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Real Estate Roundup by Sharon Alva: Should I stay or should I go?

Submitted by on 1, January 29, 2010 – 5:50 am2 Comments

In 2005, you bought a property for $600K and took one of those fancy 100 percent loans that let you pay a minimum payment smaller than “interest only.” So now your debt is well over $800K and the property is worth $650K. And  you can’t meet the payments on the property once it adjusts in the spring.

What do you do now?

Option One: RENEGOTIATE THE LOAN

Some have succeeded and some have failed. Those who have succeeded have one thing to say: “Be persistent.” It takes literally dozens of calls and constitutes a half-time job pestering your lender and getting through to the right person. Stick with it.

Loan remodification can take two forms: principal reduction or interest reduction. Some combination is the most effective for reducing monthly payments, making it possible to keep your home.

The government did institute a plan to encourage banks to help homeowners stay in their homes, but the banks have been slow to implement it. In February 2009, President Obama unveiled a plan to help beleaguered homeowners just like you modify their loan if they had been faithfully making their paying and were underwater. The idea was to get payments for housing back to 38 percent of income rate, which is considered to be a sustainable about of debt.

The Home Affordable Modification Program (HAMP), funded at $75 million, was supposed to help as many as four million borrowers obtain mortgage workouts. But it was stymied by lenders big to small. By the end of 2009, it had produced fewer than 70,000 permanent modifications, with another 800,000 or so homeowners were in a trial-modification phase. But this year, the banks may be coming around. This past Tuesday, Bank of America Corp., the largest U.S. bank by assets, became the first mortgage servicer to agree to lower or eliminate payments on second mortgages. This federal initiative, called the Second Lien Modification Program, pays incentives to second mortgage holders to work closely with first mortgage holders under the HAMP.

First mortgage holders have been reluctant to lower payments when there was a second lien involved because they did not want to take on losses while leaving payments on the second mortgages intact. The lack of an agreement with second lien holders has been a major impediment to getting successful modifications done. It’s estimated that as many as half of at-risk mortgages are burdened with second liens.

Acting now and being persistent are key to making this option work.

Option Two: SHORT SALE

The short sale process can be torturous. But if for 18 months you have not slept and fear is gnawing at you night and day, the process may be easier than living with the knowledge that you can’t make your payments.

In a short sale, you, the seller, sign the purchase agreement. But using a short sale addendum the contract does not go into effect until the lender has approved the sale at the value on it. In a short sale, the lender absorbs the difference between the sale price and your loan. Add in closing fees and commission payments, and that amount can grow to vast proportions. It is still better than a foreclosure for the bank in many cases, but the processes the banks have in place for making decisions on short sales can take months.

As with renegotiating a loan, the process is rendered even more unwieldy if there is a second lien holder. Short sales are far more likely to work out if there is just one loan.

Some lending professionals I have queried tell me the hit on credit scores in a short sale are smaller than in a foreclosure, while others say it’s the same. The situation seems to be case-specific. In both cases, the borrower’s credit score will take a major hit of 100 to 300 points.

Option Three: FORECLOSURE

Walk away and let the bank foreclose. That seemed like a coward’s way out a year ago, but the reality is that banks were helped by the government to make it possible for people to keep their homes, and they have lagged on the job. Having a home foreclosed puts some of the responsibility back on the lenders who approved shaky loans, and then misused the government assistance garnered over the last 24 months.

Foreclosure would have carried a social taint a decade ago, but as the housing market reconstitutes itself you will not be the only homeowner to have suffered foreclosure.

In Summary

If you ask me, the best option by far is loan renegotiation. But it is not always possible. And there is also a caveat (there always is). If modifying your loan still leaves you unable to make payments and just draws out the inevitable, it may be time to look at one of the other options. There are professionals who offer to take on the process of negotiating a new loan for you, but I would tread carefully and make sure that you are not paying upfront for a process that may fail. Your own calls can be as effective if you are persistent and provide your lender with all the documents they require.

A short sale is best handled by a proactive real estate agent who will manage expectations and doggedly pursue lender approval. And in both the foreclosure and the short sale situation you should check with a tax professional to see what the ramifications of debt forgiveness will be.

Sharon Alva is a real estate agent with Alain Pinel, living in Alameda. You can reach her at sharon@alvaproperties.com.

2 Comments »

  • Steve says:

    Sharon, I think that your conclusion that “the best option by far is loan renegotiation” for under-water homeowners is based on an incomplete set of facts.

    First of all, I doubt that are many (or even any) homeowners who purchased their house in 2005 who are looking at an 8% (cumulative) gain in price in 2010 (i.e., $600K paid in 2005, worth $650 today). Recall that in 2005, a $600K home in Alameda was (for all intents and purposes) a “starter” home, likely a single-story bungalow with 2 bedrooms and 1 or 1.5 bathrooms. Homes such as these have not appreciated 8% since 2005. Rather, they are now selling, on a good day, in the $400K’s. So the homeowner in your example is likely to be $300K -$400K under-water.

    Second, nine-out-of-ten loan renegotiations do not result in any principal reduction. Yes, homeowners are able, for a time, to have their monthly payments reduced. However, the bank increases the principal balance to reflect the lower monthly payments so that the homeowner’s debt continues to increase. Isn’t this what put the homeowner in trouble in the first place — owning an asset that is decreasing in value while the debt used to buy the asset increases?

    Finally, with respect to the “walk-away” option, you failed to point out that banks now take 9 months to a year (or even longer) to foreclose on a homeowner who decides to just stop making payments on the mortgage. In essence, this allows the homeowner to remain in their home rent (or mortgage payment) free until they’re forced to leave. This provides an excellent opportunity for homeowners to re-build a cash reserve and get back on their feet.

    Although every underwater homeowner’s situation is unique, and there is no blanket prescription that covers them all, I very much doubt that the loan-renegotiation option is the best by far as you conclude.

    By the way, I am an Alameda homeowner who would like nothing better than to see the return of a stable real estate environment with affordable home prices. However, the reality is that as long as the real estate industry remains under (taxpayer-funded) government nationalization and “gimmicks” like tax credits and low FHA down-payments drive the market, we’ll continue as we are now.

  • Sharon Alva says:

    Steve,

    I agree that loan modifications are not easy to come by and many do not result in reduced principle. I mentioned it both at the head of the article and in the summary. But its not impossible and so worth pursuing for folks who want to keep their homes but can no longer pay the mortgage. No guarantees. I know personally of a few that have had their interest rates drastically reduced with no affect on principle. It is on a case by case basis.

    Two bedroom one bath starter homes in Alameda are now in the low $500’s if they are in decent shape. Homes in the 400’s have structural issues or other serious challanges. I’d be happy to email you the solds for December-Janaury if you want to see comps.

    And it is a good point that allowing the foreclosure process to proceed allows folks to set some cash aside. That’s true for short sales as well as there is ususally a period of months when the loan is not being paid before the short sale goes through. In both cases there can be tax ramifications, but I think more and more people are willing to walk away and have the house foreclosed.

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