When should a homeowner consider a short sale?

There’s a lot of buzz regarding the upcoming changes to HARP which go into effect on March 17.  The biggest change is that the loan to value ratio (LTV) of homes with a Freddie Mac or Fannie Mae mortgage is lifted. Previously, the LTV on these loans was 125%. With this gone, refinancing may actually become a viable option. But there are still circumstances in which a homeowner should consider a short sale. In this article, we will take a look those circumstances in more detail. The decision should be driven by four factors: income, the loan involved, the home location, and your psychology. The first factor is household income. To do a refinance or a loan modification, there must be household income. What is considered income varies from lender to lender, and from desk to desk within the lender, but there must be some cash flow. Ideally, the cash flow is such that a house payment is less than 33% of the gross income, called the debt to income ratio (DTI). To determine this, simply divide your house payment by your gross income. For example, if you’re household income is $3000 and your house payment is $1000, your DTI is 33%. If your DTI is really high, like 50% or above, you may not qualify for either a refinance or a loan modification. At that point, you should begin to think about a short sale instead as the math becomes difficult, and refinancing becomes less likely. The second factor is LTV. This is the value of the house divided by the principal amount on the first position trust deed or mortgage. For example, if you owe $300,000 on a $150,000 house, your LTV is 200%. Your first step, assuming there is income, is to determine if a refinance is possible under HAMP or with your existing lender. Experience with short sales and loan modifications in the past has shown that a LTV above 150% is problematic in that even a refinanced or modified house payment puts the monthly payment above either rental value or a replacement property. This is especially true of high foreclosure areas. If your LTV is exceptionally high, and you are just making ends meet as it is, you may want to consider selling. The third factor is location. There were definite bubble areas: California, Nevada, Arizona and Florida (Michigan and Ohio have a separate set of problems). These areas saw prices rise far out of proportion to the underlying economic conditions. In addition, there were a massive number of new subdivisions build progressively farther away from city centers. It is entirely possible that due to energy and demographic changes in the years ahead (gasoline will not be below $3.50 per gallon nationwide anytime soon and there is a reduced number of potential home buyers due to economic conditions, student loans, and the drop in numbers from baby boom times) that properties in outer boom areas.  We are in Southern California. If you purchased in 2006 or 2007 in the high desert, Apple Valley, Temecula and environs, I submit to you property values may never recover, or the process will take decades to complete. Your acid test is simple. Print out a map of Southern California. Find LAX, Ontario Airport and John Wayne Airport. Draw a triangle between these. If you drive more than 30-45  minutes to hit one of the points of the triangle, you are in grave danger of stagnated prices for decades. For the homeowner in these areas, this could mean that a refinanced or modified loan will put you in a position that the existing LTV is so far above actual market price, that it makes no economic sense to refinance or attempt to modify a loan. In that situation, your best bet is the economic decision of selling now to minimize losses. Finally, there is the psychological stress involved. Refinancing is very time consuming, not easy, and will be plagued with lots of false starts and dashed expectations. Attempting a loan modification is simply cruel; at our shop we call it the “Gauntlet of Hell”. Everybody laughs when they are told this. Nobody laughs at the end. Unless you are mentally prepared, and tough enough to deal with lender and servicer abuse for weeks and months at a time, your best bet is to cut your losses and move on. For a free consultation regarding this and other loan matters, email or call us today.