Almost a third (31.4%) of homeowners with mortgages are underwater, according to the 2012 first quarter Zillow Negative Equity Report, yet 90% of them are current on their mortgages and continue to make payments. Deciding whether to “stay and pay” on a home that’s worth less than you owe is a tough financial decision, and judging from the email and comments we are getting, one that many are struggling with. One reader writes:
I am 55 y/o and my partner is 62 and like so many others our mortgage is upside down. We have a fixed rate of 4.5% and 9 years left to pay. The current mortgage balance is $97K. We built our home in 1989 and it cost $73K. According to Zillow.com, it is now worth $77K. … I don’t want to give up my home. But at what point do I walk away?
We purchased a home back in 2007 for $400,000. We put 5% down and [we’ve been paying for] about 5 years never late. Our balance now is 356,000 at 6.375% with lender paid pmi. Now the house worth $280,000. Now we trying to refinancing to see if we qualify through harp 2, so far we still waiting for response. At the same time, we both (wonder) if its a good option just to walk out or short sale instead of refinancing. The only problem is we don’t want to ruin our credit because both our names (are) on the loan.
Ultimately, of course, this is a decision only homeowners themselves can make. And while it’s fraught with emotion for most, there are a number of financial factors that you can and should consider. In fact, looking at the numbers may help you face the facts and make a better financial decision in the long run.
Own Vs. Rent
When you were thinking about buying your home, you may have tried a “rent versus buy” calculator. (Of course, those were likely created before the housing meltdown and may have overstated some of the value of owning.) Now, however, you must flip the equation look at the cost of continuing to own versus the cost of renting.
To do this, spend a weekend apartment or house hunting. Go and take a look at rental homes. Find out what’s available, what they cost, and what kinds of requirements landlords are looking for in terms of deposits and credit.
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The goal? To get a realistic idea of how much you’d pay to rent for so you can compare the cost of renting with what you are paying for your mortgage. When you look at the “own” side of the equation, don’t forget to factor in periodic expenses such as maintenance (including repairs that will have to be done in the next few years) and property taxes (if they aren’t included in your mortgage payment).
One more twist: If your mortgage (or second mortgage, if you have one) is a variable-rate loan, then you should also consider the cost of your mortgage when interest rates rise. Try an online mortgage calculator to estimate the your monthly payment at higher interest rates.
Getting Back to Square One
One of the arguments in favor of owning versus renting is that as you pay down your mortgage you are building equity. But with so many homes underwater, the real question is “when?” When will your home be back in the black and start building equity? Until it does, you are effectively renting. And how much will that cost in the meantime?
Of course trying to guesstimate future home price appreciation is like trying to predict where the stock market it headed. Just take a look at the March 2012 Zillow Home Price Expectations Survey. It compiles predictions from a diverse group of 104 experts – economists, real estate experts, and investment and market strategists – to measure expectations about the projected path of the S&P/Case-Shiller U.S. National Home Price Index over the next five years. According to Zillow:
The most optimistic quartile of panelists predict a 1% increase, on average, in home prices during 2012 (rising by more than 19% over the next five years), while the most pessimistic predict an average decline of 2.8% this year (rising only 0.6% over the five years).
So is it .6% or 19% over the next five years? That’s an enormous difference and it depends at least on part on what the market may do where you live. But it does illustrate that for those who are upside down by 20%, even the most optimistic forecasts have them breaking even in about five years at best.
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Ask yourself whether you can realistically expect to stay in your home and keep making the same payment (or more if your interest rate or property taxes go up) for the next five, ten, or twenty years while you wait for values to return. If not, then you may be forced into a short sale or foreclosure in the future, despite your best efforts now to avoid that.
Don’t Forget Uncle Sam
There are two tax issues you’ll want to weigh. The first is how much of a current tax deduction you’ll be giving up. If you itemize your taxes and get a large deduction for mortgage interest, you’ll want to see how more you would pay in taxes if you no longer claimed that deduction. Remember, though, that you only really get to deduct the itemized deductions that exceed your standard deduction, since you’d get the standard deduction anyway. If the tax deduction is a possible dealbreaker, ask your tax professional to help you figure out what it’s really netting you, or try a tax preparation software program to do that math for you.
There’s another potential tax pitfall: cancellation of debt income. The IRS considers canceled debt taxable income and the lender must send you and the IRS a 1099-C reporting that “income.” Many taxpayers can avoid paying taxes on some or all of their forgiven debt if they qualify for an exclusion, such as the Mortgage Debt Relief Forgiveness Act.
But that law expires at the end of 2012 unless Congress extends it. That means you generally must finalize a short sale or be foreclosed upon (without the possibility of recourse) by the end of this year if you want to take advantage of the current law.
For some, this looming deadline is motivating them to take action. A national survey of its current clients actively considering or navigating through the foreclosure process by YouWalkAway.com, an agency that helps people understand and manage the foreclosure process, found that 34 percent of those surveyed indicated that the Mortgage Debt Relief Act expiration date of December 31, 2012, contributed to their decisions to walk away sooner rather than later from their properties. “The survey results are not surprising; YouWalkAway.com saw a number of homeowners reach out to us in early and mid 2011, due to the impending 2012 deadline,” reports Jon Maddux, CEO of YouWalkAway.com.
If you don’t qualify for tax relief under that law, however, you may still be able to avoid paying taxes on canceled mortgage debt to the extent that you are insolvent. (The insolvency exclusion is not set to expire.) Use the Worksheet in IRS Publication 4681 to figure out if you qualify or contact your tax adviser to help you understand the tax implications of losing your home or selling it in a short sale.
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When Will It Be Over?
Finally, you want to find out whether you could be pursued for a deficiency balance later on. If you sell your home in a short sale, for example, you’ll want the lender to confirm in writing that it won’t pursue you for a balance later. If you walk away, you need to make sure that the loan is a non-recourse loan, or you need to discharge any remaining debt in bankruptcy. If you aren’t sure about whether you may be on the hook for debt even after the home is gone, meet with an attorney (see below). Consider it part of the planning process.
Where To Get Help
It can be challenging to get the financial advice you need to make the best decision you can. But there are professionals who help clients walk through their options. Consider talking with:
A fee-only financial planner: Consider hiring a financial planner for a few hours to help you run the numbers and look at the big picture. Visit GarrettPlanning.com or NAPFA.org. Be sure to ask the planner in advance if they handle these kinds of situations.
A bankruptcy attorney: While a bankruptcy attorney will likely lean toward evaluating bankruptcy as a solution, many also have expertise in foreclosure-related issues. If the attorney you reach out to doesn’t offer this kind of advice, ask for a referral to another attorney who does.
A real estate attorney: Some attorneys help homeowners negotiate short sales and loan modifications, and/or fight foreclosure. Find out whether you can hire the attorney for a consultation just to go over your options before you commit to one approach or the other.
A credit counselor or debt consultant: Free foreclosure avoidance counseling is available through HUD-certified counselors. The emphasis will be on trying to identify ways to save your home. A couple of debt negotiation experts offering consultations for a reasonable fee include DamonDay.com and SecondMortgageAdvice.com. Both offer money-back guarantees.
YouWalkAway.com offers an interactive calculator you can use to run through some of the numbers I have discussed here.
Image: Images_of_Money, via Flickr