Dear Debt Adviser,
This is in reference to refinancing a home. Basically, a $215,000 home in 2006 is now valued at $85,000. Refinancing allows for only 80 percent of the $85,000 current value, or $68,000. The adjustable rate on the loan has escalated to an 8.625 percent interest-only payment after five years and is scheduled to be reviewed every six months, with a maximum interest rate 14.625 percent. The current mortgage balance is $170,000. In order to refinance, I would have to pony up $87,000 to obtain a mortgage for $68,000 — for a house that’s valued at just $85,000. I’m 60 years old and my remaining earning potential is only two to three years. I have a small military retirement, some savings and hopefully Social Security to retire on. Any recommendations?
You have some decisions to make, the main one being whether it is in your best interest to try to stay in your home. I’m not sure about the math in your question. It seems to be off by $15,000 (a $68,000 mortgage and $87,000 from which you will only pay $155,000 of the $170,000 you owe). But the math won’t change my advice. To help you make your decision, I’d like you to weigh these considerations.
Begin by asking when you are planning to retire. What are your plans? Will they include accessing credit? Will you want to move and buy a new home or condo?
You state in your letter that you have only two to three years of earning potential remaining. If that’s the case, you don’t have long for your home’s value to rebound if you opt to put in the cash necessary to refinance at 80 percent loan-to-value. You may want to consider getting out of the home with a foreclosure or short sale.
If you’ll be looking to buy another home once you stop working, be aware that a foreclosure rather than a short sale will exclude you from getting a Fannie Mae-backed loan for seven years. So, for seven years, if you go mortgage shopping, you may have to consider a nonconforming product from the Federal Housing Administration, or FHA. These loans, which do not follow Fannie Mae underwriting guidelines, typically require mortgage insurance premiums and, for those with low credit scores, higher interest rates and steeper down-payment requirements. You can expect that your credit score will be in the dumps from a foreclosure for two to four years, everything else being equal.
Even so, $85,000 is a lot of money. So it may be worth considering a short sale. I wouldn’t feel too bad for the bank. The bank knew loaning you the money for your home was a risk and despite its protests to the contrary, many knew they were making unsound loans and didn’t care as long as they could pass them on to someone else.
One last point: Any money from your mortgage used for something other than your home purchase — such as furniture, a car, or paying off credit card debt — may be taxable. If it was all used for your home, you will qualify for full debt forgiveness under the Mortgage Forgiveness Debt Relief Act of 2007. The act exempts from income taxes any housing debt canceled (forgiven) by the bank, up to $2 million ($1 million if married, but filing separately). But the law expires in 2012. So if you decide to give the house back to the bank, be sure to do it before then.
To help you make the best decision, consider a dispassionate professional point of view. An accountant or financial planner can give you a complete assessment of the impact either way. I also suggest that you go over your situation and mortgage with an attorney who is experienced with mortgage issues.
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