Underwater Rental Property - Hold or Fold?

18 Replies

Hello BP! Several years ago, a 22 year old me (and my wife) with a baby on the way decided to purchase our first property (with little to no money OR real estate experience). We purchased this home mid 2006. Fast forward to two years ago...We moved into a SFH due to the arrival of my second child. The townhome is upside down in a major way and we are losing some serious cash on it monthly (especially now since our first and only tenants just vacated the rental). My question is do we hold onto the property and wait for the market to pick up or should we fold on the home and try and get out of it?

Here is some background info on the Loan:

  • Loan Type: VHDA - Rural Development
  • purchase price: $286,008.00
  • balance left: $251,121.00
  • loan rate: 5.75%
  • Zestimate: $162,329.00
  • underwater: $88,792.00
  • mortgage: $1,850.00
  • taxes (2013): $1,278.00
  • SQFT: 1700

And some background info on Rent:

  • rent: $1,395.00
  • Property Manager: 10% of rent per month
  • Take home Rent: $1,255.50
  • monthly loss (tenant): -$455.00
  • yearly loss (tenant): -$5,460.00
  • monthly loss (no tenant): $1,395.00
  • yearly loss (no tenant): $16,680.00

Option 1 - Hold

Im tempted to keep the home because the homes in that location tend to rent very well and the home is still in very good condition. Another reason to hold is the tax situation. The benefits would still be there but I would assume most of that is being eaten away by my negative cash flow. With the Mortgage Forgiveness Debt Relief Act off the shelf id be liable for the forgiven debt if I were to successfully conduct a short sale.

My wife and I both work, so with some new lifestyle modifications, we have been able to afford to keep making payments (even with no tenants). If I keep the home, I would do my best to try and pay down on the loan primarily through wholesaling/flipping so that I could attempt to refi and drop the mortgage payment.

Option 2 - Fold

Ive thought about walking away because I believe the money we would free up could help drop some debt we have elsewhere (small amount of CC debt and student loans) or with saving up for our future REI adventures we have been planning.

One of the major issues I have with this option is I'm not 100% sure how this would affect the building of our REI business in the future. The home is in my name only so my wife wouldn't be affected by a short sale. However, I was looking to partner with my father this summer on some deals. If we moved forward with a short sale, how would that affect those proceedings?

Part of me sees the negative cash flow and thinks this property has to go. But the other part can see the value in having this unit (with the right financing). I just wanted to put this out and hear from others who may have run across this situation previously. Thanks for any advice you offer up.

Thanks,

Jermaine

First you have to decide what is important for you. If you were my client I would suggest you strongly consider a short sale. There will be a credit hit and possibly an income tax event for the debt forgiveness. Eighty thousand dollars is a lot of loss to eat. Almost enough to put one of your children through a decent college for 4 years.

On the other hand there are your personal feelings. I have a personal thing about paying my debts. It took me years to pay off the cost of my children's births because we had no insurance and there were some complications. Everyone got paid but some took many years to get it all. It was the right thing for me, but is not the same for everyone.

The good thing is that you have a choice on whether or not to stick it out. Not everyone has that choice and are forced into giving up the land. Good luck

@Kwambe H.

In your calculation, don't forget that you're paying off some principal every month, even though you're losing cash flow.. so you'll be getting closer to even equity over time.. especially if there's any increases in the market (but not sure about your area..)

Can you afford it now? Have you tried any of the gov't programs to refi? Are rents going up? Down? Can you see the light at the end of the tunnel?

Tough situation, but it may very well affect your ability to get financing on deals at least in the near future.. Some banks understand. But they view it differently if you got overleveraged and don't have the ABILITY to pay now. They view it differently if you're able to pay, and you decide to walk...

Be careful if you have a worthless second also, b/c they may come after you.. (see one-action rule in your state if any..)

@Bill Gulley , I don't see much residential stuff, but have you encountered these situations from the other side of the table much, and do you recommend to never walk, even if you think it's better for your family/kids?

TOugh call! Good luck!

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Jermaine, I can't really say based on the information but I can tell you this:

If I were the banker or even a broker, I'd find some reason not to make a loan to someone who walked away. I would never be the first lender to a walk away, even if it were ten years ago. I wouldn't care about things dropping off a credit report because it is the greatest borrower sin to me. I'd do a short sale, I'd do a bankruptcy and take a borrower who had other serious credit issues, but walking away when there are other options just smacks me with gross irresponsibility, why would I contract with someone who has demonstrated that they don't care about contractual obligations?

Jerry has given very good advice, look into a short sale, if you don't have the ability to pay.

If you do have the ability to pay and you want to move, the rental option would be best for your future ability to be in RE in the future. Man up. Get another property since your credit is good, generate more income to subsidize the looser property, some day it should change.

Now, as J Martin pointed out; you're 22, wow, I'm impressed you're even in your situation with your home, most "kids" can't get into a 5 figure home, much less a 6 figure home. You are another generation from those of us here giving advice, our outlook goes more to responsibility. You might find some 28 year old loan officer who would take a totally different attitude than mine. (Understand his boss won't be 28, those with ultimate loan approval could be much older and think like I do). You might find another lender, I think it would be very tough to convince a lender that you would uphold your obligation after walking away from another.

We all make financial mistakes, it's how we own up to what we might do wrong that defines us. I bought a big boat that barely hit the water, terrible purchase, a whole in the water in which you pour money!

I'd say this is as much about character as it is about money, you can't buy integrity. :)

drop the property manager or find a cheaper one if your going to hold it.

Seeing as its a mortgage taken at the height of the fraud by most lenders you should know that they have sold your home several times and been paid handsomely for it. Google "pooling agreements and securitzation of loans". Then they reached into our tax payers pockets and got a bail out. Search "tarp". Then if you default they have insurance to pay for their losses not to mention the tax break they get as well. If they foreclose they will take the home and sell it thereby getting paid AGAIN for their fraud. So if you are in a position where you cant make the payment amd decide to short sale, chpt 13, chpt 11 or just walk. Then you have to see it as a business transaction and nevermind all the guilt mongering ANYONE is going to lay on you. Especially in a forum. Lol

Then be truethful with your father if he asks what happened. He's dad.

Not a plan or advice just my 2cents

Originally posted by @Clinton Holmes :
Have you thought about some sort of rent to own or owner financing to try and get the negative cashflow to zero?
Just an idea Clinton

Passing the buck in this situation is not going to be a solution. First rule of seller financing: Financing does not add value to any property.

To go there to bring this to zero would really be getting involved in predatory lending and dealing, might search those issues, or better, just don't get involved in such things. :)

zestimate is pointless to use. They have a 20% +/- window on their things. Look at other comps/recently sold to get a better ball park. Have you looked at re-finacing it? may be more intially but dropping from 6% intrest to 4% might help you a little and shave off some of the monthly loss. Now instead of $400 /month you could be only missing on $300, a new property mgmt that only takes 7% could save you a few extra dollars, and rent increase? Are you below market? is the market improving? Rent going up? Demand going up and supply is decreasing?

All good comments. I would also consider calling your lender to see if you qualify for a streamline refi and try to get your interest rate closer to 4%.

Originally posted by @Bill Gulley :
Originally posted by @Clinton Holmes :
Have you thought about some sort of rent to own or owner financing to try and get the negative cashflow to zero?
Just an idea Clinton

Passing the buck in this situation is not going to be a solution. First rule of seller financing: Financing does not add value to any property.

To go there to bring this to zero would really be getting involved in predatory lending and dealing, might search those issues, or better, just don't get involved in such things. :)

Bill,

In regards to "financing does not add value to any property.." I don't think the Fed would agree. The crazy low rates push people into financing, and lenders stretching to get the yield has definitely helped the housing market and prices. On a more individual level, I don't think FNMA/Homepath would agree either.

In my area, Homepath homes regularly sell for 10-20% above the market, because they come with 5% down for owner-occ, and NO appraisal.. It just sounds like they have a legal way to do it, because they are a GSE.. I wouldn't mind paying above market either for a good seller carryback on something I liked..

Originally posted by @J Martin:
Originally posted by @Bill Gulley:
Originally posted by @Clinton Holmes :
Have you thought about some sort of rent to own or owner financing to try and get the negative cashflow to zero?
Just an idea Clinton

Passing the buck in this situation is not going to be a solution. First rule of seller financing: Financing does not add value to any property.

To go there to bring this to zero would really be getting involved in predatory lending and dealing, might search those issues, or better, just don't get involved in such things. :)

Bill,

In regards to "financing does not add value to any property.." I don't think the Fed would agree. The crazy low rates push people into financing, and lenders stretching to get the yield has definitely helped the housing market and prices. On a more individual level, I don't think FNMA/Homepath would agree either.

In my area, Homepath homes regularly sell for 10-20% above the market, because they come with 5% down for owner-occ, and NO appraisal.. It just sounds like they have a legal way to do it, because they are a GSE.. I wouldn't mind paying above market either for a good seller carryback on something I liked..

Yes, the street rate and bond rate certainly influence the market value of all properties, when I'm saying financing does not add value I'm saying one loan product or source of financing a specific property does not increase the value of the property. Now, in the old days when we had assumable FHA and VA, some properties were selling a bit higher to obtain that existing loan, however the difference was pretty much restrained by the cost of alternative financing, so that is not significant. We've been over the economic value of seller financing with respect to alternative choices, like 3%, but not 10/15/20% as some seem to think they can get simply because they can talk a buyer into the deal.

And, paying more is certainly fine, when the buyer is aware he's paying a premium, just don't finance the premium, that's a clear issue.

Secret be know, I've bough properties at a premium as to what the seller was asking, but my plans were usually changing use or carry it with more utility which still was a better deal for me, I don't have to disclose that I'm turning some house into an insurance office. :)

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I totally agree with @Bill Gulley about not walking away if you can afford it. If I was in your shoes I would see it as "I have -400 in cash flow a month". Bill's idea of subsidizing the loan w/ other cash flow from rentals and other profit from REI ventures is spot on. I'm pretty sure if you can continue to make payments your credit score will not be hit (perhaps it will go up) and not to mention that the debt will eventually paid off w/ a free and clear property. It will also act as a self-confidence booster (at least for me) to know that you're a problem solver and that you've offset your debt by jumpstarting your REI business. After you've increased your rental cash flow from REIs to offset loses (you're at zero here), you can continue from their to grow your business!

Nobody wants to loan to someone who just walked and ESPECIALLY to an investor!

In summary find a creative solution, keep your credit intact, pay down the property, jump start your REI business from there and succeed!

That's my best man... Wish you the best!

~ John

Originally posted by @Jerry W. :
First you have to decide what is important for you. If you were my client I would suggest you strongly consider a short sale. There will be a credit hit and possibly an income tax event for the debt forgiveness. Eighty thousand dollars is a lot of loss to eat. Almost enough to put one of your children through a decent college for 4 years.

On the other hand there are your personal feelings. I have a personal thing about paying my debts. It took me years to pay off the cost of my children's births because we had no insurance and there were some complications. Everyone got paid but some took many years to get it all. It was the right thing for me, but is not the same for everyone.

The good thing is that you have a choice on whether or not to stick it out. Not everyone has that choice and are forced into giving up the land. Good luck

Thanks for the feedback! I think a short sale is definitely still on the table at this point. There is a ton of money going into this house that I just won't ever see again. I still have a lot of info I need to grab to see if it makes sense (like exactly what my tax liability would be) but I have not ruled it out. With regards to my personal feelings about the deal, I too believe all debts should be paid, and have felt that way most of my life. Especially when doing so is within my means. That feeling is at constant battle with my developing entrepreneurial mindset which is leaning towards cutting the loses, learning from my mistake, and applying what I've learned to the next one. I'm not sure which side will prevail, but I know what I'm losing monetarily I'm gaining in personal growth.

Originally posted by @J. Martin :
@Kwambe H.
In your calculation, don't forget that you're paying off some principal every month, even though you're losing cash flow.. so you'll be getting closer to even equity over time.. especially if there's any increases in the market (but not sure about your area..)
Can you afford it now? Have you tried any of the gov't programs to refi? Are rents going up? Down? Can you see the light at the end of the tunnel?
Tough situation, but it may very well affect your ability to get financing on deals at least in the near future.. Some banks understand. But they view it differently if you got overleveraged and don't have the ABILITY to pay now. They view it differently if you're able to pay, and you decide to walk...

Be careful if you have a worthless second also, b/c they may come after you.. (see one-action rule in your state if any..)

@Bill Gulley , I don't see much residential stuff, but have you encountered these situations from the other side of the table much, and do you recommend to never walk, even if you think it's better for your family/kids?

TOugh call! Good luck!

Is walking away and going through a short sale the same? I assumed it was, but if not then I may have come off wrong. To clarify, I plan to either hold the rental until I can refinance the current loan or work with my lender and get a short sale. I dont plan to ever stop paying the mortgage unless its through the approved short sale process my lender has established.

The principle is helping. When we were looking for homes back then, getting a 30 yr fixed mortgage was the only requirement I had at the time. No ARMs...no interest only...fixed.

I just looked over my amortization schedule again and I should reach what Zillow has the home listed at 1 Sept 2025 (just in time for my 43rd bday :-)). That doesn't take into account market fluctuations as you mentioned so im hoping (at the very least) the market and I can meet somewhere in the middle.

Ive tried looking into HARP but that’s only for freddie and fannie backed loans. I plan to call my lender and see what type of refi i may be able to get. Most of the ones I looked into had an owner occupied stipulation, but we shall see! Thanks for the great feedback J. Martin !!

Originally posted by @John E. :
I totally agree with Bill Gulley about not walking away if you can afford it. If I was in your shoes I would see it as "I have -400 in cash flow a month". Bill's idea of subsidizing the loan w/ other cash flow from rentals and other profit from REI ventures is spot on. I'm pretty sure if you can continue to make payments your credit score will not be hit (perhaps it will go up) and not to mention that the debt will eventually paid off w/ a free and clear property. It will also act as a self-confidence booster (at least for me) to know that you're a problem solver and that you've offset your debt by jumpstarting your REI business. After you've increased your rental cash flow from REIs to offset loses (you're at zero here), you can continue from their to grow your business!
Nobody wants to loan to someone who just walked and ESPECIALLY to an investor! In summary find a creative solution, keep your credit intact, pay down the property, jump start your REI business from there and succeed!

That's my best man... Wish you the best!

~ John

Thanks for your response John E. . The more I learn about the various ways to make money within REI, the more comfortable I am coming to terms with holding the property. Thanks again!

Originally posted by @Rocky V. :
All good comments. I would also consider calling your lender to see if you qualify for a streamline refi and try to get your interest rate closer to 4%.

Thanks Rocky V. I plan to call them tomorrow!

Originally posted by @Andy Robison :
zestimate is pointless to use. They have a 20% +/- window on their things. Look at other comps/recently sold to get a better ball park. Have you looked at re-finacing it? may be more intially but dropping from 6% intrest to 4% might help you a little and shave off some of the monthly loss. Now instead of $400 /month you could be only missing on $300, a new property mgmt that only takes 7% could save you a few extra dollars, and rent increase? Are you below market? is the market improving? Rent going up? Demand going up and supply is decreasing?

@Andy Robison As I understand it, to view comps outside of sites like zillow or realtor.com, I need to have access to the MLS. If this is in fact true, I don't have access to MLS at the moment. I plan to talk to the real estate agent I want to use for my business this weekend, so perhaps he can assist with pulling these.

The VHDA has a streamline refi available, however its for owner occupied units (according to their website). I will call them tomorrow to see what options I have.

According to rentometer, we are about $50 above the median rent for our local area and about $70 below the 80th percentile. Sounds like theres some room for improvement there as well. Im hoping to get rid of property management all together but I still have a bunch to learn. Not to mention my wife and I both work so times can be tight occasionally. Its definitely on the todo list.

Thanks for the feedback!