Advice on a complicated situation (at least complicated to me)

[Jeremiah O]

Hi all,

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.

Thanks,
Jeremiah

[Jon Holdman]

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.