By Dave Dinkel, BREIA
For probably five years I have been asked by homeowners and investors what to do about their upside down properties. The question was always, "Should I stay and lose money every month or default and just move on?" The answer has ramifications that are far-reaching, but a decision eventually has to be made. Whatever decision is made it should only be in the property owners' best interest. The decision is not a hard one to make when you understand the "real" consequences, which are not as bad as the unknown of what could happen.
I listened to a very misinformed "expert" recently on television talk about this subject and she said that the defaulting homeowner's credit would be ruined for seven years and they could not buy a home for that long. I almost started spitting blood I got so mad. Not only can a foreclosed homeowner buy a home using non-conventional financing in just weeks, it usually doesn't take more than 4 years to buy another home using conventional financing.
This "financial expect" went on to explain that the homeowner couldn't buy a car or do any financing at all - period. Wow - what a misleading group of statements! I wonder if she would do the same non-research and make incorrect assumptions if she had the problem herself. This information is propaganda from the lending institutions and an excuse to charge borrowers more interest on fully collateralized loans. "Stuff happens" to us all and a glitch in our personal lives isn't a reason to penalize us for the rest of our lives.
About four years ago, I first started getting questions about pre-construction condos that didn't achieve the results investors had expected. Frankly, I told these investors to stop making their payments immediately and let the developer or lender take the properties back. In one particular case the investor had a $2,000 per month negative cash flow on his three condos and this didn't include his skyrocketing property taxes that he wasn't paying at the time. Their response was always the same - "I have an 800 credit score and it will get killed", "I think the market will come back and I don't want to take the loss", or "I have a moral issue with defaulting, as my word is my bond".
He decided to try and protect his credit score and the last I heard he was still making payments and looking for a second job to cover the monthly rental deficit. In the last four years the condo market has probably dropped to 50% or more from what he paid so the decision to give them up was eventually made for him. Ironically, the issue he didn't ask me about was the issue of deficiency judgments. This can be an issue if you are an investor so you have to know the problem is out there for the next seven or so years and you will need to prepare for what's ahead - that means to legally avoid collection if you didn't get it. There are options to legally avoid collection - bankruptcy, negotiation, payment plans, no assets in your name, etc. - check with an attorney and your CPA for more information.
The problem I have had telling people to quit their mortgages is that it is emotionally painful and not what people want to hear. I have empathy for them and the easier thing is to suffer monthly until they can't take it any longer. As a certified financial planner for years I had to tell people that they had made a mistake with certain investments. They would not listen because they always said "I don't have a loss unless I sell the investment". This statement is very short-sighted and mostly motivated by the failure (ego gets hurt) they feel when they actually take a loss - or that a spouse or partner will never let them forget. But as I learned from years of experience and tens of thousands of stock, commodity and real estate transactions, "99.9% of the time, your first loss is your smallest". Many of the investments I tried to have these investors sell later became totally worthless.
You are beginning to hear from the media about that expected foreclosures could be topping 4,000,000 in the coming year(s). These are distressed properties that have had lis pendes or Notice of Defaults filed against them but they are not yet For Sale, and they are sometimes referred to as the "shadow market". The really staggering number is the 14,000,000+ properties that "Upside Down Not in Foreclosure and Not for Sale". This is the coming wave that the regulatory agencies seem to be overlooking and not concerned with now. These regulatory agencies are instead spending their time guaranteeing the banks' massive losses and lashing out at the public and real estate investors as if we were the cause of their problems.
Just as FNMA reversed their decision about how many multi-family properties investor could buy (reducing it and then months later going back to the historic number), the sages at HUD will eventually "get it" and will have to reverse their decision to take investors out of the owner-financing market. Their latest attempt to restrict seller financing is typical of the people in charge of HUD who are essentially doing the bidding of the national banks. These banks are putting up a shield that they claim will "protect" the public from unscrupulous homeowners who will do financing to buyers who could otherwise get a conventional loan. These are the same conventional loans that the lenders won't grant or the borrower will have to pay much higher costs to get. What are these people thinking and why are they so out of control? The answer is simple - money and greed. OK, OK. I'm climbing down from my soapbox right now....
If you are a homeowner that is contemplating foreclosure you should take the emotions out of your decision (easy for me to say) and treat this as a business decision. The reality is you will not likely get a deficiency judgment against you because of the "amnesty for homeowners" that is in place. Even if you get a 1099-C Form for Miscellaneous Income for the deficiency amount, and even if you have to pay the taxes on this amount, it will be far less than the actual deficit. Ask your CPA, or a knowledgeable one, about these possible tax consequences - keep asking until you find someone who has had it happen.
Another issue is the homeowner's credit score or, more correctly, his lack of a credit score. Yes, it will impact your ability to finance major purchases at reasonable interest rates, but not so unreasonable that the sellers won't give you credit. Actually, this may be a good thing to keep some buyers from over-extending themselves again. The simple solution is to save a larger down-payment for the purchase. No matter how bad your credit is, it can be re-established within a few years. A great credit score is "kool" but not worth a $1,000 to $2,000 a month to keep it at 750+.
Foreclosure is not the end of the world and it will pass. It may be inconvenient, but the 20,000,000 Americans who have lived through it can attest that it is not the end of the line. Don't make it into more than it should be - a business decision in the best interest of you and your family. Children understand more than their parents believe and can benefit from the experience if the parent shows them courage and steadfastness.
Is the real estate market coming back so that the average upside-down homeowner can get back to what he paid in a few years? In our tri-county area, over 25% of the homes are Distressed or Upside down - that means over 250,000 single family homes. If the rate of sales continues as it is - about 3,000 per month for all types of distressed and non-distressed properties, it could take 83 months or 7 years to get out of our current inventory. No one knows, and only a fool would say that the market is coming back. What I can say is that that the homeowner's cost to carry the property for years will increase his breakeven point even more and that as investors this is either the greatest opportunity in the history of the real estate market, or the worst time ever - you decide.
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