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. In the last week, I've looked at between 50 and 60 properties, and in the case of 20 to 25 of them, I can explain to an idiot why it is priced wrong by at least 10%. 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 obvious 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 show up 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. When I originally wrote this, if you had a property that appraised for $500,000, you might have only gotten $480,000 or less on the purchase contract - and you may have had 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. It depends upon your local market, the condition of the property, and the neighborhood it sits in. Things are better than that now, but there are many new issues, most of them brought about by regulators that I'll grant meant well but didn't understand what they were doing.

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.

When I originally wrote this, another alternative was a negative amortization loan. Those are pretty much history now with long overdue regulatory changes, but I'll leave the example just in case they come back: Something fairly middle of the road in a negative amortization loan would have a payment based upon a nominal (in name only) rate of 1%, for which the 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 not 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 you need to get 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 start sliding again, 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.

People have a tendency to assume that the market will keep doing what it has been doing in the most recent past. At the last update, lots of people were writing how my local market is going to lose another 20% in the next year - completely ignoring that we're no longer priced at economically unsupportable levels, and indeed, we were about thirty percent below where a macroeconomic analysis of real estate prices suggests that we should be. We didn't lose 20% - in fact things went up. The excess inventory ("high supply") that was half the reason the prices fell has been steadily falling for the last year, people are now finding that they can qualify for more house than they thought (removing the bar that has been choking the demand side). Decreasing supply and increasing demand: What do you think is going to happen? Furthermore, buyers were coming out of the metaphorical woodwork at that point in time. I had been running every second of the last previous three months, and I hadn't been soliciting - every last bit of business I can handle was been coming my way all on its own. Furthermore, in the high demand areas of town we were starting to see regular bidding wars like we did in 2003 and 2004, only this time the people involved have hefty down payments, and are qualifying for "A paper" thirty year fixed rate loans full documentation. Five years ago, military personnel had to settle for crummy housing unless they were an O-5. Now I'm finding even E-6s and E-7s beautiful detached homes, bigger than my own, of recent construction that they can actually afford to buy at current prices with full documentation loans.

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 those rents? Are people moving out of your area, causing them to drop? A good agent in your area will know. Rents here are seeing significant upwards pressure, and although this isn't your area, the Era of Make Believe Loans is over. Sane landlords can't pretend that as long as rent makes up for the majority of what they spend, they'll eventually get it back with profit when they sell because the prices are rising as fast as they were. Apartments and condos make economic sense to rent out - single family detached housing, not so much.

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. When I originally wrote this, given that you know you can't afford the property, if you had come to me in San Diego, I'd probably have advised you to sell now (That advice would likely be quite different now). Selling is 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 to the property 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

Original article here