I know I just wrote a response to a Realtor.com “Hot Topic” - about what goes in to your credit score and how it affects you as a home buyer.  But their most recent hot topic was too interesting to pass up.  The question: “Should you continue to pay for a home where you owe more than it’s worth?”

I’ve blogged before about strategic defaults - where a homeowner, who can afford his mortgage, intentionally stops paying and either lets the bank foreclose or tries to negotiate a short sale.  The posts generated a lot of attention - a firestorm, really.  Some people thought that strategically defaulting could be a sound business decision for some people.  Others found it morally reprehensible.

Zillow.com estimates that 22% of all homeowners in the U.S. have negative equity.  In the Phoenix Metro area, 80% of homeowners with nonprime mortgages do.  The average amount of negative equity (among subprime and Alt-A borrowers) is $73,314.

Does it makes sense for those homeowners to continue to pay on their homes, or should they walk away?  I must sound like a broken record, but I have to say that I’m not advocating for strategic defaults; nor am I condemning them.  That said, there are a number of factors to consider when thinking about “walking away”:

1) How “upside down” are you?  One of my newest clients is trying to negotiate a short sale for her home, even though she can still afford her mortgage.  She lives outside of Phoenix where the bubble and bust were particularly dramatic.  She owes almost twice what her home is worth.  If we assume that the market will return to a normal rate of appreciation in the next few years, it would take her more than a decade to get out of the hole.

Contrast her situation to one of a North Scottsdale homeowner who owes just 5% more than his home is worth.  Again, assuming that the market will return to a normal rate of appreciation in the next few years, it shouldn’t take this homeowner more than a year or two to get right-side up again.

2) Do you have to move?  Even if you owe more on your home than its current market value, that’s all on paper - unless you need to sell today.  My new client, in addition to being way upside down, needs to move because her husband has a new job in Desert Ridge (which means a three hour commute every day right now).

If you don’t have to move - and you likely won’t have to move in the near future, staying put is probably the best thing to do.

3) Are you willing to accept the consequences of walking away?  Even if you are able to negotiate a short sale with the bank, you’ll feel the ramifications of your choice for several years.  First, if you’ve missed your mortgage payment in the run-up to the short sale, those late payment dings will hurt your credit score for 2 years.  If the bank forecloses, that black mark will stay on your credit for 7 years, and will probably prevent you from buying another home for at least 4 years.

Clearly, answering the question, “Should you continue to pay for a home where you owe more than it’s worth?” is tough - and it should be.  No matter your circumstances, a mortgage is a contract - a promise you made to the lender that, in exchange for the money to buy a home, you would repay that money as agreed.  Breaking that promise, while it may be the right decision for some people in some circumstances, shouldn’t be taken lightly.

What do you think?  Are there circumstances in which walking away is the right decision?  Click on the “Comments” link below and join the discussion!

A huge percentage of the existing home sales in the Phoenix area these days are foreclosures.  Some need heavy-duty repair work, others are practically move-in ready.  Some are in blighted inner-city neighborhoods.  Others are in master-planned communities with swimming pools, tennis courts and golf courses.

Wherever you look, whatever your price range, there are great deals to be found in foreclosed (often called bank-owned, or REO) homes right now.  But it will pay to know what you’re getting yourself into — to look before you leap, if you will.  Because the fact is that buying a home that has been repossessed by the bank is different — even if not completely dissimilar — from buying a home from the owners who are relocating, moving up, whatever.

When you buy a foreclosure, you’ll have to play by slightly different rules.  And, you’ll have to be even more vigilant about the inspection — unfortunately, foreclosed homes are often damaged but are nearly always sold by the bank “as is.”

So here are some tips to make your bank-owned home buying experience a great one:

1. There are a number of assistance programs designed to help homebuyers purchase foreclosed properties.  The last time I checked, programs were offered by the state, by Maricopa County and by the cities of Phoenix and Chandler.

2. A home auction can be a great way to find a foreclosed home at a good price.  But know that while the Arizona Department of Real Estate does require home-auction companies to have a real estate license, it doesn’t regulate the auction process itself, so even manipulative tactics are not illegal (though “frowned upon” by above-board auction companies, according to the Republic article).

If you’re thinking about bidding on a home at auction, consider these six tips first.  As I always say, Knowledge is Power!

• Auction Tip #1: Read the Rules

• Auction Tip #2: Do Your Homework First

• Auction Tip #3: Come With Financing

• Auction Tip #4: If It Looks Too Good To Be True, It Probably Is

• Auction Tip #5: Get Help

• Auction Tip #6: Caveat Emptor

3. Know your market. If you don’t already live where you plan to invest, make sure you get to know your investment market well - what neighborhoods you should stay away from, where great hidden deals might be, where the hottest new development is, etc.

4. Develop an investment strategy. Foreclosure investing is like any other type of real estate investing - develop a strategy for what you want to accomplish, the risks you are willing to take, and how long you plan to be investing and then stick to that strategy.

5. Develop your best practices. There are a lot of foreclosure buying techniques out there. Decide which is best for you, given your investment strategy.

6. Be a bit skeptical. Just because a home is in foreclosure doesn’t mean it’s automatically a good deal.

7. Ask for help. Foreclosure investing takes a lot of work. Invest in the help of a trustworthy team.

8. Make friends with mortgage lenders. Often, you’ll get the best deal if you can negotiate a good purchase price with the seller and get the lender to forgive a portion of the debt (the difference between the sales price and the loan balance, for example).

9. Move fast, but not too fast. You’ll need to act quickly once you find a foreclosure property that you want to buy - before other investors beat you to it. At the same time, you don’t want to be too rushed or you may make a decision you’ll regret later.

10. Know the law. There’s more legalese involved in a foreclosure transaction than in a traditional home sale.  Plus, foreclosure laws differ from state to state.  Read up on your state’s foreclosure laws and ask your real estate agent to recommend a good real estate attorney with experience helping people purchase foreclosed homes.  According to U.S. News, a detail as tiny as the wrong font size on your documents could hold up the transaction or — worse — land you in legal trouble.

What do you think?  Have you invested in foreclosure properties?  What’s your experience been?  Click on the “Comments” link below and join the discussion!

I blogged the week before last about strategic defaults — when a homeowner decides to default on a mortgage (typically through a short sale or by letting the bank foreclose) even though he can still pay the mortgage.  Typically, a homeowner does a strategic default because of negative equity — when the mortgage is more than the home’s market value.

On July 24, I talked about the recent academic paper citing that 26% of all mortgage defaults are strategic.  On July 27, I wrote about the nuts and bolts of a strategic default — include the process and its consequences.  Yesterday I had a long chat about it with my friend Matt Maret, a mortgage banker with Bell Mortgage.  It was fascinating to get a mortgage lender’s take on this trend toward “strategic” defaults.

Matt echoed the real estate attorney’s statement that Arizona’s anti-deficiency laws protect a homeowner’s other assets (besides the home) in the event of a default.  But Matt qualified that the anti-deficiency protection, as of September 1, will apply only to primary residences, not to second homes or investment properties.  (In other words, if the home is not a primary residence and the owner defaults, the bank can seize other assets, garnish wages, etc. to satisfy the balance owed.)

Matt also elaborated on one option I talked a bit about last week — the short sale.  He said that the FHA will lend to a person who has a short sale on record (even if it was yesterday) — as long as there are no late payments on the person’s credit (and that person is otherwise qualified, of course).

I have heard from clients that banks will reportedly not entertain the idea of a short sale if the homeowner is not in default.  Matt, though, said that all it takes is a good real estate agent to “help” the bank understand that the choice is 1) accept the short sale offer; or 2) foreclose on the property.  “The lender will always choose the short sale,” Matt said.  Why?  “Because they’re not going to be able to sell the home for more than market value anyway and they’ll accrue upwards of $50,000 in legal costs to foreclose.”

Even if the home is foreclosed, Matt said, a person could qualify for an FHA loan 2 years after the foreclosure.  And while FHA loans fell out of popularity during the real estate boom (because FHA didn’t allow “funny business” like no-document loans) they’re immensely popular now.  In fact, Matt said that 90% of all loans originated in Maricopa County now are FHA loans.  That’s in part because of tighter requirements for conventional loans and in part because the FHA will still make a loan with as little as 3.5% down (conventional lenders are now requiring at least 10%).

At the end of the day, Matt said that often the economics of a strategic default just make sense.  Moral considerations, that’s another story. . .

What do you think?  Have you thought about a “strategic default”?  Click on the “Comments” link below and join the discussion!

I have to say that I am not an attorney and none of the information I’ve presented here should be construed as legal advice.  If you have questions about foreclosure or “strategic defaults” or are thinking about defaulting on your mortgage, consult with a legal professional.

Last Friday I posted on the fact that 26% of all mortgage defaults are “strategic” — where the homeowner can afford the mortgage but chooses to walk away, most often because of negative equity (when the homeowner owes more on the mortgage than the home is worth).

I ended with the question “What can you do about it?”  To answer that question, and to get the inside scoop on the strategic default trend, I talked with a local real estate attorney.  Here’s what I learned:

Credit score implications

• Most mortgage lenders won’t lend to people who have had a foreclosure within the last 4 years; so if you do a “strategic default” plan on renting for 4 years.

• While you may be able to get a mortgage in 4 years, the foreclosure stays on your credit report for 7 years.

• Interestingly, it’s not the foreclosure or short sale that does the most damage to your credit report — it’s all the late payments you rack up as you move toward foreclosure or a short sale.

• Fortunately, those late payments will be off your credit report in 2 years.

Legal implications

• In Arizona, there are two “anti-deficiency” statutes that protect the homeowner’s wages and other assets from the bank.  In other words, if you default on your mortgage loan, the bank can take the collateral for that loan (the house) but has no other recourse.  Not every state has those anti-deficiency statutes.

• If you have a second mortgage, as long as it was used as “purchase money” — to buy the home (as in an 80/20 mortgage) — the bank cannot come after your wages or other assets if you default on that loan.

• If you default, the bank has two options: 1) it can sue you in court; or 2) it can foreclose through a trustee sale.  The second, as the cheaper and faster option, is the most common.

• If you decide to do a strategic default, you’ll probably have about 6 months from when you stop paying until the home is foreclosed. 10 months is not uncommon.  But the only time guarantee is that the bank is required to notify you 91 days in advance of the trustee sale (the date the home will actually be foreclosed).

Tax implications

• There is a “forgiveness of debt tax” but it doesn’t apply as long as you’ve lived in your home for at least 2 of the last 5 years and the mortgage was used entirely as “purchase money” — to buy the house.

• There is an additional form you’ll have to submit to the IRS.  Talk to your accountant.

Other options

• If you make the decision to do a “strategic default” you should be sure that you’re comfortable with foreclosure as a possible end result.  That said, there are some other options you could pursue with the lender.

• One alternative to foreclosure is a short sale.  You sell your home as you normally would, but the bank has to agree to the purchase price — which will be some amount less than what you owe on the home. The bank takes a loss on the difference between what you owe and the proceeds of the sale.

• A short sale will still be a negative mark on your credit, but not as negative as a foreclosure.

• In some cases, you could negotiate with the bank not to report the late payments (those payments you miss between the time you default on the loan and when the short sale goes through) to the credit bureaus.

• Another option is to negotiate down your mortgage principle.  If you’ve decided already that you’re willing to accept a foreclosure, if that’s the end result, you could call the bank and ask them to reduce the principle you owe on your mortgage to the market value (or close to).  If you no longer have negative equity (or as much negative equity), that should eliminate the reason you decided to do a “strategic default” in the first place.

I have to say that I am not an attorney and none of the information I’ve presented here should be construed as legal advice.  If you have questions about foreclosure or “strategic defaults” or are thinking about defaulting on your mortgage, consult with a legal professional.

What do you think?  Have you thought about a “strategic default”?  Click on the “Comments” link below and join the discussion!

It feels like I posted just yesterday on the topic of walking away from a mortgage, but I checked and it was in fact 2 weeks ago — how time flies!  Nevertheless, I’m not a fan of belaboring points, but this one just keeps rearing its head — in the blogosphere and in the mainstream news.  And since most Phoenicians are, in one way or another, affected by foreclosures, I thought it appropriate to address the issue again.

This time, I have a name for what I’ve been referring to as “walking away” — it’s apparently called a “strategic default” — at least according to the folks in the University of Chicago economics department.  Several professors there released a paper earlier this month revealing that a whopping 26% of all mortgage defaults are strategic — meaning the homeowners are defaulting even though they can afford to pay their mortgage.

The professors make some interesting points.  Among them:

• No household would default if the equity shortfall is less than 10% of the value of the house.  (Calculate the equity shortfall like this: house value - mortgage = equity shortfall.  So if a house is worth $165,000 and the mortgage is $181,500 then the equity is -$16,500, or 10% of the value of the house.)
• 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house.  (So if a house is worth $165,000 and the mortgage is $247,500 then the equity is -$82,500, or 50% of the value of the house.)
• People who know someone who defaulted are 82% more likely to declare their intention to do the same.  In other words, in communities where foreclosure rates are very high, strategic defaults are more likely.

In contrast to defaults that occur because the homeowner’s mortgage rate adjusts to an unaffordable level or because of an unexpected event like illness or job loss, strategic defaults are almost entirely due to negative equity — when a homeowner owes more on the mortgage than the home is worth.

Zillow.com estimates that 22% of all homeowners in the U.S. have negative equity.  In the Phoenix Metro area, 80% of homeowners with nonprime mortgages do.

But, as the professors point out, it’s not so much the fact of being underwater as it is the magnitude of the negative equity.  According to a study by the Federal Reserve Bank of New York, among nonprime borrowers (subprime and Alt-A) in Phoenix the average amount of negative equity is $73,314 (in other words, the average home is worth $73,314 less than the mortgage on that home).

In many areas of the Valley the equity shortfall approaches 100%.  For example, a friend of mine in Queen Creek owes $290,000 on her house that is now worth $150,000 — her equity shortfall as a % of her house value is 93%.

Okay, so those are the numbers.  What can you do about it?  Stay tuned for next week’s post The ABCs of “Strategic” Mortgage Defaults.

What do you think?  Do you know someone who has “strategically” defaulted? Click on the “Comments” link below and join the discussion!

The Associated Press reported today that the gap between the monthly mortgage payment on a median-priced home and the median monthly rent has shrunk from a $777 difference three years ago to $221 today (in other words, today, monthly rent payments are, on average, $221 less than monthly mortgage payments).

That phenomenon, which is owed primarily to rising home affordability (not rising rents), combined with the $8,000 first-time homebuyer tax incentive, the usual mortgage interest tax deductions, and relatively low prices make Phoenix-area homes look mighty enticing to would-be buyers.

As more and more first-time buyers enter the market, though, we’re once again seeing bidding wars on those properties that combine desirability with a low price tag.  Yesterday morning, in an article titled “Low-priced foreclosures incite bidding wars,” Arizona Republic columnist Jonathan Cooper talked about how low prices for bank-owned properties are sparking bidding wars.

“Experts say the environment is strikingly similar to what they saw at the height of the real estate bubble.  ‘This market is about as abnormal as the hypermarket that we came out of a few years ago,’ said Jay Butler, director of the Realty Studies program at Arizona State University.”

As buyers snap up properties, the inventory of unsold homes in Greater Phoenix has fallen dramatically.  Today, about 32,000 homes are on the market in Maricopa County — 30% fewer than in January.

What’s the message in all this?  Now may well be the time to buy — get in while the gettin’s good.  If you’re looking to buy a home or investment property in the Phoenix area, check out the must-read article, Six Steps That Will Save You Thousands on Your Next Home.  And check out my last blog posts on investing in short sales and foreclosures.

What do you think?  Is now the time to buy Phoenix real estate? Click on the “Comments” link below and join the discussion!

I’ve blogged before about whether walking away from your mortgage is okay.  It’s clearly an incredibly subjective question — what is one person’s smart move is another’s moral outrage.  The smart move/moral outrage debate has been raging in the blogosphere so it’s been on my mind lately.  It’s the first thing I thought about when I came across this old New York Times article, from last December:

A Holdout Against Developers Leaves a Legacy

Photo: New York Times

The article tells the story of this little old lady, Edith Macefield, who was 86 when she died last June.  When developers wanted to buy her home and property to develop it into an LA Fitness and Trader Joe’s, she said “No.”  They offered her $1 million for the tiny, 108-year-old house.  She still said “No.”

Some people suggest that she was making a statement — the last bastion against steel-and-concrete development in the old fishing village of Ballard, near Seattle.  Others say she just wanted to live in her house.  Either way, what a contrast she is to those who bought high in 2005 and are now paying mortgages on homes worth 20, 30, 40 or 50% less than what they paid and say, “Walking away sure sounds enticing.”

Financially, maybe walking away makes sense.  I don’t really know; that’s not my area of expertise.  I do know it’ll take a huge bite out of your credit score — making it very hard if not impossible to get credit at a good rate for at least seven years.

Certainly there are families who have been hit by a job loss or a medical emergency, who simply can’t afford to pay once-affordable mortgages.  There are families who simply messed up — who went willingly into mortgages they couldn’t really afford.  There are families who were duped by unscrupulous lenders into teaser mortgages they can no longer afford.  Sometimes, in other words, you simply can’t afford your home anymore.  In that case, I guess, you have to let it go.

But what about circumstances where a family really can afford the mortgage but hates paying for an asset that has lost so much of its value?  A family who bought at the peak with no money down in an area where price declines have been really steep might be paying double what they would pay to rent the same house.  Does it make sense to walk away then?

Maybe we should ask, “What would Edith Macefield do?”

What do you think?  Would you walk away from your mortgage?  What’s your opinion on people who do?  Click on the “Comments” link below and let me know!

Before last week, if you wanted to refinance under the government’s Making Home Affordable plan, you couldn’t owe more than 105 percent of your home’s current market value.  So a Phoenician who bought at the height of the market with 20 percent down or less and saw the value of their home decrease 35 percent, for example, wouldn’t have been able to refinance under the original plan.

But last week the U.S. Department of Housing and Urban Development extended the Home Affordable Refinance Program (HARP) to borrowers who owe up to 125 percent of their home’s market value.

How do you qualify?

• You can’t have missed a payment by more than 30 days during the past year

• The home must contain no more than four single-family units. That means certain small multifamily properties can qualify.

• Your mortgage must be owned or guaranteed by Fannie Mae or Freddie Mac (Fannie and Freddie loans constitute about 50 percent of outstanding mortgages in the U.S.).  The best way to find out if your loan is a Fannie or Freddie loan is to ask your lender (call the phone number on your mortgage statement).

• You can’t owe more than 125 percent of your home’s current appraised value.

If you think you might be eligible to refinance your mortgage under the Home Affordable Refinance Program, visit http://makinghomeaffordable.gov/refinance_eligibility.html and/or contact your loan servicer (the company you mail your monthly mortgage payment to).

For more details on the Home Affordable Refinance Program and the Making Home Affordable mortgage modification program, check out these blog posts:

• How the “Making Home Affordable” Plan Might Affect You

• Obama Expands Making Home Affordable

What do you think?  Click on the “Comments” link below and let me know!

I wrote a post earlier this year about the two-pronged mortgage relief plan created by the Obama administration.  One part of the plan is designed to help as many as five million homeowners who would like to refinance their mortgage.  The other part is designed to help three to four million homeowners modify their existing loans to make them more affordable.

But one of the criticisms of both parts of the plan was that they didn’t really help homeowners who are deeply underwater — owing much more on their mortgages than the current market value of their homes.  Last week, the Administration announced a third prong, designed to help those kinds of homeowners.

According to the press release issued by the Treasury department on May 14th, the Making Home Affordable (MHA) program now includes:

• Foreclosure Alternatives provide incentives for servicers and borrowers to pursue short sales and deeds-in-lieu (DIL) of foreclosure in cases where the borrower is generally eligible for a MHA modification but does not qualify or is unable to complete the process.

• Home Price Decline Protection Incentives will provide lenders additional incentives for modifications where home price declines have been most severe and lenders fear these declines may persist.

In a short sale, the homeowner sells the home for market value that’s less than the homeowner owes on the mortgage, and the lender forgives the difference between the sale amount and the amount owed.  When a homeowner is unable to make his mortgage payments, a short sale can often be in the lender’s best interest because it allows him to avoid the costly foreclosure process (for more details on short sales, see this blog post).

A deed-in-lieu of foreclosure is when the homeowner signs over the property title to the lender to satisfy the mortgage.  So the end result is the same as if the lender had foreclosed (the lender gets the title to the property) but without the added expense of foreclosure proceedings.

What do you think?   Click on the “Comments” link to join the discussion!

Last Wednesday on KJZZ, local real estate experts talked about whether the Phoenix-area real estate market is nearing, or at, the bottom.  One sign that we’re at the bottom — or at least that the downward trend is losing momentum — is the rising sales price per square foot of homes in the metro Phoenix area, according to fellow Realtor John Wake.  Plus, he added, in April more homes were sold in Phoenix than ever before.

ASU finance professor Tony Sanders was less optimistic that we’re at the bottom of the real estate downturn, but he did say that if job losses stabilize, and banks continue to do short sales and auction foreclosures to get real estate assets off their books, then we will see a turnaround sooner than later.

What that turnaround will look like is another question.

Let’s hope it looks like a V — a fast recovery.  An L would be the worst — that would mean the economy has set a new, lower level of economic growth.  Earlier this month the Arizona Republic detailed V-shaped and L-shaped recoveries, as well as U- and W-shaped turnarounds.

V: Fast recovery

“This is the most common type of recovery since World War II and the most preferred. It means the economy hits bottom and recovers fairly quickly.  Because of the large number of unsold homes, the number of unemployed people and the still-uncertain effects of toxic mortgages on bank finances, economists don’t expect V to be the shape this time.”

U: Slower recovery

“Economists generally believe this will be the shape of the recovery from the current recession. We could bump along the bottom for a while, perhaps into late 2009 or 2010. This also could be what is termed a ‘jobless recovery,’ because skittish businesses may be afraid to hire.  Scottsdale economist Elliott Pollack has even stretched out the bottom of the U, making it look more like a saucer.”

W: Double downturn

“Usually, recessions come several years apart. But, in the 1980s, the country experienced a W recovery, with recessions a year apart. The economy first suffered a six-month contraction from January to July 1980, and then, a year later, went into a 16-month recession from July 1981 to November 1982. They were prompted by a 1979 revolution in Iran that caused gas prices to skyrocket and then a series of Federal Reserve interest-rate increases that severely depressed home sales.”

L:  A new “normal”

“In an L-shaped recovery, the economy collapses sharply, similar to what happened in September, when the collapse of Lehman Brothers brought financial markets to their knees. Credit remains tight.  The L recovery brings no recovery. The country has to adapt to a ‘new normal.’  This is what happened to Japan in the 1990s, after an investment bubble burst.”

What do you think?   Are we at the bottom?  What will the recovery look like?  Click on the “Comments” link to join the discussion!