At what point would you walk away from your house?
 

I was shootin' it with a neighbor last week who told me how crushed he was on one of his investment properties. He's not a flipper. I think he bought each house, lived in it a while and then rented it out. He has at least three now, I think four. One of them was on a 3/1 ARM with HSBC. His payment went from $2600 to over $4000 on the first adjustment period, and I suspect that's even with a drop in prop. taxes. This was not some exotic teaser ARM, but rather I think a LIBOR. So now, despite his down payment, he's almost upside down on the house and can't raise the rent. So he's around $1600 a month negative. He tried to get HSBC to work with him, either freeze the rate or refi at 100% LTV. They said no dice. He's actually thinking of mailing in the keys. He already has other houses, so he has options for where he wants to live. And it's not even that he wants to stop paying because the value has dropped. He simply cannot refinance, despite perfect credit and there's no end in sight for his neg. monthly cash flow.

This got me thinking. My ARM adjusts in Nov. '09, my margin is 2.25% and tied to 1 yr. LIBOR, capped at 9.25% on the first adj. period. My rate is now 4.375%, so no way can I justify refinancing, even if I could find a loan at my current LTV due to drop in value. If LIBOR doesn't move too much before my adjustment period, the new payment won't be too bad, so I should be ok. But geeze, don't banks want to work with people who could just walk away or keep paying what they've been paying? Seems to me it'd be better to get 80% of something than 100% of nothing.

Every morning when I go to work...

I suppose if I couldn't make the payments and was going to get kicked out anyway. Other than that, I think you stay and make good on your contract. I have no sympathy whatsoever for the idiots that bought expecting to be bailed out of lousy terms by endless double-digit appreciations. They deserve exactly what they get.

Simply walking away and defaulting on a contractual obligation because it becomes inconvenient for you (i.e. "you can't make a huge profit short-term") is in no way a justification to walk away. I think you only walk away if you are seriously defaulting and foreclosure is inevitable otherwise anyway.

I think everyone who gets an ARM plans on refinancing or selling before it adjusts. If you've made your payements on time and kept your credit good, then refinancing shouldn't be a problem, right? But when you put 20% down, then the value drops by that much and 100% loans disappear, you're in a world of hurt.

Remember, there are always two sides to the story. You haven't seen this guys credit score or his investment portfolio. If you have a good down payment and excellent credit, you still can get a loan today.

That said, stopping to pay may get the banks to be more negotiable.

One thing I see happen around me is people walking away from their home even though a short sale would have left them with only very little debt. Say 25% of their annual income. This is short term thinking - maybe the same type that got them in trouble in the first place?

Cheers,

George

The ARM you are talking about is some funny loan where the rate was artificially low in the beginning and then kicked up after x years. If you do not refi before x, you are screwed. However, there is the traditional ARM which can be okay long term:

A traditional ARM actually "adjusts" to a tied interest rate, i.e. the 10 year treasury bill. In addition these loans usually limit the possible adjustments both annually and with an overall cap. I used to have an ARM like that and it would be around 5.5 percent APR currently. (If I would have not refinanced into a fixed rate long time ago, because the adjustability of my monthly mortgage payment had me a little uneasy. ;))


George

The reason you refi now even though you have 4.375% as your rate now is because rates are low on fixed mortgages. You KNOW that your rate is going up for the long term.

If you refi now you might be able to get as low as 5.25% (unless you are a jumbo) which means you don't have to worry about that 9.25% cap ever again. Historically speaking 5.25% is a damn good rate, we got it on our fixed 4 years ago when we bought (they were pushing an ARM at us). We also put enough down to be able to handle the decline we're expecting. Granted in the short term we will probably see a negative flux. We saw our house appreciate to just shy of $1 million over the last 4 years. Which is about a 90% increase in what we originally paid.

Seriously - I've been to my house - it isn't worth $1 million.

Still, with the way we bought the house even if we had to sell it at a 20% loss we would still be able to walk away honestly.

But also since we bought the way we did we probably don't have to worry too much about that; While we do expect to loose some value in the short term - the long term we will see some gain. It'll be another 10 years before I really want to think about buying another house so we've got 10 years to recover.

Well, I will take a stab at it, my approach may be totally wrong but just the process of debunking me may help you think it through and decide.

1yr LIBOR has been as low as 1.3% and as high as 7.4% in the past decade. 1yr LIBOR tends to move with 1yr Treasury, although admittedly the spread is high right now due to credit market turmoil. 1yr Treasury is low right now, 2%, due to Fed rate cuts and flight to safety. 1yr Treasury has been as low as 1.0% and as high as 6.3% in the past decade.

If 1yr LIBOR went to its lowest rate in the past decade, and your loan adjusted, your rate would be 3.55% ( = 1.3% + 2.25%). If I understood you right. If 1yr LIBOR went to its highest rate in the past decade, your rate would be 9.65%. Thats a range of potential post-adjustment rates of 3.55% to 9.65%, based on a 10-year history of 1yr LIBOR. The middle of that range is 6.6%.

If you had no insight into what rates will do in the future, no basis for making a bet, then you might guess that on Nov '09 1yr LIBOR is most likely to be somewhere in the middle of that range, with some but not a high chance of being at either extreme. Implying your post-adjustment rate is most likely to be somewhere around 6.6%, with some but not high chance of being closer to the extremes of 3.55% or 9.65%.

In that case, if you can refinance now at a fixed rate of 6.6% or lower, you might consider that the better choice.

How to make the thinking better? You could look at historical LIBOR and figure out more precisely the probability of different levels. Here is a source for monthly rate back to 1988. http://www.moneycafe.com/library/libor.htm You might find that simply taking the mid-point of the two extremes is misleading, maybe the average LIBOR rate is actually higher or lower. And you might find that LIBOR is more or less normally distributed and then look at 1 and 2 standard deviation levels. That might help refine your estimate of where LIBOR is most likely to be, simply from a statistical approach.

You could also look at LIBOR over economic cycles, and then if you have a view on what the economy will look like in late '09, you might be willing to modify your bet on LIBOR, from merely a statistical one. For example, LIBOR tends to be high when the economy is strong and low when the economy is weak, much like 1yr Treasury. So, if you think we are entering a recession now, and if you think that recession will be over and the economy growing again by Nov '09, then you might want to move your bet higher. If you think the contrary, you might move your bet lower.

And, of course, you have to decide how much the certainty of a fixed rate is worth, the cost of refinancing, your willingness to walk away if the rate resets to an unaffordable level, and - very important - your view on whether the condo's value will be higher or lower by late 2009, and the cash flow implications of renting it. Since you're moving to PHX, I assume your interest in the condo is now purely as an investment property - the roof-over-head aspect is gone.

I realize that fixed rates are pretty good now and, even if they're a point higher than my ARM currently, it'd still be a good deal. But since I put 20% down and my value has dropped a lot, I'd need a >90% LTV loan. Maybe the values will pick back up before my ARM adjusts. Other than going FHA, I'm not even sure high LTV loans are available anymore without huge headaches and/or PMI. To make things worse, I'm moving in less than two weeks, which will technically mean my house is an investment property and then much, much more difficult to refi.

Anyone who has an ARM of ANY kind should REFI like yesterday, thats it in a NUT shell.

Todd :)

Hmmm, So I guess the rate of 2.5% for 10 years is not that bad then :)
Fixed rate for 35 years is 3.1% ...

It's a shame that the place I'm looking at will probably keep loose 50% of it's value during those 35 years :( :( But then again that is the whole market on this island for housing :rolleyes:

The good pooint of the place is that the build quality is better than 70% of the other places in the neighborhood and if look at selling pre-April I'll be able to dump the place.
And ...
Rent might just be only a few Andrews off from mortage payment ... means I'll have to pray the roof and what not don't go to pot in the mean time.

no more flippers in this country for the moment ...

Answer, I wouldn't get into a situation where I would have it consider it but if it ever happened, I would never walk away. I would make payments as long as it was physically possible and would not miss a payment if i had money to pay.

Your friend signed legal binding contracts to pay back the money he borrowed and that is exactly what he should do, no matter what.
Walking away is just a legal punk out, a way to get out of facing up to your responsibilities.

What is the acronym LIBOR? And why do so many otherwise literate people spell lose as "loose"??

I agree, but it's not like he was a subprimer or a flipper. He put X% down, lived in the place and then rented it out a few years later. Even before the bubble was obvious, no one ever thought they'd be upside down on a house they put money down on and so then would be unable to refi. I think the worst thing about this situation is that the bank won't negotiate with my neighbor unless he starts missing payments. They don't seem to take someone seriously if they have perfect credit and have never missed a payment, but then call in to ask for some kind of deal. Once you're 90 days behind or so, it seems the bank gets willing to negotiate. Obviously, you have hurt your own credit score to start playing this game. But I'd think banks would be more pragmatic, especially when they have someone they know can and will pay if they cut a deal, as opposed to having that person just mail in the keys.

LIBOR is London Interbank Offered Rate

Can't he (your friend) sell the house whose rent won't cover the mortgage?

I wouldn't think banks would be eager to restructure the mortgage on an investment property, because if the house value declines further, the investor could well just walk anyway.

I dunno if he can sell it for what he owes on it now, probably not if he has to pay a realtor for the effort.

I was thinking, HSBC probably knows your friend owns other houses, and that he is thus not without assets. That perhaps makes them more disinterested in cutting a deal. May depend on whether mortgages are recourse in VA?

Anyway, he might have to accept that he made a bad investment and take a loss. It happens.

He might also have to evaluate his other houses, and whether he should take profits (hopefully) on them now and get his cash out, live to fight another day. I note that our resident RE investors here, motion and jurgen, haven't been shy about selling their houses.

He's got to make a call on RE prices and his cash flow.

BTW, I disagree w/ those who say that walking away is verboten. We've discussed that topic before.

For you - my personal, gut feeling - is that if you can refi to a fixed now, and still cover the mortgage with rent, you should really consider it. My guess is that if by Nov 09 the economy is recovering, then LIBOR will be higher and the adjustment will be worse than a fixed rate today. If the economy is still bad by then, then LIBOR might still be low, but who knows what the condo will be worth after 1.5 years of recession. Just my 2 cents worth, or since I don't know much about your specific situation, then probably 0.2 cents worth but something to think about.

A home mortgage is a secured loan. The lender made an informed decision to loan X amount against a real asset. If the lender made a bad decision, tough luck.

Any real estate purchase is a business decision.

If a business owner fails, and "walks away", not a judgmental word is uttered by anyone. (screw the commercial property owner whose lease agreement is defaulted upon, screw the suppliers who extended credit to the business owner and is left with no recourse, and screw the customer who is left with no warranty on good/services purchased...)

its business. nothing more, nothing less.

People that walk away from their mortgages should have all their possessions taken away and be thrown in debtor's prison. :)