Things to Consider If You Can't Afford Your Payment

I read a lot of the info. you have on your web page ... thank you.

I don't live in San Diego so I'm not looking for a home.
What I am trying to decide is whether to sell or refinance.

I live in DELETED. My mortgage payments are now approx. $2,400. I cannot afford to refinance into a fixed rate mortgage or interest only. I wanted to reduce my payments and I was recently offered a neg-amortized loan.

While I do have plenty of equity in the home, I balk at the thought of using my home as a piggy-bank. It's just not my style. I feel like I made a terrible mistake. I had a very modest home ... fairly low payments & property taxes ... but I wanted more, so I sold it.

I bought a good-sized lot with the proverbial "fixer-upper." Mistake #1 I should have thought of it as the "MONEY PIT."

Anyway, five years later and I've just survived a remodel but I'm still struggling.

Do you have any sound advice/suggestions?

First off, despite your market being somewhere I am licensed, each area's market is significantly different. Unlike the loan market, each commuting area has enough of its own concerns that nobody can keep track of more than one - not really. If someone called me out of the blue and asked me to list a property even a few miles outside my normal area of San Diego County, I would not have a good idea what it should list for. I can do a comparative market analysis, but that's just cranking numbers, and there's a lot more to market knowledge than cranking numbers. I can point to a dozen properties I've looked at in the last week where the listing agent priced it wrong. Sometimes they're under, sometimes they're over. Whichever it is, it's not good for the owner. Some agents will tell you there's no harm in being high, which is a premeditated lie. Properties that sit on the market because they are priced too high will sell for less money than the owners could have gotten, and that's if they sell.

Some properties are money pits, while others are vampires, charming on the surface, while they embed their fangs permanently in your wallet. The best opportunities, however, are all fixers. The reasons a good buyer's agent is worth more than they will ever make are legion, no matter how much our local dog-target keeps pushing discounters. I just got a call from one pushing a property I previewed last week. Yes, it had a view, but the view was of a high school stadium, and every surface in every room needed to be redone. It's got potential, but it's going to take $100,000 to get that potential, and the property would only be worth maybe $40,000 more than they're asking. Leave out those pesky numbers and a less capable agent can make it seem like a great bargain. On the other hand, I found the same people a property not far away that needed about $40,000 worth of work to be worth $120,000 more than the asking price. Money the discounter would have rebated: roughly $5000. Difference in outcome: $80,000 in prospective equity and $60,000 of wasted work. Prospective differences in listing agents are every bit as large.

Now, let's consider the kinds of issues that might give you a better idea about what to do about your situation.

You say you've been through a remodel and have significant equity. That's good news in that you are not "upside down", but should be able to sell the home for more than you owe on it. That's better than a lot of folks right now.

However, the unavoidable fact is that it costs money to sell. A good listing agent is going to cost money - and a bad listing agent will cost you more, and this cost is no less real for the fact that most of it won't be on the HUD-1. A good listing agent is going to tell you to offer a good buyer's agent percentage, also. Furthermore, you're going to buy a home warranty, and a policy of title insurance. I warn my fixer clients that it's going to cost about eight percent of value to get the fixed up property sold at a good price - so they might as well include that estimate in the calculations of whether the property is worth buying in the first place. I'd rather work a little harder, and have a client that keeps coming back to me because they keep making a profit worth making. So figure eight percent of value in addition to the fact that this market is very soft for sellers, although I'm seeing indications my local market may be firming up. Your market may be softer or not so soft. The softer it is, the less you're going to need to be prepared to accept if you sell. Around here, if you've got a property that appraises for $500,000, you may only get $480,000 or less on the purchase contract - and you may have to give allowances on top of that. $480,000 less eight percent is $441,600, and if you have to give a $15,000 allowance for closing costs, that's $426,600. So you can have a good amount of equity on the face of things, and be upside-down in fact when it comes to the actual sale. Even if you have $100,000 in equity, it just turned into $25,000 to get you out from under a loan you can't afford. That's my local market. Yours may be different, of course.

On the other hand, given the fact that you cannot afford your payment, your alternatives do not include doing nothing. If you try to do nothing, you will have your credit ruined and lose the property as well as quite likely get a 1099 love note from the lender that says you owe taxes and possibly (depending upon whether or not your loan has recourse) a deficiency judgment. So doing nothing is not an option.

The other alternative is a negative amortization loan. I don't know what numbers you would get, so I'm going to assume something fairly middle of the road. A 1% payment on $400,000 would be $1287, saving you $1100 per month in cash flow. On the other hand, if your real rate is 7.75 (reasonably median), at the end of two years you owe $433,500, and that's no including the prepayment penalty. After three years, when most negative amortization penalties expire, you owe $452,000, assuming rates stay exactly where they are, which I do not expect them to. Even if you got the loan for zero cost, you spent $1450 per month of your equity. In order for you to come out even, you'd have to net almost $479,000. That means a little over $520,000 sales price in three years if you don't have to fork over that $15,000 allowance, or $537,000 if you do.

It's true that you don't have to make only the minimum payment every month. Nor do you want to. However, let's be honest with ourselves. For most people, most of the time, they will. Even if they had it to spend on the mortgage, the kids need shoes, they "need" a new car, or they "need" a vacation. My understanding is that less than 5 percent of the people who have negative amortization loans make bigger payments than minimum more than five percent of the time. So whereas you won't necessarily owe this much in three years, it seems a pretty good bet to me.

Now here's where people helping people in situations like yours get grey hairs. We're guessing at where the market is going to be in three years. Not only about what we think the general market will be like, but what we think this property will be worth. Some things are consistent. For instance, unless you do another remodel, it's unlikely your property will spontaneously acquire brand new cabinets and stainless steel appliances, and since you are stating that you can't afford your current payment, it's unlikely that you'll be able to purchase such. Your property will probably compare to the rest of the market about like it does today, or maybe a little worse. The carpet will get older, the paint on the walls will be a little older, the shingles on the roof will have used three more years of their useful life. You get the idea.

On the other hand, the market really doesn't have to gain much to offset this. Mostly it just has to firm up, and if it does so, then even a two and a half percent annualized rise in prices would cause you to break even. On the average, that's trivial. Less than half the overall average annualized rise. On the other hand, it's not something I or anyone else can guarantee. It's investment risk. The market could continue to slide for a while, or it could be completely flat. Once you buy an investment, any investment, there is no way to remove risk from the equation completely. One of the things that caused the problems a lot of the country has in the current market was agents who promised the people that their property would appreciate - and sometimes it doesn't. It's one thing for people to make the choice knowing the risks; it's quite another to sell them property by telling them that "real estate always appreciates," or even that "Real estate never loses value." Both are patently false.

As to what I expect my local market to do the next three years: I do expect it to firm up. I've started to see this happening already. Due to the number of bad loans, however, mostly people that were sold negative amortization loans, I don't expect to see any large increases for the next few years.

There is one more level of complexity to add, though. What are you going to do for a place to live if you sell? What do the alternatives look like? How are rents, and what are likely to do in your area? Are landlords going to have to increase them? Are people moving out of your area, causing them to drop? A good agent in your area will know. It's not happening to any appreciable degree here, but this isn't your area. To the extent it is happening here, people are more than replacing them.

These, then, are some of the things to consider. There's less risk in the "sell now" option, but you're accepting a significant hit by exercising it. If you hang on those three years, you might be just fine, or you might be hosed even more completely than you are now. Given that you know you can't afford the property, if you came to me I'd probably advise you to sell now. That's the safe option, however unsatisfying it is. Once you have sold, the hemorrhaging is over - you're not bleeding green every month. Sell to someone who can afford the property, and who can afford the risk that it will further decrease in value over the short term. The assumption would be that they would be getting a deal - but what if you hold on and the dice come up snake eyes? You are looking at a maximum length of time before you will have to cut your losses or have them cut for you. This is a recipe for a disaster even bigger than selling now.

Caveat Emptor