As always, Liz Pulliam Weston has another insightful piece entitled “Is your home worth keeping?” Here she explores whether it is better to walk away from your house if the value has dropped and you are too deep in depth. One important point that she does drive home is the importance of doing what is best for you, and not what will be best for the economy, national or global. She writes:
But what’s good for the economy may not be good for you personally. Falling home prices and the details of the modifications mean fighting to save your home isn’t a slam-dunk.
Unfortunately, in purely financial terms, sometimes the smart decision may be to let the bank foreclose.
Some of the reasons she provides is the fact that even after revising the terms, individuals will still have to pay too much per month and they will still owe more than what the house is worth. This is worth repeating:
Your payments will still be high. Most loan modification programs seek to reduce payments to 38% of the borrowers’ income. I advise folks not to spend more than about 25% of their gross income on shelter, 30% at the outside. Otherwise, it’s tough to pay your other bills and save for retirement. If you have big expenses other than your mortgage, such as credit card debt or child care costs, spending nearly 40% of your income on a mortgage could doom you to years of financial struggle and an inadequate retirement.
I know what it is like living where every penny goes to paying off debt and always being fearful of some unexpected expense (car breaking down, ex-wife asking for more money, etc.) will bring down your fragile house of card debt.
The other problem is that homeowners risk being underwater for years. They will likely be forced to sign onto 40-year-mortgages where all the payments will be going towards interest. But, what happens if you lose your job and have to move to find work? You will be stuck selling a house that will be worth less than what you owe.
What are the options? What are the options? As Liz notes, the smartest option is quite often to stop paying and continue living in the house until they foreclose. She writes:
The long, slow foreclosure process gives you an opportunity to save. I was furious the first time I read about homeowners living for free while their lenders foreclosed, a process that can take up to a year. It seemed dishonorable to stay in a home you weren’t paying for. But again, in purely financial terms, it made sense, since people could save up the money they had been spending on mortgage payments, property taxes and insurance.
Once you are forced to move, then the best option is to rent. The fact of the matter is that if rent is much cheaper than paying a mortgage, you are better off renting than buying. Yes, the house is an “investment” but it is an investment that is costly to maintain. You have to do repairs, you have to pay property taxes, you have to mow the lawn and shovel the snow…. These expenses add up, and under normal circumstances the price of a house follows the inflation rate: it may be a bit higher, but not by much. Paying a bit more for a mortgage may make sense as it is a lifestyle choice, paying a lot more is simply stupid. As Liz writes:
You may be far better off renting. In many areas, you can rent a place for much less than it would cost to buy it — and that’s at current prices. If you bought at the peak, you may be surprised at how nice a place you can get for the same amount, or less, than you’re shelling out each month for your home. If you lower your housing costs, you’ll find it easier to build up a savings cushion, pay off your other debt and otherwise stabilize your finances.
As I have been writing in this blog, the best thing you can do for yourself is pay off high interest debt. A penny saved and used to pay off debt it worth at least 3 to 5 pennies earned. The ideal is to pay off debt and then have saving that can be invested in a safe place. With the magic of compound interest, you can accumulate as much as you would in the “equity” of the house in normal housing market (i.e. not a housing bubble).
Finally, she notes that the money saved living in a house while it is being foreclosed can help you save money that can make the transition to finding a place to rent easier:
And a fat savings cushion can go a long way toward persuading a landlord to rent to you, said bankruptcy attorney Stephen Elias, author of “The Foreclosure Survival Guide: Keep Your House or Walk Away with Money in Your Pocket.”
“You can offer the landlord a bigger deposit or even pay six months in advance,” Elias said. “There are ways to make it palatable for a landlord to accept you.”
The problem most people face, however, is the shame they will feel if they choose to stop paying their mortgage. As the author of the Foreclosure Survival Guide says to Liz:
“Just as people don’t like to file for bankruptcy, they don’t want to allow a foreclosure,” Elias said. “They feel they should pay their debts.”
It is difficult. Most of us try to be decent and honest. However, there comes a time when you have to acknowledge that you cannot cope and that it is better to be smart than honor-bound. However, before making any decision, it is best to be informed and to consult with a specialist, notably a bankruptcy lawyer.