Q: I have an option ARM mortgage and a home equity line of credit. Between the two, I owe about $300,000 more than my home is currently worth. Even so, I would still be willing to keep my home, and I have applied for a loan modification. However, it looks like the modified payment on my home will still be very high — I can try to scrape to afford it, but if the economy and business gets any worse, I’ll end up back in trouble. I wonder if I should give up on all these efforts to try to keep my home at any cost and try to do a short sale. What are your thoughts?
A: In many ways, this current phase of the housing market has been like a reset button on the market. Every day I get e-mails from homeowners who are considering simply "walking away" from their homes, without making any effort to discuss modification or short sale with their lenders. I appreciate the considerable effort you have exerted thus far, and the fact that you would be willing to honor your mortgage obligations if you could get them modified to be feasible, even though your home is upside-down.
Mindset Management
As much as I dread discussions that end with people losing their homes, the time has come for us as a nation to grow up and face the hard facts with respect to our mortgages. The goal of your current decision-making exercise should not be to drag out your financial pain, or to prolong the inevitable. The reality is that if your home is simply not affordable for you, even if you minimize your expenses and maximize your income, then the sooner you can get some closure on this experience the better — both emotionally and financially. I recently saw the statistic that about 54 percent of loans modified later end up back in trouble; I don’t want you to go through all the turmoil of a loan modification and then end up with the same, foreseeable issue again.
In your situation, I disagree with your characterization of a decision to short sell your home as "giving up." The test of maturity and responsibility is whether you can get closure on this experience and begin rebuilding your finances and reaping the benefits of the lessons you’ve learned, while still behaving morally, ethically and legally vis-à-vis the mortgage obligations you created. You, my friend, pass that test, by virtue of your efforts to work something out with your lender, then putting forth the effort involved in a short sale, when many people around you are just walking away.
Need-to-Knows
It is correct that your option ARM payment is not likely to be lower, after modification — the uber-low, negatively amortizing minimum payment on an option ARM is lower than the modified payment on your loan would likely be. Option ARMs are typically modified so that the negative amortization feature goes away, the interest rate and payment is fixed for five or seven years, and back payments or fees are added to the end of the loan, bringing the loan current. None of this reduces the payment, though. So, if you cannot afford your current minimum payment, you are correct that you will not likely be able to afford your modified mortgage payment.
Many loan modification companies are promising homeowners like you that they can achieve a principal reduction, which would potentially make the critical reduction you need to your payment. Don’t be deceived; the latest statistics show that only 1.3 percent of loan modifications include a principal reduction. It is extremely unlikely, and the statistics render the expense of paying someone to negotiate a principal reduction the same as throwing good money after bad.
However, before you make decisions on the assumption that you cannot afford the payment, you should go through the exercise of listing out your monthly income and expenses line by line. Be honest about the discretionary expenses you could cut out: eating out, cable TV, etc. Also be honest about whether your household income is as high as you can get it. Do you have rooms or areas of your property that could be rented out? Is it feasible for a spouse who has been working part time to work more hours? I won’t tell you to nitpick about a latte here or there, but get real with yourself about whether you could afford your house if your expenses were leaner and your income maxed out.
If the result of this exercise is a clear understanding that you cannot afford your home, then trying to do a short sale is a good alternative. With most lenders, you can discuss your short sale with the same loss mitigation staffers who you are dealing with on your loan modification. A short sale does have some negative credit consequences, almost equal to those of a foreclosure. However, the negative federal tax impacts of short sales have been eliminated through 2012, and under the new federal lending guidelines, short sellers are eligible to buy their next home two years after their short sale, while owners of foreclosed homes are forced to wait three years.
Be aware that a short sale is a good option, but it is not a sure thing. You may not get an offer, or your lender may not cooperate. If all efforts at short sale fail, consider negotiating a deed in lieu of foreclosure. This agreement to hand your home back to the bank saves both sides drama and expense, and some lenders will help you cover your moving expenses with the money they saved by not having to hire attorneys to foreclose.
Action Plan
1. Crunch your own numbers. Get clear on your monthly income and expenses, then make sure your income is as high as it could be, and that your expenses are minimized.
2. Make a decision about whether you can or cannot afford to keep your home, based on your discussions with your lender about the projected, modified payment.
3. If you cannot afford your home, be responsible and work with your lender to craft a graceful exit strategy, be it a short sale or a deed in lieu of foreclosure.
Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.
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