Shameless, Responsible, or Ignorant to Walk Away?

Over the last 3 years, 2.9 million homes have went into foreclosure.  For the point of this article, let’s assume that most of those foreclosures were executed over the last 2 years, which is the heart of the worse economic crisis we have seen in the U.S. since the Great Depression.  Today, the midpoint of 2009, we have seen some progress in how Congress is handling this financial crisis.  We have seen the Obama administration pass the stimulus package which was followed by the TARP (Troubled Asset Relief Program) Funds and an income tax credit of up to$8,500 to homeowners purchasing real estate this year.

Still, we are seeing real estate prices plummet to record lows.  Unemployment is now a leading indicator in determining the outcome of our housing crisis, an indicator getting worse, increasing the housing market pains.  Wall Street has layed off tens of thousands of brokers, and many other Americans have either been layed off, taken substantial paycuts, and are ultimately victims of higher cost of living.  Let me ask you this.  Five years ago, did you see broccoli selling for $3 per pound at your grocery store?  Did you see canned string beans for $1.50?  As I recall, this is about 30% higher than what it was just a few years back.

Let’s get to the point.  You are a homeowner in the midst of seeing your home value plummet, have no hopes of refinancing in the forseeable future, but see record low mortgage rates today?  Are you tempted to just walk away from you house that you are 30-50% upside down in?  Many of you say no, because you want to be the “responsible homeowner” and feel obligated to pay your mortgage every month on time, despite the fact that you still have a job, make a decent living, and can support your family.  God forbid you have to tell your neighbor that you are just giving up your house!

Well join the club.  You are one of millions of Americans reeling with this decision and as much as you want to just throw your house away, you are ashamed to bruise your ego, credit,  immediate credit availability, and contribute to the growing number of foreclosures across the country.

Since the early 2000′s, Wall Street was making gazillions of dollars investing in mortgage backed securities.  This was mostly due to the subprime lending practices which evolved into predatory lending practices.  Just so you know, if there was no such thing as “subprime”, we wouldn’t be even close to where we are economically today.  Easy lending guidelines made it easy for mortgage loan officers to inflate incomes, fooling underwriting that you could actually pay for this mortgage just so people could buy the house they felt would not only be the house of their dreams, but also a lifetime investment.  Sound familiar yet?

Fast forward to today again, where most homeowners are underwater, some as much as 50%.  I have a friend in Cape Coral, Florida.  He bought his house at the peak for $300,000.  He is a fireman and makes about $50,000 per year.  Out of his monthly $4,000 +/- paycheck, he owes about $2,500 for his mortgage, taxes, and insurance.  This leaves him with $2,000 per month to pay for his other bills and expendable savings.  Let’s assume he lives cheap and his necessities ie. car payment, utilities, cable, internet, groceries, credit cards total $1,000 per month.  After all of this is paid, he now has $250 per week in expendable income to do as he pleases.  Good enough for some weekend partying, happy hours, but not near enough to take a nice Caribbean vacation, even if he saved all of his money for 2 months.  No happy hour?  That’s torture.

I am going to let your mind determine where I am going here.  Just for the record, I do not favor walking away from your home.  Foreclosure is the last option, an option that no responsible homeowner would ever choose, however it doesn’t need to be a shameful and life ruining experience.  Today, we are looking out for ourselves, our family, and trying to make one of the biggest ”Business Decision” of our lives.  See below for some reality.

In 2005, you purchased a home for $300,000 that is now worth $150,000.

On a $300,000 purchase, chances are in 2005 you put a down payment of 10%, leaving you with roughly a $270,000 loan principal amount.  Let’s assume your interest rate was 6% and your mortgage was locked as a 30 year fixed.

• Your monthly mortgage including property taxes and insurance runs $2,500
• Assuming you live in your house for 30 years, your 360 total payments tally up to a mind blowing $728,176.  I say 30 years just for the sake of conversation, although many homeowners don’t stay in their home that long.
• Let’s assume you can sell and break even in 15 years.  Your remaining balance on your loan is $187,144.  In 15 years, if you sell, assuming closing costs, including realtor sales commission total 7%, you are selling at a LOSS.  IN 15 YEARS!

Let’s assume you make the business / family / life decision to walk away from your home to start all over.  Let’s also assume that your girlfriend, boyfriend, or current spouse is not affected from any decision to foreclose. You can read my Rent vs. Buy article HERE.   Your current home is a black hole and you don’t know if your value will ever get back to peak prices.  A similar home in your area is now on the market for $160,000 in a short sale, and your realtor believes you can buy for $150,000.  Let’s look at the new numbers, based on a purchase price of $150,000 still based on a 30 year fixed and an interest rate of 6% to be fair even though today, you can get rates as low as 5%.  I will also base my new numbers on FHA financing which requires only 3.5% down payment, however an extra mortgage insurance premium of $70 per month.  This would likely be the most popular finance product for someone capable of purchasing after a foreclosure (through spouse, live-in bf/gf/roommate.

• Monthly Mortgage including property taxes and insurance is $1,570
• Assuming you stay in this home for 30 years, your 360 total payments tally $431,588
• Assuming in 15 years, you decide to sell, your loan payoff is going to be roughly $100,000.

If you are in my friends’ situation, who has a fiance not on his current mortgage, this difference will save you about $1,000 per month,  nearly $175,000 over 15 years, and if you live in your home for the full 30 year loan term, it will save you nearly $300,000.

If you took the time to read this entire article, I intentially referenced YOU as opposed to third person.  Maybe you are in this position.  Maybe you aren’t.  The bottom line is that today, your prized possession is your home.  What are you going to do with it?  Be smart and talk to a professional.

The value and price example made above is a real comparison to an experience a real friend is having.  Not all homeowners are in this substantial negative equity position and not all homeowners have the option to purchase through family.  There are many examples of how the crisis is panning out for people.  This is just one of many.  Be sure to understand the difference between foreclosure and short sale.

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