Free Money Finance posted a question from a reader who's paying on a house that's now worth less than what's owed on it. The reader is upside-down on his mortgage, but the mortgage is a 30-year fixed-rate, and he paid 20% down. It wasn't a teaser loan by any stretch, and it didn't really sound like he was having trouble making the payments.
He's like to be able to leave Las Vegas, but he's stuck now unless he sells at a loss on top of losing his down payment. He bought near the top of one of the hottest local housing markets in a really big housing boom. (Las Vegas was one of a handful of metropolitan areas where real estate had appreciated more than 80% from 1998 to 2006.) That market is rapidly cooling and has now consumed all of his equity.
Maybe he couldn't have chosen to live elsewhere, but he could have chosen not to buy. Immobility is the consequence of his decision to buy at that time. Moving is a poor option, if it's an option at all. If he can't swing the shortfall between what the house would sell for and what's owed on it, he's stuck. Hopefully the development he lives in — and will live in for a while — is completely built; others in a similar predicament may have a not-so-beautiful view of empty dirt lots and an unfinished clubhouse.
Misery loves company, and he's certainly got lots of company. Most homeowners, if they're not upside-down on their mortgages, have lost equity or at least have handed back some of their paper gains. I'm not in the same boat as this gentleman but I know I wasn't really that much better informed than him, or that much more conservative in the amount of house I bought. I bought a house that I could afford, I got fixed-rate financing, and I put a good-sized down-payment, as he did. I just happened to buy a few years earler than he did, and that has kept me in the black so far. But my house wouldn't sell anywhere close to what it appraised for in 2005 when I refinanced.
This softening housing market will strand a lot of people who bought near the top, and only a recovery will give them their mobility back. If they didn't buy with crazy financing and didn't buy more house than they could afford (like this gentleman) then that's all that will happen. If not, then it will hurt more. We'll see.
If he wants to move, he should hire a company to rent out his house. The rental market is really heating up in regions where housing has been hit hard.
Even if it doesn't cover his costs, at least he is not having to pay the transaction fees associated with selling his house; he also will have the opportunity to gain his value back. It may take 10 years, but it is better than losing $50 grand.
For years the NAR has been threatening folks if they don't buy know "they'll be priced out forever." The flip side of that, is those who bought in the past few years may be "priced in forever."
@SmBizMan: I see you think the recovery's going to take a long time, too. 😉
@TheMightyQuinn: Primarily the Realtors care about moving product because nothing good happens until there's a commission. Instilling fear is one way to do that.
@SmBizMan: Your math may not make sense in this person's case. Let's say he rents it out as a loss of $300/month on the mortgage. After 10 years, that's a $36,000 loss, and that doesn't include maintenance, property taxes, or the fact that rental prices are actually going down in overbuilt places like Vegas.
It's unlikely that, having bought at the top, he could rent it out for anything approaching a full mortgage payment. He'd be better off doing a short sale and clearing the debt now than having an albatross hanging on his neck.
@ericabiz: Obviously, the math has to make sense. But, just as real estate value is bound to go up, RENTS also go up. So, even if he starts out with a $300/month loss, after 2 or 3 years, it may be a much smaller loss. After 5, it may even be cash flow positive. And after 10 years, the value may be back and he will have had a cash flow positive rental for 5 years.
You've just got to think long-term here.
However, like you said, if he is burning though $1000/mo that wouldn't make sense…
This is very unfortunate for the people in this position but we must all learn a lesson from it. Buying a house is a big undertaking and we must be sure that it is the right house for us, in the area that we want to live before we buy. Of course he does have the option of renting out the house and using that rent to pay rent himself elsewhere but that is obviously a complicated option.
Regarding rentals, they are not "easy money". Being a landlord can be extremely stressful. If he's moving away from LV, he will either be an absentee landlord (not good) or he will need to hire a property management company (another iffy solution). Tenant turnover can be tremendous – how is he going to meet and select tenants? A basic rental investment rule is to buy an investment property within a 30 minute drive from your home. Sometimes, the bullet must be bitten regarding whether to try keep holding on or letting go so that one can move on with more important things in life.
Renting out was my suggestion too on FMF blog. I rented out my old condo in the 90s instead of selling it at a loss when I decided to upgrade. Worked out really well. The only thing is – he has to have some money in savings to deal with the periods when the property may stay vacant. The rental market situation in the area is important.
The numbers have to make sense, but because of tax breaks $300 shortfall may not be so bad. First of all, when you rent out, not only the mortgage and taxes are deductible, but also repairs, homeowner associations fees, some other expenses. But the biggest thing is depreciation. Say his property value today is 200K. Divided by 27.5 (standard period for residential rental property depreciation) it is over 7000 a year. This is the amount he gets to deduct from income. Assuming he pays 1/3 of his income in state/federal taxes, it could be extra $200 a month savings.
Sure, if he sells his property later for more than base-value – depreciation he'll have to give some of this money back. But in this case, he'll have gains from sale. Additionally, recaptured depreciation is taxable at max 25% whereas he may be in higher tax bracket. Also, by that time he could've invested this money he gets from uncle Sam.
@kitty…
thanks so much for sharing! I think Mighty Bargain hunter could make a post about exactly what you just described.
If you think long-term as an investment, holding now may be better than selling now, especially when you factor in the "transaction costs" of real estate. Realtors fees, closing costs etc and really add up.
I guess in each case one would need to take a sharp pencil to the specific case and make a decision.
But at least there is a possible better way out than flat out losing tens of thousands of dollars.
SmBiZMan
It is so scary that this is happening to people. I am stuck in my house now as we bought it when we had two incomes and borrowed the maximum amount we could. Now we only have one income coming in we cannot possibly borrow more money and so cannot move. It means that the children have to share a bedroom but we figure it own't hurt them.
My husband and I are stuck in Las Vegas too… We saved for several years and bought near the top of the market. We paid 300k for our home and put down 60k. We have a 30 yr fixed rate at 6%. We currently owe 230k and our home is now worth about 140k. My husband’s income is based on tips which have gone way down (I’m salaried luckily). But we’re STUCK big time. We don’t have a lot of money and we work hard to pay our bills, but it’s very frustrating that our tax money is bailing out others and we aren’t getting any help. It’s those people who made irresponsible decisions that ruined it for those of us who tried to do everything right. Ugh…