When Taking a Loss is a Good Thing

I just finished sending an email to a client who bought a house through me about four years ago.

In it, I was explaining something no one else is really writing about.... how taking a loss can be a good thing.

Saying this makes me sound crazy! No one wants to take a loss on their property, right?

There was a time when I took a loss on a house that I am very thankful for.

The first house I ever bought back in 1996 I thank God every day I took a loss on when I did.

At the time, the house was all we could afford, and at the time it was also in a decent location. I paid $52,000 for it as a college student with very little income. I admit that I refinanced the hell out of it like many of us do before we learn the ropes of what's a good decision. Those refinances helped me to overimprove the house (shame on me I do that with every house I live in :-), pay for extra expenses when my daughter was born, buy a car, switch jobs, get out of credit card debt, etc.

I rented it out for a while but like all of us who are landlords know NEVER rent a house you are emotionally attached to (a house you used to live in) because it will bother you even more when the tenant destroys it. I fixed it up again to sell and by the time all was said and done I ended up losing about $20K on the house.

Boy was I lucky. That house today would bring about $35K in pristine condition because the neighborhood values have dropped so much. When I sold it I got $85K for it which was a very fair price at the time, amazingly only about 5 years ago.

But "losing" that money was worth it. You see, I really didn't lose that much. I had taken the equity out and spent it on other things, and even though I don't recommend everyone do that it helped me in times when I really needed the money. The trick is eventually I was earning enough to pay up.

The client who I was talking with is a little more disciplined than I was. He owes more than he can get simply because the economy has gone down.

But he can take a loss and be glad too and here's how I explained it....

"You owe about $81K

Let's say your house sells for $75K in today's market With fees and taxes that have to be paid and commission and all that jazz let's say selling the house costs $86,000 for example. So you're short $11K (this is just an example).

You would have to bring $11K to closing as a loss.

That part sucks.

Here's the good part though.

Everyone else is selling for less too, especially the banks. So you make up your loss when you buy for less. It's kind of a wash. Most people can't understand this part... YOU lose but THEY lose too. It evens out.

Say you buy a house for $40K that needs work. You get a FHA 203K rehab loan for 3.5 percent down. You fix it up nice and you have maybe $55,000 in it and then you have a house you really like, the way you want it, that doesn't need any work.

Your payment is at the low interest rates of today, probably less than what you're paying now (under 6 percent usually, sometimes closer to 5).

So say your current loan is at 7 percent (I don't know for sure this is just an example) and you're paying $552 a month principal and interest. The new loan, assuming a rate of 5.7 percent at 55K would be $319.22 per month principal and interest. You save every month plus you have a house that doesn't need any work at that point and it's the house you want that fits your needs.

If you keep your current house as a rental you're looking at a break even likely every month rather than a profit, which makes that plan not so appealing.

The downfall is you no longer have the money you lost on the first house.

If you don't sell your current house, then when the market turns around if you're in the house you're in now you can clear the loan without a loss and buy another house that's pretty much the same for the same price or buy another one and invest more.

On the other hand, If you're in the fixed up house you can sell it and likely make some money, or you just have really low payments and you have a house you like and you don't have to worry so much every month. You'll get your $11K loss back and then some if you resell the new house in a good market."

The most important thing if you sell and buy the house you want NOW, you're living the house you want NOW, rather than waiting for years to get there. Make sense?