My wife and I purchased a home 7 years ago (at the high point of our market). We still owe more on the home than it is worth. We are considering moving and I am trying to analyze each option. My 2 options are (1) sell our current house at a loss and buy a new one or (2) turn our current property into a rental property (which we would be renting at a loss) and buy a new house. Here is the info.
Option 1 - sell now:
Since we will be selling at a loss, this would require us to pay about $30k at close, which reduces our savings for the down payment on the new house.
Option 2 - rent: As stated above the rent will not cover our expenses on the property, we will have about a $10,000 loss per year on the rental. To analyze this option, I looked at if we sold the house 5 years down the road and then 10 years. I assumed a 3% appreciation of the current house value.
With those assumptions I calculate:
After 5 years=$14,000 loss on sale
After 10 years=$19,000 profit on sale
I know that in general investors do not hold a rental property that does not cash flow, so maybe the answer is cut my losses now. The downside of that is that we lose $30k that we could be putting into a down payment on the new house. Any advice is appreciated.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
12y
OK, I will comment.
Stay put.
Only a desperate or foolish person would sell a property subject to. It does not sound to me like that describes you, @Jeremiah O When you do that you give up all control of the property but retain responsibility for the loan.
Are you willing to do the property management yourself? If so, you need rent of about 1.5 x the P&I (just principal and interest, not the full PITI) part of your payment. If you're not willing to deal with a tenant (and that means doing an eviction and kicking a family to the street if they don't pay, toilets are easy) then you need rent of 2x the P&I. If you're short of those number, that's your loss.
IMHO a house you live in is just an expensive doo-dad. Like a car or a boat. Unfortunately there's a whole industry that tries to convince people that its an investment. As you've found, its not. Its just an expense. Now, lots of people got lucky and bought and sold at the right time and made some money. Lots of others, like you, are stuck upside down. Sounds a lot like buying a car, doesn't it? I've bought and sold several residences and never made a dime on any of them and took loses on one.
There's no easy way out. The least painful thing is to just stick it out. Cut expenses (you'll have to anyway in order to buy a new house and support a loser rental) and save as much as you can as fast as you can to escape your hole.
Realize that if you do buy a new house and rent this one the rental income will not be counted in qualifying for the new loan. You will have to have enough regular income to support both the new house and the old one. Lenders are wise to the "jump and dump" process where someone buys a new house then lets the old one fall into foreclosure. So they want to be sure you can afford both of these liabilities.
Yes, selling with an agent will cost you 8-11% in costs - 6% commissions, 2% for closing costs (mostly title insurance) and 0-3% in seller concessions depending on your market. If you do a FSBO you will save 3% of that amount - the commission you would pay to the listing agent. If you refuse to pay a commission to the buyer's agent you will greatly reduce your pool of buyers. So, you're really stuck with playing this game (set up by the same folks who told you a house was your biggest investment, what a surprise) and paying these costs.
All these other options - lease/option, wrap mortgage, subject to, etc are risky. And don't immediately help your financial situation as far as buying another house. So your real choice is the slow loss vs. the quick and painful large loss vs. just staying put. Even that choice is limited if you can't qualify for both loans at once. Assuming you can, then the slow vs. fast is really just a math question.
I will say that I would NEVER assume 3% annual appreciation in making this choice. Maybe that will happen, maybe it wont. At the least, use a set of scenarios. If you're in an area that is seeing some improvement, and many are right now, then you might use 3% annual appreciation as one scenario. But also consider flat prices and declining prices. Then, evaluate the two choices in the different scenarios. If one choice works out better in several scenarios and the other only works out well in one, then choose the one that works out better in more scenarios.
Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
12y
Is there an option to refi that house at a lower interest rate than what you are paying? That could be the difference between positive and negative cash flow. If the annual loss is $10k/year if you rent it, are you saying it'd be negative just under $1,000/month? That's a lot.
We could refinance but that we require we need to put down a lot of money to get some equity in the property. This would essentially be the money we are looking to use on a new home.
The $10,000 loss/year assumes that the house is not rented out the full year and some maintenance costs, but yes, it is quite high.
Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes
12y
@Jeremiah O I think Ali was talking about a refi where they would only adjust your rate, so that way your payment would be lowered. There were, and I assume still are, several programs that would allow you to refi even if you were upside down. Since you still occupy the home that opens up the most possible options to you, more so than if it was an investment property, or you had moved out already.
I won't pretend to know what your thought process thus far has been, but could you stick it out another year? Not knowing where you are specifically I'm not sure what your market is doing right now, but a lot of markets are coming back at better than 3%/yr. Between that and another year of payments reducing some principal you may be in a position to be able to just sell for a net 0 next year.
Are you sure you will even qualify to keep the home and get another? Lenders are going to take the payment into account for your DTI calculation. I know you've been thinking and evaluating everything, I just wanted to make sure this is even an option for you right now.
Matt,
Thanks for the feedback. I will look into refinancing with a program like you suggest. I was under the impression I could not do that.
You are right, each year we stick it out the better the situation gets. We are in southern NH, so not sure how properties are appreciating right now, but I wanted to be sure I was realistic (even is conservative) with my numbers.
Yes, we do qualify for another mortgage with the payment. I appreciate you pointing that out though.
Contractor · Round Rock, TX · Member since 2013 · 767 posts · 389 votes
12y
Where do you live? As Matt said, lots of markets are coming back and you might find yourself breaking even in a year or two. If you short sale, there goes your credit, so you won't be buying another house soon. You'll be throwing money into renting and losing the equity you would have been building up. What is the purpose of moving? Tired of house? You and family outgrew it? If I were you, I'd suck it up for a year and see what happens, maybe in the meantime, save up some extra money or throw more at mortgage building more equity.
Investor · Los Angeles, CA · Member since 2013 · 71 posts · 16 votes
12y
Have you tried looking into HARP?
I was going to use HARP to refinance my condo until there was a sudden uptick in values in my area and I was able to do a conventional refinance. What HARP allows you to do is refinance your home even if you are upside down.
That might be something worth looking into. Here's more information here: http://www.harp.gov/
Brian,
Current reason for moving is simply to get to a different area. A couple years down the road we will need to move to a bigger house to make room for kids.
Barrington, IL · Member since 2010 · 204 posts · 54 votes
12y
I agree with Jonathan M. Try the harp program, it's designed for situations just like this, and from what I understand of it, can remove negative equity based on what other properties are valued at on the appraisal.
The key factor is, you need to refi the home before you rent it out, as the benefits reduce for non-owner occupied properties to the point it may not be worth it.
That said, I found myself in a similar situation 2 years ago, living in a 3/2 in a nice area that was growing too small for my family. We were about $50k under water based on comps.
I found a great new home, rented out mine, and moved out to our new home. As I expand upon my contacts in investing, I met a mortgage broker who recommended the Harp program for my 3/2 that I had rented out at $1550 a month. Unfortunately, because I no longer occupied it, the rate/payment was only reduced slightly less that the current payment, but also reset the amortization clock back to 30 years, so I opted to keep my payment the same, and keep it as a rental, even though I was losing just a touch of money per month.
So far it's been great, as I screened hard and got a great tenant who has been there since we moved out, and every month that goes by, I know I got into a much better opportunity, gained equity in the purchase of my new house which was a great deal, and the mortgage gets paid down. It's another property in my portfolio, and soon I may be able to refinance it out for more favorable terms.
You gain wealth by owning property they say right?
Rental Property Investor · NH · Member since 2013 · 111 posts · 28 votes
12y
JO, I agree that you should be looking into HARP if you have not already. What is your current rate and is it adjustable or fixed?
I know the pain of a growing family, a house that's upside down and the strong desire to move on to your forever home. You feel trapped and sometimes it feels like you can't make it another month, never mind a year.
Looks like you've looked at all the angles and you've done your research. Just to be sure though, have you calculated depreciation of the investment property? This is a needle mover come tax time. Maintenance and miles are all decent write offs as well that could help to bridge the loss gap.
Like I've said, I've been in this situation myself and my personal bias is that you hold onto the asset. You can never undo that loss when you sign over the $30k at close but you can fight like heck to manage that property as efficiently as possible and get the best rent that the market will bear. Better to bleed slowly and preserve your options than to throw in the towel and open up a vein and bleed out all at once. That was graffic, but you get the point :)
Also, consider a lease option or a rent to own! Perhaps the LTV desparity is too great today, but assume you rent it today for a $200 per month loss. Those losses will be offset by tax benefits mentioned above such as depreciation and that will help. HOWEVER, a year or 18 months from now if values rise modestly, now all of a sudden your property is a prime candadite for a lease option or sub-to.
I don't think you listed your value above so let's just say your property is worth 110K today but you owe 140k (I'm assuming a condo given your circumstance wrt the S. NH market). In 18 months the property has appreciated to 117k. You leave your loan in place and sell a lease option to a buyer / renter. You have TWO SEPERATE documents, this is important! A lease agreement where you set up the rent terms (maybe you can charge $1550 by now in this fictional example), and the second document is the option to buy after 3, 5 or 7 years. The terms are negotiated up front, therefore you can charge earnest money (seperate from your rent deposit, you can ask for that too!) and an "option fee" (a fee just for providing the option, maybe 1k). You can charge more than market value bc you will be selling this option to an individual who cannot get a conventional loan. There are tons of people with poor credit but plenty of money in their pockets and a strong desire to own their own home. You may be able to sell the property for 130k and collect 8-10k in earnest money. There are all kinds of opportunities for negotiation, not all are in your favor. The buyer / renter may request a lower deposit and that a certain amount of their rent be added to their deposit each month, 100, 200 each month? At the end of the day you have renters with the mentality of owners. You have their earnest money, it is non-refundable and it is money in your pocket. It also ensures they are fully committed. You have a known value for which you will sell, and a time for when that sale will occurr. Maybe you still have to bring some cash to close but it is likely way less than if you sold today bc you found a motivated buyer who couldn't go conventional. You are a less stressed out landlord bc you have tenants who view the property as their home.
Another option is to sell sub-to and leave your financing in place. That is a tougher sell given your situation as you are trying to find a buyer willing to assume an asset that is upside down, AND has a mortage that is higher than the rental market. It is a great option when you have financing at a slight discount to market rent but your value is slightly upside down or break even. Thats a great sub-to situation.
Long story short my vote is go with the slow bleed. Fight hard, don't quit, keep researching and learning. There are tons of solutions and every day your situation gets better and better.
Thanks for all the responses. Looks like HARP requires your mortgage to be a Fannie Mae or Freddie Mac, unfortunately ours is not. We have a private mortgage.
Brett,
Thanks for all the great ideas.
If we rented this house for say 10 years, and then decided to sell (for a profit!) how is the home treated. Since we lived here as our primary residence for 7 years, will we fall under the tax exemption? Or is it now treated as an investment property?
Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes
12y
Your Choices....
Sell with an Agent
Sell FSBO - no comission
Rent - DIY or Property Manger with fees
Sell On Terms (Rent to Own - Lease Option)
The costs to sell with an agent average 10% of appraisal with closing costs and other items (holding costs, closing costs, etc) minimum.
If you are underwater, selling on a long term lease with separate option to purchase might make sense.
You have to be cautious about a disguised installment sale. A 12 month lease with possible extensions may be the way to go.
Would you be willing to make an extra payment directly paying down principal to the amount underwater? Say $500 a month directly toward principal? Then there may be some appreciation over the next 3-5 yrs?
If we rented this house for say 10 years, and then decided to sell (for a profit!) how is the home treated. Since we lived here as our primary residence for 7 years, will we fall under the tax exemption? Or is it now treated as an investment property?
Time for @Steven Hamilton II the tax guy to keep me on the straight and narrow, but no you won't get your exemption. you have to have lived there 2 out of 5 years. So 3 years from now would be your cut off for taking the exclusion.
(Steven that was what I got out of the similar question that Bill Exeter responded to)
Investor · Appleton, WI · Member since 2012 · 1k+ posts · 464 votes
12y
Jeremiah, You would lose the $250,000 capital gains tax exclusion when you habe no longer lived in the home 2 of the last 5 years. So if you sold the property in prior to 3 years from moving out you would not have any capital gains tax.
From what I have seen you are looking ahead which is great. It also sounds as if you do not need to make a decision tomorrow either. One thing I have not seen mentioned is if you could add on to your current home to meet your needs. This could be an answer to your problems since you appear to have the resources to make this happen.
I believe you will choose to move at some point in the near future either way so it is just a matter of setting yourself up for the best opportunities going forward. If I were in your shoes I would be analyzing your current mortgage and messing with the amortization tables. If you make an extra principle payment of $5,000 now how will that affect you 3 years out with your principle balance. Maybe it is a combination of a lump sum paymemt now and then an extra $100 a month going forward.
If I were you and wanted to move I would figure out a 5-10 year plan with this property and your new home. I would see what I can do with my current cash on hand in order to get the current mortgage principle balance down to a desired level or at least with a lump sum paydown you make each payment going forward work harder for you with more of it applying to princle paydown. Then I would rent the home out when you find your new home. Get a second opinion on rental price for your current home. It could bring in more than you think. While you are in the process over the next couple months I would recommend you study up on your state's landlord/tenant laws so you can be prepared. I like that you have taken a conservstive approach to your numbers but I also have a feeling that you will fare better than that $10,000 a year loss that you estimated. You should also have a healthy loss once depreciation comes Into play which will lower your income taxes.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
12y
OK, I will comment.
Stay put.
Only a desperate or foolish person would sell a property subject to. It does not sound to me like that describes you, @Jeremiah O When you do that you give up all control of the property but retain responsibility for the loan.
Are you willing to do the property management yourself? If so, you need rent of about 1.5 x the P&I (just principal and interest, not the full PITI) part of your payment. If you're not willing to deal with a tenant (and that means doing an eviction and kicking a family to the street if they don't pay, toilets are easy) then you need rent of 2x the P&I. If you're short of those number, that's your loss.
IMHO a house you live in is just an expensive doo-dad. Like a car or a boat. Unfortunately there's a whole industry that tries to convince people that its an investment. As you've found, its not. Its just an expense. Now, lots of people got lucky and bought and sold at the right time and made some money. Lots of others, like you, are stuck upside down. Sounds a lot like buying a car, doesn't it? I've bought and sold several residences and never made a dime on any of them and took loses on one.
There's no easy way out. The least painful thing is to just stick it out. Cut expenses (you'll have to anyway in order to buy a new house and support a loser rental) and save as much as you can as fast as you can to escape your hole.
Realize that if you do buy a new house and rent this one the rental income will not be counted in qualifying for the new loan. You will have to have enough regular income to support both the new house and the old one. Lenders are wise to the "jump and dump" process where someone buys a new house then lets the old one fall into foreclosure. So they want to be sure you can afford both of these liabilities.
Yes, selling with an agent will cost you 8-11% in costs - 6% commissions, 2% for closing costs (mostly title insurance) and 0-3% in seller concessions depending on your market. If you do a FSBO you will save 3% of that amount - the commission you would pay to the listing agent. If you refuse to pay a commission to the buyer's agent you will greatly reduce your pool of buyers. So, you're really stuck with playing this game (set up by the same folks who told you a house was your biggest investment, what a surprise) and paying these costs.
All these other options - lease/option, wrap mortgage, subject to, etc are risky. And don't immediately help your financial situation as far as buying another house. So your real choice is the slow loss vs. the quick and painful large loss vs. just staying put. Even that choice is limited if you can't qualify for both loans at once. Assuming you can, then the slow vs. fast is really just a math question.
I will say that I would NEVER assume 3% annual appreciation in making this choice. Maybe that will happen, maybe it wont. At the least, use a set of scenarios. If you're in an area that is seeing some improvement, and many are right now, then you might use 3% annual appreciation as one scenario. But also consider flat prices and declining prices. Then, evaluate the two choices in the different scenarios. If one choice works out better in several scenarios and the other only works out well in one, then choose the one that works out better in more scenarios.
Wholesaler · Gladstone, NJ · Member since 2013 · 47 posts · 1 vote
12y
Hi Jeremiah-
Since it doesn't sound like you are THAT far under water, and you are willing to rent it, a lease option would work well for you. If you do it right, I believe you could cover your costs and possibly even pocket a little extra each month as I do these often. Save your credit, possibly pocket some income, keep your down payment money for your next house.
Thanks for all the responses. Looks like HARP requires your mortgage to be a Fannie Mae or Freddie Mac, unfortunately ours is not. We have a private mortgage.
Brett,
Thanks for all the great ideas.
If we rented this house for say 10 years, and then decided to sell (for a profit!) how is the home treated. Since we lived here as our primary residence for 7 years, will we fall under the tax exemption? Or is it now treated as an investment property?
If you sell within 3 years after it being your primary residence you would meet the requirements for the Home Sale Exclusion(still have depreciation recapture) and you're able to exclude the gain; however, if you keep beyond 36 months after moving out you will pay capital gains/recapture on the entire gain.
Lender · Tyngsboro, MA · Member since 2009 · 3k+ posts · 2k+ votes
12y
Jeremiah, you might also talk to the private lender about reducing your interest rate. The lender probably knows you are underwater, and may consider reducing your rate depending on their own personal situation if it is a person. You can put that savings, if you get any, toward paydown of the principal.
Selling now locks in your loss. Hanging in there might reduce your loss to a more manageable level.
One last question, if we hold the house and sell in say 10 years after renting in out, will the capital gains still be based on the original purchase price (the price that we paid for the house as our primary residence)? If so, in 10 years if the house appreciates back to the price we originally purchased it for this would mean zero capital gains.
Or is it somehow based on the market value at the time we turn it into an investment property.
Investor · Appleton, WI · Member since 2012 · 1k+ posts · 464 votes
12y
Jeremiah, The cost basis of the property will be the price you purchased the property at originally. However once you turn it into a rental property you are able to depreciate the property. For example, if you bought the house for $200,000 and $40,000 was land (can't depreciate land) then your would depreciate about $5,818 a year. That is taking the $160,000 divided by 27.5 years (irs straight line depreciation schedule). This is two-fold for if you have mortgage interest of $7,000 taxes of $3,000, insurance of $1,000 and other expenses of $1,500. So as of now in lets say 2014 you have $12,500 of expenses on paper for your taxes. Now if the property was rented all year for $1,500 a month then you would have an yearly income of $18,000. Once you add depreciation of $5,800 you now have total expenses of $18,300 so you will have a loss of the property and not be required to pay any taxes and in fact lower your taxable income by $300.
The other side of this depreciation coin is that each year your cost basis effectively drops that $5,818 from that $200,000 that you purchased it for. So if yiu rent it for 10 years, your new cost basis will be roughly $142,000 and if the property is then aold for $250,000 then you will pay long term capital gains tax on $108,000.
Thanks everyone.
One last question, if we hold the house and sell in say 10 years after renting in out, will the capital gains still be based on the original purchase price (the price that we paid for the house as our primary residence)? If so, in 10 years if the house appreciates back to the price we originally purchased it for this would mean zero capital gains.
Or is it somehow based on the market value at the time we turn it into an investment property.
@jeremiah O,
Your cost basis will be the lower of Your actual basis (purchase price plus improvements) OR Fair Market Value.
That means if you bought at 200k and it is now worth 150k. If you convert to a rental today your depreciable basis will be 150k(Minus land).