6

7.5% fixed rate 30 year mortgage, ~100k more than the house appraises for. 7 years into the loan. Variable 'extra' income between 20k and 30k net per year (new job!). No other debt and our only investment is a small 401k.

Not knowing what will happen to interest rates or home values in the future, should we be putting everything we can into paying down the balance to gain some equity? Or should we invest elsewhere and wait for home values to come back up?

  • 1
    First off, could you qualify for a HARP loan? 7.5 is sky high, and if you could knock it down below 4 you would be building equity a lot sooner with your current payment. How do you feel about the house? Do you love it? Will the value come back? – Pete B. Aug 25 '13 at 9:40
  • No chance of HARP. Bank has been very clear that we have no options to lower the rate. The house is fine and we figure the value will come back eventually. We just figured we'd be here at least until then. – user11043 Aug 26 '13 at 15:27
  • Do you plan on moving? How secure is your job? Do you want a different house? Are you generally safe? What is you horizon for living in the home? What is the market like in your area; up or down? Do you have an emergency fund? Is your house in good shape? Are your cars? Is college in the near future? These would make a difference in the answer I'd give. – MrChrister Aug 26 '13 at 16:05
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    @user11043 - The bank is not who you talk to first to get a HARP. They're making interest money off you; they don't want you to be able to re-fi, and many of the big lenders are on record (and in court) for taking allegedly illegal steps to steer people away from the government-mandated programs. Go to harpprogram.org and check out the eligibility criteria. The three biggest ones are that the loan must be backed by Fannie or Freddie, you have to be current on payments, and you have to have less than 20% equity in your home. – KeithS Aug 28 '13 at 17:06
  • @KeithS - already checked and the loan isn't backed by Freddie or Fannie. Wish it was as we are current on payments and have negative equity... – user11043 Aug 28 '13 at 23:46
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In economics, there is a notion called the Sunk Cost Fallacy. In a nutshell, the sunk cost fallacy says that human beings tend to prefer to "throw good money after bad" because of a strong loss aversion. That, coupled with how we frame an issue, makes it very tempting to say, "if I just add these funds, I'll recoup my loss plus..."

In reality, the best best is to ignore sunk costs. (I know, far easier said than done, but bear with me a second.) How much you've invested is really irrelevant. The only question worth asking is this: "Would I invest this money in the asset today?"

Put it this way - any money you spend on "rescuing" this upside mortgage is an investment that trades ready funds for a little more equity. Knowing that the mortgage is $100K in excess of the value, why buy that asset? If you could do a HARP, different story - but as you say, you can't.

As such, buying into that investment is not the best use of your funds. You are throwing good money after bad. Invest your money where it will earn the best rate of return - not where your heart lead you.

4

I'd rent and put the $30K/ yr into savings. When the short sale comes off your credit, you'll have a substantial downpayment.

You don't mention the balance, but the current rate you're paying is 3% too high. Even if you get the rate reduced, you have a $100K issue.

I recommend reading through Will Short Sale Prevent Me From Getting VA Home Loan Later? A bit different question, but it talks more about the short sale. A comment for that question makes a key point - if you have a short sale, will the bank chase you for the balance? If not, you have a choice to make.

Adding note after user11043 commented - First, run the numbers. If you were to pay the $100K off over 7 years, it's $1534/mo extra. Nearly $130K, and even then, you might not be at 80% LTV. I don't know what rents are like in your area, but do the math. First, if the rent is less than the current mortgage+property tax and maintenance, you will immediately have better cash flow each month, and over time, save towards the newer house.

If you feel compelled to work this out and stay put, I'd go to the bank and tell them you'd like them to recast the loan to a new rate. They have more to lose than you do, and there's nothing wrong with a bit of a threat. You can walk away, or they can do what's reasonable, to just fix your rate. With a 4% rate, you'd easily attack the principal if you wish. As you commented above, if the bank offers no option, I'd seriously consider the short sale. There's nothing wrong with that option from a moral standpoint, in my opinion. This is not Bedford Falls, and you are not hurting your neighbors. The bank is amoral, if not immoral.

  • JoeTaxpayer is right... but it really comes down to what do YOU want, user11043? If you can get more clarity on that, then we are easily able to frame up how you can answer the questions regarding how to get that. For example, do you want the best financial value (most in an account/net worth)? Would you feel like you were being dishonest by doing a short sale? Is this a house that you and your loved ones are attached to? Do you need to retire sooner-ish? All of these are factors. – THEAO Aug 25 '13 at 16:32
  • That's a tough one - we like the house, but it is feeling cramped (4 kids). We have a spotless credit history and have a really tough time thinking of walking away. Retirement is a long ways off, but we have done very little to prepare for it. Just trying to figure out if paying down a 'bad' mortgage is a good investment in the long term. – user11043 Aug 26 '13 at 15:51
  • I have to agree with Joe regarding the amoral/immoral actions of the bank. – MrChrister Aug 26 '13 at 19:07
3

I said it in the comments, but I think it stands as a possible answer; if the bank's the only one telling you you are ineligible for HARP, get a second opinion. The bank is making lots of money off of you, at a time when the pickings are otherwise slim. The bank doesn't want you to refinance, and will do anything it can to convince you that you can't. Many of the big lenders have been taken to task (and to court) by the government for actively hindering these loan modification programs.

So, don't trust the bank's word alone. Go to http://www.harpprogram.org and check the eligibility criteria, and if you think you meet them, fill out an application. The basic criteria are:

  • Your current mortgage is guaranteed or owned by Fannie Mae or Freddie Mac; these are the two biggest mortgage guarantors but not the only ones, so check the paperwork you signed and any notices about transfer of servicer or ownership (which can also result in a change of guarantor).
  • The mortgage was underwritten or bought by Fannie or Freddie before May 2009. You signed the papers in '06 so as long as Fannie or Freddie were the guarantors at origination, no worries there.
  • Your payments on this mortgage are current and you have not been more than 30 days behind on any payment scheduled in the last 12 months. If you've been behind since November 2012 there's pretty much no hope.
  • You have less than 20% equity in the home (the actual requirement is a loan-to-value ratio >80%, but your equity percentage is 100% - LTV% so it's the same thing). You're allowed to be underwater, but if the new mortgage will be an ARM, you cannot owe more than 105% of the home's value (so don't get an ARM; it's a bad deal anyway with rates so low).
  • The loan has not been modified by HARP before, except for a grace period during 2009 when servicers/lenders were doing it wrong. You only get one go-round, so take your time and shop around for a deal you can live with at least till you get to 20%.
  • You can make the payments of any new mortgage loan you are offered. Affordability is based on a metric taking into account your income, other debts and expenses, and a maximum percentage of earnings.
  • The new loan puts you in a substantially stronger long-term financial position. This is a judgement call by the HARP agent; they basically want to see a lower rate and a shorter term to get you back into positive equity ASAP.

Some caveats:

  • You will still owe the same principal amount; it will not be adjusted to the appraised value. Someone has to satisfy the debt to the bondholders, and basically it's either you or the American taxpayer (the bank will just get a bailout or go under and put the gov't on the hook anyway).
  • The HARP representative will strongly encourage a loan with a shorter term, which will both reduce your interest rate and allow you to pay more principal faster, to get your head back above water sooner.
  • So, the HARP program may not reduce your monthly payment; because of the shorter payback period that will be encouraged, you have to pay more each month. The point is not to increase discretionary income, it's to get you the current market rates and move you into positive equity territory as fast as you can afford to. However, between your current rate (7.4%) and the rate you can get with a re-fi (between 4-5%), you should be able to get a somewhat lower payment on top of all this.
  • All servicers and lenders that have any loans on their books backed by Fannie or Freddie are required to participate in HARP and to cooperate with refinancing attempts under HARP. Your bank could be subject to federal penalties if they stonewall this process.
  • You have to want to stay in the home and eat the deficit amount. The other answers are spot on that your $100k deficit is money you may never see again if you continue to pay a mortgage on this house, HARP or not. If it were $10k (which was my own equity deficit based on the tax value of the home; nothing to worry about, and the assessment recovered half of that this year), I'd say stay put and make it happen. $100k is a huge chunk of change, and I'd have to sit down and think about that one.
  • The HARP Program ends on December 31 2013, so you have until Christmas to get it all sorted out including your 12-month payment history. If you have been more than 30 days past on any payment since November 2012, there's little hope.
  • If you don't go with HARP, you have to get to 20% equity in the value of the home before you qualify for a traditional re-fi, so your 20-30k discretionary income each year doesn't just have to pay back the $100k, but whatever dollar amount over that represents a fifth of the home's current appraisal value. A $100k loss of value doesn't say much; that could be on a million-dollar home in DFW or a formerly $250k home in Detroit. Whether it's all worth it depends on what the home's still worth; a 10% loss can be made up over time if you plan to stay, while you may never recoup a 40% hit to the home value in your lifetime.
1

Here are the pros and cons and an analytical framework for making a decision.

Pros of walking away:

  • Nullify 100k of debt at a high rate from your life
  • Make the lender take a loss if it benefits you rather than the sheep arguments about "ethics"
  • Opportunity to get into a new house

Cons:

  • Transaction costs (based on your state/locality), time, and hassle of moving
  • Tax consequences on the difference between auction value and outstanding loan value
  • The bank will be reimbursed for the loss anyway [1] [TARP]
  • (If you don't have credit card debt) 7.5% interest rate is a great motivation to pay ones earnings to and reduce consumption
  • You could save $120k over the years simply by getting a 5% fixed rate which should be easy [2]

Here's the framework: compare the value of first and second sections for you

[1] http://www.nytimes.com/2009/07/30/business/30serviceside.html?_r=0

[2] http://www.mortgagecalculator.org/

  • 1
    How are the 3rd and 4th items in second group, 'cons'? 7.5% is motivation to pay down a mortgage on a non-under water loan, but here, it's not 7.5% saved, but thrown away. (and FYI, I was not the downvote) I actually liked your list approach. – JoeTaxpayer Aug 27 '13 at 14:49

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