If other readers can pitch in with their own stories or add points to anything I have written here I welcome improvement. Any updated information involving this timely subject will be appreciated.
I wish you good luck. Please write again if you have other questions.