Dan Melson: October 2016 Archives

Well, sometimes. Okay, most of the time. But not always.

Foreclosures: Bargain hunters beware!

Myth no. 1: A big spike in foreclosures is right around the corner...
...That's because in most of the country, anyone who has owned a home for even a year or two is likely sitting on enough equity to sell or refinance if the loan payments become unaffordable.

Used to be true. Not so much any more. When prices are going up 20% per year, this is true. When prices have slid as much as they have, anybody who bought for peak or near peak prices is in trouble, not to mention the folks in negative amortization loans that got into a situation where they can't afford the real payment, and now they owe thousands of dollars more than they paid. Nonetheless (as the article mentions) the banks want the loan repaid. They don't want to own the house. A "hard money" lender will foreclose fast and hard, but a regulated lender wants the loan repaid, and they'll pretty much take a loss anytime they foreclose, and it's always bad business, because it's always someone who won't use that bank, and who tells all their friends and family. The bank isn't going to have a representative there to tell their side of the story, so no matter how justified they were in foreclosing, it's bad for business. They will put it off as long as they possibly can.

It can take a couple of years after payments start being a problem before the lender decides to cut their losses and foreclose. Sometimes the individuals concerned go to heroic lengths to stay out of foreclosure, drawing out all their savings, even their retirements to meet the payment. They are usually ill-advised to do so; nonetheless I understand the emotional attachment that occurs. The peak for foreclosure is usually somewhere around the fourth year of the loan. Foreclosures have been falling for years in my local area, as the option ARMs really became popular in 2004 and the trouble really got bad in 2007 have been mostly dealt with.

Myth no. 2: Foreclosed houses sell for far less than their market value.

In a study of foreclosure sale prices in more than 600 counties nationwide in 2005, Christopher Cagan of data provider First American Real Estate Solutions found that, on average, foreclosed properties sold for about 15 percent less than comparable homes in the area that were not distressed. But in states where real estate prices have risen the most, including Arizona, California and Virginia, foreclosed properties sold for within 5 percent of full market value.

This is true. Furthermore, many foreclosure homes have maintenance and repair issues. If I can save myself several tens of thousand dollars of equity by fixing the property up a little bit and cutting the price a little in order to sell it before foreclosure, I'll do it. On the other hand, if I bought it for $500,000 with a 5% down payment on a negative amortization loan, and now it's only worth $420,000, my investment is long gone, and any work I do and any money I spend is helping nobody but the bank. Some people may even strip the copper out of the walls for scrap (I've seen what a few such people have left behind). Some people may even take a sledgehammer and break things in one last act of spite.

In highly appreciated areas, the auction is usually the worst time to buy. Get them from the owners before the lenders pile on all the default and foreclosure fees, while there is still something to save for the owner, equity-wise. Get them from the lenders as REOs after they fail to sell at auction. Depending upon who forecloses, that can wipe out entire trust deeds. For instance, if there's a first and a second on the property, and the first forecloses, that second is gone. Dust. History. Worthless paper with unimportant markings, basically good for fire starter. If it originally sold for $500,000, and there's a $400,000 first and a $75,000 second, but the property is only worth $420,000 now, that second holder is crazy if they show up to the auction to defend it, especially since the holder of the first has added thousands of dollars in fees, every penny of which gets paid before the second gets a penny. The second is unlikely to get a penny, and bidding on it is throwing good money after bad. It's a waste of an employee's time, if nothing else. For buyers at auction, there's a key phrase to remember: cash or the equivalent. You don't win the auction and then arrange financing; you have to have that first. This doesn't apply to sales before and after the auction. Nor does California's ninety percent rule.

Now, you are not (if you're smart) buying at auction sight unseen. You can usually make an appointment to see the property in the days before the auction. You should also look at other properties in the area. Know the market before you bid. Know what you intend to do with the property, know how much it's going to cost. Depending upon the law where you are, there may be a building inspection required, or perhaps you can take an inspector with you. This costs money, so you may want to preview once before you haul the inspector out there. Do your homework before you toss your money into the ring. That's what the people who make money at foreclosure auctions do. It's a full time job if you want to do well, and if you're not doing it all the time, a good agent is a lifesaver. Every situation is different, and it takes a certain amount of experience to know the best way to approach buying a given distressed property. You're competing with people who do this full time for a living. Ask yourself questions like "Why should I be willing to pay more for this property than Joe, who's been doing this for twenty years?" Auctions get crazy and emotional. If you have someone there to help take the emotion out of it, you are less likely to waste large sums of money. If you have someone there to help point out the pitfalls, you've probably just saved yourself every penny of their commission and thousands of dollars more besides. So long as they do what they say they will, of course.

No matter what else is true, there is always an element of risk in buying a foreclosure, more so than most other homes. The owner (the lender) has never lived in the property and is exempted from most disclosure requirements. Often, they honestly don't know about problems that exist. This doesn't mean they don't have to tell you about problems they know about, but having never lived in the property or dealt with its maintenance issues, they just have no reason to know about many problems that really do crop up. Furthermore, the lender addendums that lenders will require to be signed make buyer due diligence difficult, and lenders will not fix anything they don't have to. It can be a real struggle forcing them to make repairs to safety and habitability issues, as they are required to do in California. It is also my experience that the agents that work for lenders aren't at all hesitant to defraud buyer's lenders in concealing property defects that are loan killers - a buyer's lender who may be another branch of the lender that owns the property.

Buying foreclosures is not generally for people who want to just move their furniture into a property. Buying foreclosures can be quite rewarding, but you need to have a certain amount of financial resources to be able to withstand the consequences of the risk if it goes bad.

Caveat Emptor

Original article here

On a fairly regular basis I get email asking what I think of this or that loan calculator on the web, this or that predictive model for real estate prices or loan rates, etcetera.

Loan calculators are pretty simple when you get right down to it. Numbers go in, other numbers come out. It's just math - except that you've got to be careful about the numbers going in. Just because your balance is $400,000 now does not mean it'll be $400,000 after the refinance. It's very possible to do a zero cost refinance that adds nothing to your loan, but most people don't do it. Furthermore, I know I've said this before, but the only calculator out there that I trust is one that I know the provenance of. I've caught more than one company that had programmed its calculator to low-ball the payment. There's no way to tell for certain except using your own calculator, and if you have your own financial calculator, why are you using the web? You can cross check, however, because it's rare that two calculators will be mis-programmed to yield the same wrong answer. Also remember to add in closing costs and prepaid interest and escrow accounts, if you're going to have one, and always figure the cost of any points after everything else is added in there, because that's what the bank is going to do. Finally, don't take it for more than it's worth. Just because they tell you, "nothing out of your pocket," does not mean there are no closing costs. They exist. Somebody is paying them, somehow. Unless you know for a fact otherwise because you've discussed it and know where the money is coming from, I'm guessing that "somebody" is you, and they're getting rolled into the balance of the new loan. I've had people bring me paperwork from other companies showing new loan balances thirty thousand dollars higher than they were expecting, with correspondingly higher payments. (I've also told people to never shop for a loan based upon payment more than a few times, also)

For spreadsheets, what you can get is usually an analysis of one variable per spreadsheet. I've programmed a loan comparison spreadsheet, but it only compares two alternatives at a time and it's not really suitable for use with the public, because you have to understand the limitations and GIGO factor. Just like I've got spreadsheets that answer the "rent or buy" question, among others, but you have to understand the limitations on the results imposed by your model.

As a computer programmer, I make a pretty decent loan officer. In order to compare financial information via spreadsheets, you have to understand what points of comparison the calculations are meant to compare. If your data is out of whack, if your assumptions are away from reality, or if you're trying to apply the comparison outside its design limits, what you get is useless.

I have several spreadsheets I have programmed and use. All of them have limits that need to be understood in order to get useful information out of them.

The first is a rent versus buy spreadsheet, that I first talked about in Should I Buy A Home? Part 3: Consequences. In that article, I spent a good paragraph telling you what my assumptions were in cranking the numbers. I think they are good and reasonable assumptions for the markets I have seen in my area in my lifetime, but many people might not. I just had someone make a comment to the effect that "rent doesn't increase with inflation." Well, it hasn't been keeping pace with the cost of buying of late, but that's not the same thing as not increasing roughly with inflation. Furthermore, we've gone through a period when landlords were keeping rental rates low in the attempt to have someone else pay most of the mortgage of their investment property. Judging by the "loaf of bread" or hourly wage comparisons, or anything else except the price to buy, local rents have increased by a factor very close to general inflation over my adult lifetime. Whatever you think of my numbers, though, the fact remains that they are assumptions, and if they do not correspond to future numbers, the conclusions they reach have no bearing on the real world.

The second limitation upon this sheet is that it's assuming smooth increases. This is not what happens, as anyone over the age of ten ought to know. Over longer periods of time, the data may tend towards an aggregate average, but that says nothing about any given year. In reality, some years are plus thirty percent while other years are minus twenty. Even if my assumptions for averages are good, the spreadsheet that predicts the next thirty years is useful mainly to predict overall level of the market many years out. The numbers for any particular year are so much garbage, as far as the real world goes, where a 5% differential between estimate and actual is often enough to render something worse than useless. Even if my assumptions for average return are right on the money (and if I didn't think they were pretty close, I'd use others), any particular year could be at the top of a peak or the bottom of a market trough. If you know what state the market will be in in a particular year three decades out, why the heck aren't you richer than the ten richest billionaires in the world combined? Knowing what the market was going to do these past few years is a lot easier than knowing what it'll be like thirty years from now! I have what I think are good predictions based upon good models, but I don't have any god-level knowledge of where any part of the economy will be thirty years from now, and neither does anyone else. We see the future dimly, reflected through the present and the past.

Speaking of which, let's drag one of the standard disclaimers out and air the dirty laundry. "Past performance is not indicative of future results." Averages of past results may be the only way we have of predicting the future, but those results depend upon unknowable factors. Somebody could invent something tomorrow that utterly changes the face of housing thirty years out. You think the urban planners of the 1920s foresaw urban sprawl? I know for a fact that they didn't. What no model of the future can predict is unforeseen factors. I can't tell you what they will be or what effects they will have, but I can promise you there will be some. In 1894, Michaelson (who first measured the speed of light) said, "Our future discoveries must be looked for in the sixth decimal place." This just a few years after the formulation of Maxwell's equations, and within a year Rutherford had changed the atomic model forever, while the basis of quantum mechanics was being laid, and less than ten years later were Einstein and relativity. Michaelson was right in a technical sense that precise measurements were the key to unlocking future discoveries, but wrong in the sense he meant it, that all the major discoveries had already been made. My predictive model is more detailed than most, and I do my best to include all of the factors I see, but I have no way of including factors that I can't see, and one thing I can promise you is that there are some. It may work out that I guess right anyway, but that doesn't mean there weren't any unforeseen factors, just that I got lucky despite them. The further out the model goes, the more it is dependent upon subsequent events no one can predict. Someone could announce man-portable fusion power tomorrow, or "Star Trek" transporters, or any of dozens of new potential technologies that could alter the world, and that's just the technological possibilities. Politics and demographics will utterly change in the next thirty years (When I graduated high school, more people were predicting the world conquest of communism than the collapse of the communist system. Mr. Carter's presidency was not the United States' shining hour).

Just because we know that the precise numbers are wrong, however, doesn't mean that those numbers have no value in predicting the future. The way the numbers will move relative to each other is much more important information. Population is increasing and will continue to increase. Demand in major urban areas and desirable areas will continue to rise faster than supply, and since such areas are where most of us live or want to live, the price of real estate will quite likely continue to increase faster than inflation. Particularly types of housing which are universally desired, such as detached single family residences sitting on a certain amount of land owned basically fee simple. PUDs and townhomes are less desirable for most folks, true condominiums less desirable yet, and below that are apartments. Offer most people the chance to move up on the ladder of desirability, and they'll take it. Since the only thing preventing most people from doing so is price, price is what's going to make it ever harder to make that transition to more desirable housing. Living space in a desirable location is a scarce good. Living space, desirable location or not, is a limited good. The only way to change this is to somehow manufacture more space or arrange to have fewer people to share it. I'm not aware of any plans to manufacture enough space to make a difference to the billions of people on earth, so I'm guessing that barring worldwide nuclear or biological warfare, population density is going to increase, demand for housing is going to increase, and supply is going to stay pretty much right where it is. Nonetheless, this is only a guess. My guess is that housing will be about four to five times as expensive as it is today thirty years out. If it's only twice as expensive as today, we'll all still live in million dollar houses. If it's eight times, we'll be in four million dollar houses. The wider the net, the more probability I have of being right - and the less useful the information is. Unless the price right now is something like two cents, nobody sane is going to invest money for that long without a better idea of what the payoff will be.

Whether I'm right or not is something nobody knows right now, or even how close. Actually, not being quite that much of an egotist, the question in my mind is more akin to "how far off will I be?" But the data is still useful, because it tells me that as long as my assumptions are anything like real, we're all looking at living in million dollar real estate - the only question is exactly when. It tells me what people will be need to be able to pay every month, at least in a general sense, and it tells me that more and more people are going to get priced out of real estate, or down into less desirable housing, and that real estate is therefore going to be a quite satisfactory vehicle for creating personal wealth.

Each of the changes has consequences, assuming it does indeed happen. If it's difficult saving the money for the down payment when homes are $300,000, how difficult is it going to be when they're $1,000,000? At a guess, three times as hard. Fewer people will be able to do it, proportional to the numbers today.

On the other hand, no system of projecting the future is better than the limitations imposed upon it by limited foresight. If the population of the United States drops to 1789 levels all of a sudden - or 1607 levels - all bets are off. Of course if that happens, most of us won't be here to worry about it, and the ones that are will have bigger problems than the price of real estate. It's pointless to waste time worrying about the price of real estate in such possible circumstances, where the price of real estate would be the least of our worries.

Caveat Emptor

Original article here

You might get what you pay for. You don't get what you don't pay for, despite the fact that the local dog target loves giving discounters free puffery.

I'm not against discounters. I'm very happy to do a discounters work for a discounter's price. Fifty percent of the pay for less than ten percent of the work and almost none of the liability is a real win as far as I'm concerned. The difference is that I'm not willing to pretend that you're getting the same value from me. In fact, the amount of value the buyer receives from their alleged "agent" is pretty much negligible, and it would be a lie to pretend otherwise.

Let's illustrate with a recent example. Some full service clients of mine had gotten interested in a property. They wanted a fixer property with potential and a view, and they asked me to check this one out. Yes, it had a view, but the view was of a high school stadium, making peaceful enjoyment of the property rather hit and miss, subject to the local sports schedule. It had some potential, true, but every surface in every room needed to be redone. It is going to take $100,000 to get that potential, and the property would only be worth maybe $40,000 more than the owners are asking. Leave out those pesky numbers and a less capable agent can make it seem like a great bargain. If all you're thinking of is a potential $5000 rebate check from the buyer's agent, which can be fraud for reasons similar to these, you may think you got a deal from a discounter. Lots of people never do figure out how much that rebate check actually cost.

If they had been clients of a discounter, they would have been in escrow on the first property. Too bad about that $100,000 they'd have to spend to get $40,000 benefit. 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. What does a discounter do? Write the offer on the first property. Now you've got a property you need to put $100,000 into to make it usable, that's worth only $40,000 more than you paid. Money the discounter would have rebated: roughly $5000. If they didn't have a full service agent to compare with, it even looks like a great deal, because none of the value I provided these folks shows up on the HUD 1 form, or anywhere else as numbers on paper. The value is still there, as my clients know.

If you know enough about the state of the market, what problems look like and what opportunities look like, you may spend less with a discounter, or get a rebate that doesn't cost you several times that difference. If you know everything a good agent does, there is no reason not to put that money in your pocket. But if you know everything a good agent does, why is the discounter making anything? Why aren't you doing your own transaction? Why aren't you in the business yourself and getting paid for your expertise?

A full service agent goes a long way past filling in the blanks on Winforms and faxing the offer. When I go out looking at 20 to 30 (or more) properties per week, I'm not just finding individual bargains. I'm also learning about the general state of the market, what things to look for in a given neighborhood, what common problems are with a given model of house. I know what's sold in the neighborhood recently, and I know what it looks like because I've been inside it, and I know how it compares to other stuff that's out there now. I have a pretty fair idea of what it's going to take to beautify properties, and I know what they'll be worth when the work is done, because I know what other stuff that already looks like that has sold for recently.

Real estate is a career. It may not absolutely require a college education, but many agents have one, and know many things you can't learn in college - because the professors don't know, either, unless they're active real estate agents. A good agent spends a lot of time and effort not only learning their local market, but keeping their knowledge base updated. This thing changes constantly, and it doesn't even change uniformly. How did La Jolla get to be La Jolla? I assure you it wasn't some random seagull anointing the neighborhood from above with the Bird Dropping of Higher Property Values. Rancho Santa Fe doesn't even come close to the ocean, and it's the highest mean property value zip code in the nation. How did your neighborhood get to where it is? Is it likely to change, and how? What are the known and probable upcoming changes in the neighborhood? How is it likely to effect your prospective property? Wouldn't you like to know about that redevelopment zone - or the railroad tracks they intend to drive through the area?

Full service can be a very hard sale when all that you consider is the numbers on the HUD 1. There just isn't any space for "Agent kept you from making a $60,000 mistake," let alone, "Agent showed you an $80,000 opportunity." But people who know property know that there is a lot more to every transaction than the numbers on the HUD 1. If you're dubious, may I suggest this experiment when you're ready to buy: Find a couple full service agents willing to work with a non-exclusive buyer's agency agreements, and sign them. Then compare what happens as compared to the service of the discounter you use for properties you find yourself. There is no need to sign even a non-exclusive agreement with a discounter, by the way, as any sales contract will note the agency relationship for that transaction. Like I said in How to Effectively Shop for a Buyer's Agent, let the ineffective alternative select itself out.

I'm perfectly willing - happy, even - to do discount work for "discounter" pay. I only make half the money, but I can service a lot more than twice the clients for a much smaller level of risk and still be home in time for dinner. I'm even a better negotiator than dedicated discounters, because unlike them, I know what's really going on in the areas I serve. However, saying "full service at a discount price," does not make it so, and I refuse to pretend that it is. Same as saying a fifth-hand Yugo is the same as a new Ferrari, saying something like discount service is the same as full service does not make it true. Furthermore, the people who approach me for discount work usually end up understanding that a real professional is worth a lot more than the extra money I make, and are happy to pay it. Most people have no problems understanding that the reason a good car commands a higher price than a bad car, let alone a skateboard, is because a good car provides more value. People will pay $100 per seat for decent - not great - musicians in concert when you couldn't pay them enough to attend a garage band practice session. Why should this principle hold any less true for expert help in what is likely to be the biggest transaction of your life?

Caveat Emptor

Original article here

Every purchase contract I write includes an addendum for Wood Destroying Pests. In California, this is accomplished via form WPA, a one page addendum that requires an inspection and details responsibility for who makes repairs. The work needed is separated into two sections. To quote from the actual standard report, Section I work "CONTAINS ITEMS WHERE THERE IS EVIDENCE OF ACTIVE INFESTATION, INFECTION OR CONDITIONS THAT HAVE RESULTED IN OR FROM INFESTATION OR INFECTION," while Section II is "CONDITIONS DEEMED LIKELY TO LEAD TO INFESTATION OR INFECTION BUT WHERE NO VISIBLE EVIDENCE OF SUCH WAS FOUND."

The standard around here is that the seller pays for Section 1 items, the buyer for Section 2. The reasoning for this is quite solid: The lender isn't going to fund loans for properties where they know about termites in the process of eating the property that they're taking as security for the loan. They could very well end up foreclosing upon a property that cannot be sold, or cannot be sold for the amount of their loan. Federal Reserve Regulations frown on that, so say the least.

So when I got this from an agent on an REO, I was skeptical

Hi Dan,
The bank will not pay the termite - Section 1. They said we must get bids and the buyer will need to pay for it. This is not allowable with VA. I already know how much it is - $1550 - I ordered the report. The property needs tenting.

I forwarded that to my clients, who responded:

Thanks for the update. As usual I have some questions.

1. (irrelevant to this article)

2. We are definitely eager to see the termite report. Are they likely to give it to us, and if it does show serious structural damage, can we back out?

3. Is the VA loan going to hinder this or is it a simple matter of writing another check?

4. Would they have told us about this if we were going the conventional loan route?

My answers?

2) They have to give us the information if they have it. Not only is it in the contract and the law, disclosure laws require it. The only legal way not to disclose it is if they honestly do not know. That isn't the case - they're telling us there is known Section 1 work needed.

3) Section 1 work eliminates the VA loan as well as any others unless it's done. It's a condition of the contract. The lender is going to want to see the report. When they see the report, they're going to say no. Section 1 work is a loan killer, no matter the loan type. The only ways to get around it are an all cash offer, or agreeing to eliminate the termite clearance from the contract.

4) They would have had to. See answers to 2 and 3

However, this work is the owner's responsibility - in this case, of the lender who owns the property. Section 1 termite work impacts safety and habitability; not to mention that no agent who doesn't hose his clients is going to agree to clients paying section 1 work before escrow is completed (in other words, before you even take title). Since transactions fail to close for other reasons at the last minute, this means you could end up paying for the work and not taking title. The property and our offer were predicated upon the property being in a certain condition, but now we know it is not in that condition. Work is needed to bring it up to that condition. Therefore, the property is worth less without that work being done. The owners can do this work, or they can give an allowance in the price, and since this work is necessary to get a loan, not doing it makes a major difference in the price.

You can decide what you want to do. This may be just a testing tactic. If we respond strongly, they may give on the issue. If they don't, I would very strongly advise you to reconsider the property - it's very possible that you would end up spending the money to tent the property and still not getting the property. But that isn't my decision to make.

I am certainly going to advise against deleting the wood destroying pest addendum from the contract offer, which would enable us to pretend to our lender that no such damage exists. Not only is it fraud (and they would come after all of us), but what happens if it were to turn out that damage was greater than represented by the sellers?

If they are going to stand upon what the agent is representing here, the property is worth considerably less than the asking price, and they are trolling for an agent who will allow their clients to be hosed in the interests of getting a commission check, or willing to commit loan fraud.

We went back and forth a bit, and this was what I ended up sending back to the listing agent:

My clients are indicating that their offer was predicated upon the Wood Destroying Pests Addendum.

Section 1 Work is required to be done by every lender and every loan type I am aware of. Failure to disclose it (when known to exist) to the lender is fraud. Therefore, it needs to be done prior to loan funding, and therefore prior to transfer of title. Since the only non-fraudulent way to get a lender to fund such a loan is to do the work, it is the responsibility of the current owner to obtain a termite clearance.

Furthermore, since required Section 1 work impacts both safety and habitability of a property, an "as is" transaction does not shield the current owner from the need to repair this fault.

So the current owner is advised that they are required by the terms of our offer and the need for most potential purchasers for financing to do the work.

Otherwise, may I suggest you solicit "all cash" offers?

Here is the situation: The current owner and listing agent know that there is Section 1 work that needs to be done. Knowing this, if we were to conspire with them to eliminate that particular phrase from the contract, we would be guilty of fraud, in that we would be asking the new lender to fund a loan where we know there is a disqualifying condition of the property, but failing to advise them of it. This would be particularly pointed in the case of an agent who also does the loan (and therefore has a fiduciary duty to the new lender), but it doesn't let everyone or even anyone else off the hook: That listing agent is conspiring with malice aforethought to keep relevant information secret from the new lender, as are the current owners, who happen to be a bank, and therefore should be fully apprised of what usual lending standards are. Fraud, fraud, and fraud.

They ended up rejecting our counteroffer. Chances are they'll find someone who doesn't mind committing fraud. Lots of agents do this, as evidenced by the fact that she barefacedly proposed this fraud in written communication (email). That doesn't change the fact that she is proposing an intentional concealment of known information that a party to the transaction (the new lender) has a legitimate interest in knowing, and that is just as much fraud as appraisal fraud, concealing cash back from the seller to the buyer, or any of a large number of other ways to commit fraud in consummating real estate sales. Remember that agents owe a duty of fair and honest dealing to everyone, not only contracted clients. That includes the buyer's lender, whomever it may be. Just because you may not deal with them directly doesn't make them any less of a party to the transaction. Lots of escrow officers and agents are discovering this now in regards to concealing sellers giving buyers cash back, because the property is therefore worth less than presented. The exact same principal applies to the termite report.

Caveat Emptor

Original article here

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