Low Equity (or Worse!) Relocations in a Buyer's Market

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Hi, Dan!
I just came across your website and you strike me as the type of guy who has answers for our situation:

My husband and I built our home 2.5 years ago. We took out a second mortgage last year which brought us up to financing basically 100% of the value of our home. We owe a total of about $305,000 on the home, and even though it was appraised for around $305-310K. if we sell, we have been told we won't get a price anywhere near that, because it is not in a development.

Do you have any suggestions, comments, opinions...which could help us out. We would really like to relocate closer to my brother out in the DELETED area-but we seem to be stuck right where we are given the circumstances-are we?

Gee, around here custom homes usually command a premium over cookie cutters, other things being equal. Not necessarily a huge premium, but a premium. Especially since they typically don't have homeowner's association, which most people do not want.

Nonetheless, I'm hesitant to second guess the agents on the scene when I have zero personal knowledge of your local market. You basically have four options: Stay where you are, rent it out, default, or sell.

You don't state whether you are having difficulty affording the payments, or whether you've got one sort or another of unsustainable mortgage. If you're not having difficulty affording the payments and you're in a sustainable loan, there's no need to do anything. If you're at or close to 100% financing, and you need to refinance, when I originally wrote this you were looking at right around 6.25%, plus PMI of about 1% until your equity improves. It would have been better if lenders were giving second mortgages above 90% financing, but that's not happening right now. At this update, if your loan is with Fannie Mae or Freddie Mac 125% financing is likely available, but those are limited time situations. I'm going to presume that all refinanced, you'd be looking at a balance of $310,000, which may be a little low. Payment worked out to $1909 on a thirty year fixed rate loan, fully amortized, plus PMI of $258 on the traditional program when I originally wrote this. Rates are much lower at this update, but the principle remains the same. Lenders are not loaning above 90% on a property refinance unless they're already on the hook for the loan and it improves your likelihood of being able to repay the loan.

If your income situation is cramped, you may be able to get "interest only" for five years (or longer!) at a slightly higher rate. If you do an interest only loan, that would be a payment of about $1680. although you need to be aware before you do it that it is a calculated risk. I don't know your market, but mine is preparing to recover and I don't see anywhere not recovering within five years. Nonetheless, getting an interest only loan sets up a deadline for doing something again, and your market isn't under your control or anyone else's. Furthermore, I don't think we'll see rates like today's again, so we're really talking "mandatory sale within five years" unless you start making a whole lot more money. I think it's a reasonable bet given that you already own the property, but it remains a gamble.

Another word on the viability of refinancing: It hinges upon your ability to either get an appraisal that covers the amount of the new loan balance, or to come up with the difference in cash. It is possible to refinance more than the value of the property through the temporary Fannie and Freddie programs, but there are several sticking points that could prevent it if someone decides to be uncooperative. If you're looking to refinance because you can't afford your mortgage, refinancing more than the value of the property is unlikely to make it more affordable. It's probably better to consider another option.

You could rent the property out. I don't know what rentals are like in your area, but if you can get enough rent to cover the monthly expenses (mortgage, taxes, insurance, and an allowance for upkeep and management), that becomes a possibility. If you can cover the difference, that's fine, also. Remember, I think the markets are going to do well once they've digested the hairball caused by the speculative practices of buying with unsustainable mortgages and the loan investors get over their institutional paranoia. If you're short $200 per month and in five years you can sell for $50,000 more, that's an investment I'd make. The question, unanswerable by anyone at this point in time, is where your local market will be in five years. $50,000 is about 16% of $310,000. Here in San Diego, I'd have leaped at that - and been wrong, thanks to our marvelous economic overlords in government ruining the economy. In your area, I don't know. In either case, it's a risk, and you need someone who knows more about your market than I do to advise you on the probabilities.

You could just default. I'm not recommending it. It's a bad option, but it is there. If you want to buy, or even rent, after your relocation, your credit will be hosed. I don't know your state law on deficiency judgments, but that's a concern. Under this same heading is deed in lieu of foreclosure, with most of the same problems. The reason people are willing to grant credit is that we're legal adults, and supposedly responsible. If you give them evidence that you're not, you may not pay for it in dollars directly, but you will pay for it, and typically the interest rate is usurious.

Or you could sell, most likely a short payoff assuming what you've been told is correct. It costs money to sell a property, more so in a buyer's market. Figure it'll cost you about 8 percent of whatever the gross sale price is to get the property sold. Using this as the basis for an estimate, even if you sold for $310,000, that'd only net you about $285,000, so you'd be short roughly $25,000. If the lender forgives the difference, you'll likely get a 1099 love note adding it to your taxable income (In normal circumstances - at this update there is temporary legislation in place making loan forgiveness non-taxable). If they don't, you could be sitting on a deficiency judgment for the difference. I don't know your state's law, but around here, if someone was liable for the difference, I'd suggest saving the legal fees by agreeing to sign a promissory note. If you fight, you're likely to be wasting the money as well as digging yourself in deeper. They're going to win, and they'll almost certainly get to add their legal fees to what you owe. So unless you really like subsidizing the legal profession, if you're in the situation, I'd suggest considering agreeing to pay without a judgment. Talk to a lawyer in your state about what the law says about your situation, of course, as spending the money for a half hour of a lawyer's time is likely to be considerably less than $25,000 plus interest.

Now if you accept such a promissory note, I actually have no idea what the rate will be, but even if it's 18 percent, you're still talking about owing only about a twelfth of what you do now. I'm not saying it'll be easy, but you can pay it off in a few years, and it's probably cheaper than the costs of defaulting, even though it does hit your debt to income ratio. People choose defaulting and bankruptcy because it's easier now, but when you go through the total costs rather than just the immediate cash, you're likely to come to a different answer.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on December 9, 2013 7:00 AM.

Saving Money by Refinancing Your Mortgage was the previous entry in this blog.

You Want an Agency That Can Pay ENOUGH Attention to YOU is the next entry in this blog.

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