Ridiculous Commute vs. Underwater Mortgage

[Lagom]

Hello Mustachians!

The DW and I both have ~50 mile round trip commutes (all surface streets, too) and this needs to change. However, we also owe $181k on a townhouse in the exburbs currently worth $150k at best. We want to move into a house within ~5 miles of both of our jobs and in which we can raise a family, but I’m not sure what the best approach is to making that a reality. Should we be making extra mortgage payments to build a bit of equity so we can sell more easily? Should we instead put that money towards down payment savings and try to get a short sale and/or make up the difference all at once when we find a buyer? Should we try to rent out our current home, even though the rent we would expect would be lower than our mortgage payments? I’m also not sure about the health of the rental market in our area. I doubt it’s booming.

Ideally, we would like to move within ~3 years. I’m not sure that’s actually feasible, but if it is, which of these approaches do you think would get us there the quickest? For the record, we can contribute somewhere in the $1000-1500/month range towards savings, extra payments, etc. Much obliged!

[arebelspy]

Should we try to rent out our current home, even though the rent we would expect would be lower than our mortgage payments? I’m also not sure about the health of the rental market in our area. I doubt it’s booming.

Do some more research on this so you know if it's a real possibility.  rentometer.com and zillow.com both estimate local rents.  Then check craigslist.

[tooqk4u22]

Assuming you can get housing in the new location (even if it is smaller) that is the same montly cost as what you have then sell the house for a loss pay the difference out of pocket if you have or do short-sale (may be tough, long and hurt your credit though). 

If you come out of pocket $30k you could probably recoup that in three years just with lower commuting costs - shorter if you sell one of the cars. And that is not even factoring in the additional time you will gain.

[Lagom]

Should we try to rent out our current home, even though the rent we would expect would be lower than our mortgage payments? I’m also not sure about the health of the rental market in our area. I doubt it’s booming.

Do some more research on this so you know if it's a real possibility.  rentometer.com and zillow.com both estimate local rents.  Then check craigslist.

Thanks for the links. According to those resources, optimistically speaking we would get $200-400/month less than our mortgage payments. Worst case looks like around $500 below. I know there are some tax breaks involved with being a landlord that could partially blunt that, but I’m sure we would lose money in the short term, at least until our PMI is eliminated and we are able to refinance with some equity. I’m not totally opposed to the idea, for all that, if there is long-term wealth building potential. I would feel more comfortable if we lived closer to the urban core, however. I’m not sure about the long-term prospects in exburban communities.

[Lagom]

Assuming you can get housing in the new location (even if it is smaller) that is the same montly cost as what you have then sell the house for a loss pay the difference out of pocket if you have or do short-sale (may be tough, long and hurt your credit though). 

If you come out of pocket $30k you could probably recoup that in three years just with lower commuting costs - shorter if you sell one of the cars. And that is not even factoring in the additional time you will gain.

Yeah that’s why we want to move as fast as possible. I figure almost any cost will still result in a net gain within a few years due to the saved time and reduced expenses. The only trick is the best way to save up for a down payment and selling the current house. I’ve been looking at homes in the  mid $200’s in my target area. With a 20% down payment, our monthly housing expenses would actually be lower than they are currently. The only trick will be saving $40-50k and another $30k to sell our current place.

Although, if that is the best approach, it becomes rather simple math. Assuming I need $70k and want it in 3 years, we’ll just have to come up with ~$2000/month to save and we’re home (literally!).

If I were to rent out our current place, however, my current $1000-$1500 savings would  be enough, but then I have to deal with the hassle of being a landlord for negative income. Hmm…

[Jack]

I apologize in advance because I realize it's not helpful, but I can't help thinking that just the description itself ("townhouse in the exurbs" -- i.e., out of town) should have been your first clue that something didn't make sense.

Based on that, I think cutting your losses is the best plan. If there were some way to buy the house in the right location relatively quickly, I'd say do that and then short sell/foreclose the "town"house. Otherwise, short sell/foreclose the townhouse first and then rent until your credit recovers.

[DoubleDown]

Just an FYI, refinancing once you've converted the house to a rental will be harder and will likely come with higher rates (probably 0.5 points or more, and lower loan to value ratio required). So, it would be better if at all possible to refinance before converting it to a rental. For example, find a way to put some money into the mortgage to hit 20% equity, refinance at a lower rate with no PMI, THEN convert to a rental.

There are lots of complicated tax rules about rental income but, in general, if you and your spouse are earning under $100k (Modified Adjusted Gross Income or "MAGI" -- look it up) combined, you can write off 100% of all of your rental expenses and losses. All of your repairs, losses in rent, rental expenses, broker fees -- you name it -- can all be deducted. And improvements can be made to the property and depreciated. So that's a pretty decent incentive to rent the place out if you can come even remotely close on your commuting savings vs. the shortfall between the mortgage amount and rent. Between $100k and $150k income the amount you can deduct gets graded down, until it's a zero deduction at $150k+. And who knows if the tax code will change.

One last point on the rental amounts, just so you go in with your eyes open: there are lots of discussions on this site about rental income, and what's reasonable to expect. Even if you do everything on your own and are able to "break even" on the rent vs. mortgage, there will inevitably be repairs needed, problems discovered, a month or two of vacancy between renters when you are getting no rent, etc. Just please factor all that in your decision.

[Jack]

I just thought of another idea: would you qualify for a mortgage modification (principal reduction)? If so, that would be better than short selling/foreclosing.

I still wouldn't keep the house for any longer than I had to though, due to the lack of long-term prospects (even if you wanted to be a landlord, you could do better with a different property).

[Lagom]

I apologize in advance because I realize it's not helpful, but I can't help thinking that just the description itself ("townhouse in the exurbs" -- i.e., out of town) should have been your first clue that something didn't make sense.

Based on that, I think cutting your losses is the best plan. If there were some way to buy the house in the right location relatively quickly, I'd say do that and then short sell/foreclose the "town"house. Otherwise, short sell/foreclose the townhouse first and then rent until your credit recovers.

No worries, I agree it was a pretty bad decision (as was the timing of the purchase!). I have ethical reservations about foreclosing (even acknowledging the general evilness of the banks), so I wouldn’t consider that option. Not sure I want to deal with a short sale either, although I know it could potentially save us a lot of cash. But when you put it that way, the fact that we could get out of our house even sooner is damn tempting…

Just an FYI, refinancing once you've converted the house to a rental will be harder and will likely come with higher rates (probably 0.5 points or more, and lower loan to value ratio required). So, it would be better if at all possible to refinance before converting it to a rental. For example, find a way to put some money into the mortgage to hit 20% equity, refinance at a lower rate with no PMI, THEN convert to a rental.
There are lots of complicated tax rules about rental income but, in general, if you and your spouse are earning under $100k (Modified Adjusted Gross Income or "MAGI" -- look it up) combined, you can write off 100% of all of your rental expenses and losses. All of your repairs, losses in rent, rental expenses, broker fees -- you name it -- can all be deducted. And improvements can be made to the property and depreciated. So that's a pretty decent incentive to rent the place out if you can come even remotely close on your commuting savings vs. the shortfall between the mortgage amount and rent. Between $100k and $150k income the amount you can deduct gets graded down, until it's a zero deduction at $150k+. And who knows if the tax code will change.

One last point on the rental amounts, just so you go in with your eyes open: there are lots of discussions on this site about rental income, and what's reasonable to expect. Even if you do everything on your own and are able to "break even" on the rent vs. mortgage, there will inevitably be repairs needed, problems discovered, a month or two of vacancy between renters when you are getting no rent, etc. Just please factor all that in your decision.

This is great information. The only problem with refinancing first is that we would have to save around $60k just to be able to refinance with no PMI and then we would have to save another $60k for a down payment. No way that’s happening in 3 years. Incidentally, we are currently trying to do a HARP refinance, which would knock a good $300 off our mortgage payments. It’s been 7 months since we started, however, so I don’t know if/when that’s going to pan out.

I suppose given those facts and my disinterest in landlording anyway, it’s looking like my best bet if I refuse to foreclose/short sell is to just save cash as madly as possible for the next few years. I guess I should have realized that. K.I.S.S. It sounds like you all agree that saving one lump sum and paying the difference on a sale is better than accelerating mortgage payments to get out from underwater?

Thanks all!

[Another Reader]

If your interest rate is the problem, it would make sense to refinance the townhouse now if it qualifies for the HARP program or one of the other government-guarantor programs that lets you refinance an underwater owner-occupied property.  If you can't do this, then you may want to consider short selling or raising the money to meet the deficiency a sale would mean.  The deficiency in a traditional sale is not just the $30k value difference.  You will also have to pay the commission, your share of the closing costs, and any needed repairs if you go with a traditional sale.  That means you will have to find more like $45k to get this sale accomplished. 

In your shoes, I would try to refinance now if the interest rate difference made keeping the property feasible.  If I could tolerate the loss on the rental, which will be more than your estimate because of vacancy and collection loss plus repairs, I would look for an inexpensive rental close to work.  If not, I would suck it up and commute.  Once it made sense to sell the exurb property or I had a down payment saved, I would buy close to work.

[Another Reader]

SEVEN months to do a HARP?????  Are you working with your current loan servicer?  A HARP loan is much easier with the current servicer because they do not have to jump through the same hoops a new lender does.  I would be all over this, like today.

[Jack]

I have ethical reservations about foreclosing (even acknowledging the general evilness of the banks), so I wouldn’t consider that option. Not sure I want to deal with a short sale either, although I know it could potentially save us a lot of cash. But when you put it that way, the fact that we could get out of our house even sooner is damn tempting…

I think you should read some of the other forum threads discussing the ethical merits of strategic default/running your finances like a business. The way I see it, it boils down to this: the banks are as ruthless in their dealings with you as they are legally allowed to be, so there's no reason for you to treat them any differently.

[tooqk4u22]

I have ethical reservations about foreclosing (even acknowledging the general evilness of the banks), so I wouldn’t consider that option. Not sure I want to deal with a short sale either, although I know it could potentially save us a lot of cash. But when you put it that way, the fact that we could get out of our house even sooner is damn tempting…

I think you should read some of the other forum threads discussing the ethical merits of strategic default/running your finances like a business. The way I see it, it boils down to this: the banks are as ruthless in their dealings with you as they are legally allowed to be, so there's no reason for you to treat them any differently.

First of all - banks are not evil contrary to popular belief.  There are two sides to deals - lender and borrower.  Banks provide necessary capital to keep/get the economy going. 

Setting that aside - The Mortgage Forgiveness Debt Relief Act and Debt Cancellation expires this year. Although I despise this act and hope it is not extended, if you were to turn over the keys to a lender do it before year end so you avoid tax consequences of the debt foregiveness.

The reason why I hate this act is because it benefits the many dopes that went and refi'd their houses with cash out then spent it or they sold their existing home and rolled into a bigger more expensive home and then got behind, turned it over, debt was wiped out, and no tax. Effectively tax free spendable income - such BS.  The only ones that really got hurt were first time buyers, but still there are no guarantees about home values going up.  This was the last straw that made it easy for people to walk away from their homes - I mean they didn't have any cash equity in to begin with - so at least there would be a looming tax impact if they walked, might have made people think a bit more because you can't run from the IRS.

God I hope this act is not extended.

[Lagom]

First of all - banks are not evil contrary to popular belief.  There are two sides to deals - lender and borrower.  Banks provide necessary capital to keep/get the economy going. 

Setting that aside - The Mortgage Forgiveness Debt Relief Act and Debt Cancellation expires this year. Although I despise this act and hope it is not extended, if you were to turn over the keys to a lender do it before year end so you avoid tax consequences of the debt foregiveness.

The reason why I hate this act is because it benefits the many dopes that went and refi'd their houses with cash out then spent it or they sold their existing home and rolled into a bigger more expensive home and then got behind, turned it over, debt was wiped out, and no tax. Effectively tax free spendable income - such BS.  The only ones that really got hurt were first time buyers, but still there are no guarantees about home values going up.  This was the last straw that made it easy for people to walk away from their homes - I mean they didn't have any cash equity in to begin with - so at least there would be a looming tax impact if they walked, might have made people think a bit more because you can't run from the IRS.

God I hope this act is not extended.

My comment was meant to be partially tongue in cheek, although I do feel that “predatory lending” is an accurate term in some cases (not mine…I was just stupid). I have put a lot of thought into the ethics of strategic foreclosure, and it just runs too contrary to my financial DNA. Depending on the circumstances, I’m not inclined to judge those who choose that path, but I don’t think I can bring myself to do it. I do see your point, Jack. It’s the same rationale I give to friends who hem and haw over leaving their jobs with no notice, leaving after only a short time in a position, etc. Most employers would fire you in a second if it served their interests, so there’s no need to feel bad about firing them.

@ Another Reader: Our current loan servicer told us they were not doing HARP refinances, although now that I think about it, that was at the beginning of the year. Maybe they have since changed their tune. I need to check.

[DoubleDown]

WARNING on foreclosure, debt forgiveness, and short sales: Make sure to check the laws in your state on these outcomes. In several states, the lender can still come after you for their lost $$$! For example, if your loan is for $150,000, and they let your house go at auction or in a short sale for $100,000 they can obtain a court judgment against you for the difference of $50,000. If you have any other available (i.e., not protected by law) assets to speak of, they can get them. You definitely do not want a large court judgment debt following you around! Some states don't allow this, so check it out for where your house is.

And in a short sale, make certain to get it in writing that your debt is being fully discharged and they are releasing any future claims against you. Otherwise, they can sell your house in the short sale, and still come after you for the difference as described above (it happens to un-savvy borrowers).

Finally, keep in mind that discharged debt is also generally taxable by the IRS at whatever is your income tax rate at your income level. So, if you have $50,000 forgiven off your loan, that amount will be considered additional "income" on your taxes that year! At a 20-30% tax rate, it's a non-trivial amount to come up with at tax time all at once.

[DoubleDown]

What do you think is the outlook for real estate where your house is located? Is it in an up-and-coming area that is likely to appreciate in value and in rents, or is it stagnant or even going down? If it's stagnant or going down, get out NOW. Take the loss on the house (maybe in just a traditional sale), and you will recover from the loss in a relatively short time with your Mustachian ways.
 
But if the outlook is good, I could see some favorable conditions for renting the house and moving closer to work, saving on commuting costs and time, and gaining the tax advantages of being a landlord.

Even though you might end up with a somewhat small, negative cash flow renting, you stand to gain overall in the longer term if the house appreciates in value decently. For example, if the house gains a modest 5% per year, on average, then in 4 years your house will be worth around $182,000 (based on your estimated current value of $150,000). That $34,000 in appreciation will more than make up for any $200-400/month negative cash flow. And as previously discussed, you will likely get tax benefits for renting out the house plus savings in commuting costs.

There's some risk involved, of course, in betting on appreciation to overcome negative cash flow. But if you (or real estate pros) in your area see your neighborhood as favorable for appreciating in value in the coming years, then I would hold onto it, continue your plans to refinance, and rent it out to move closer to work if desired. Who knows, it could even end up being a terrific long term investment and money-maker for you as a rental!

[Lagom]

What do you think is the outlook for real estate where your house is located? Is it in an up-and-coming area that is likely to appreciate in value and in rents, or is it stagnant or even going down? If it's stagnant or going down, get out NOW. Take the loss on the house (maybe in just a traditional sale), and you will recover from the loss in a relatively short time with your Mustachian ways.
 
But if the outlook is good, I could see some favorable conditions for renting the house and moving closer to work, saving on commuting costs and time, and gaining the tax advantages of being a landlord.

Even though you might end up with a somewhat small, negative cash flow renting, you stand to gain overall in the longer term if the house appreciates in value decently. For example, if the house gains a modest 5% per year, on average, then in 4 years your house will be worth around $182,000 (based on your estimated current value of $150,000). That $34,000 in appreciation will more than make up for any $200-400/month negative cash flow. And as previously discussed, you will likely get tax benefits for renting out the house plus savings in commuting costs.

There's some risk involved, of course, in betting on appreciation to overcome negative cash flow. But if you (or real estate pros) in your area see your neighborhood as favorable for appreciating in value in the coming years, then I would hold onto it, continue your plans to refinance, and rent it out to move closer to work if desired. Who knows, it could even end up being a terrific long term investment and money-maker for you as a rental!

My gut says the outlook is flat, but I definitely need to do more research. It's an exburb of Chicago, but one of the largest ones, and there are some signs of improvement in rougher areas. I would not be comfortable predicting a huge turnaround, but I also don't see signs of inevitable decay. Being somewhat risk averse, I think we will just get out as soon as we can, but not treat it as an emergency. I doubt things will tank in 3 years, and they may even improve slightly, but I would not bet on a sizeable rebound.

I really appreciate your concrete information. Thanks!

[capital]

The depreciation of the house is a sunk cost, and shouldn't figure into your decisions going forward:
http://en.wikipedia.org/wiki/Sunk_costs

The question for you now is whether the house is worth it to you at its current price, and it sounds like it isn't, since you're not anywhere near either of your jobs, with high commute costs. Chicago has a lot of affordable walkable neighborhoods, a pretty good mass transit & commuter rail system, and an improving bicycle path & lane network, so you probably want to get to a more urban location where you need one or zero cars. More urban neighborhoods usually have Zipcars if you get your car trips down to once every week or two.

How soon are you planning on having a family? If you're not having one within a year or two, have you considered waiting a couple years to buy a house, and just get a one-bedroom apartment, rather than holding extra bedrooms as excess inventory? You can even try living in a few different neighborhoods, so you can shop around before you settle down. Remember that school district doesn't matter until your future children are school age, which is several years off.