When we overindulged in real estate earlier this decade, we took generous helpings of seconds.
Now the problem for many with too much debt on their plate is how to deal with the mortgage on a second home.
Just two years ago, 12 percent of all residential sales were vacation homes and 21 percent of transactions were for investment properties, according to the National Association of Realtors.
- Selling short
- Working out a modification
- Declaring bankruptcy
When buyers purchase a home that’s not their primary residence and ask lenders to qualify them based on expected rental receipts, it’s counted as an investment property. If, though, borrowers plan to pay the mortgage out of their own pocket and use the property for their own enjoyment, it’s a vacation home.
Government-sponsored foreclosure rescue programs are aimed at saving primary homes. Indeed it’s those who are in danger of losing the one and only roof over their heads who are in the direst need.
However, there is some dispute about whether or not the recently announced government effort allows owners of bona fide vacation homes and some types of rental units to seek a refinance.
Here is a look at strategies which may help owners strapped with a double dose of housing debt.
In this period of ultralow mortgage rates, all homeowners should examine the possible benefits of refinancing, says Doug Rice, a Castro Valley, Calif., investment adviser.
But even if a refinance shaves several hundred dollars off the monthly mortgage, the expense of a second home simply isn’t affordable for owners who’ve seen their income drop, says Milo Benningfield, a San Francisco financial adviser. Instead of pursuing a refinance, they may be better served by trying to sell first, even if it means trying to arrange a short sale (see below).
Moreover, in places where home prices have taken a deep dive, refinancing may not be feasible. In Florida, for instance, lending companies typically won’t offer a refinance loan for more than 80 percent of the current value of a second home or investment property, says Jerry Collyer, president of the Florida Mortgage Professionals Association.
That leaves owners who owe, say, $200,000 on a condo now worth $170,000 without the ability to refinance.
The exception, however, is if vacation homeowners need a new mortgage and their current first mortgage totals no more than 105 percent of the current appraised value. If Fannie Mae or Freddie Mac hold the loan on the home a refinance might be available under the recent government plan.
When a realistic sales price is less than the mortgage amount, owners have to convince their lending company to accept sale proceeds, even though they fall “short” of what’s owed.
It’s easier to negotiate a short sale on a primary home, says Chicago attorney Joseph Nery. But he has seen lenders acquiescing to a short sale on a second home in recent months. “They’re being more flexible when they think the only other option will be that they eventually foreclose,” Nery says.
Still, a loss is a loss. Some lending companies will try to recoup their shortfall and will examine an owner’s other assets, like the equity in his primary home, savings and even retirement accounts, says Nery.
“What lenders may say is: ‘I’m not going to take a $50,000 loss; (the second-home owner) has to contribute $10,000 out of their other assets,'” Nery says.
Moreover, whenever part of the loan principal is forgiven, the lender is supposed to report that amount to the IRS, who can then levy income tax on the borrower for the amount. While the Mortgage Forgiveness Debt Relief Act of 2007 does eliminate taxes on forgiven loan amounts, it only applies to principal residences. In some cases, though, second-homeowners may be able to get a reprieve if they can prove other conditions, like insolvency (see IRS Publication 4681).
Working out a modification
The government plan to modify, or change the terms of a mortgage to make it more affordable, is aimed only at primary homeowners who are at risk of foreclosure.
However, in an e-mail exchange, Debora Blume, a spokeswoman for Wells Fargo Home Mortgage, says that they will consider their own modification policies, outside of the government plan, to help owners who are under a financial hardship. However, not all borrowers will be approved for a modification; it often depends on getting approval from an investor who may hold the loan.
Nery says he’s seeing more modifications, which involve a reduction of principal or interest rate charges, or other changes like lengthening the term of the loan to make payments more affordable. Still, it’s only relatively recently that he’s seen modifications for mortgages on homes that aren’t primary residences. Now, because foreclosures are growing and losses are increasing, some lenders are agreeing to modifications, given that the owner proves he’s unable to afford the current terms.
Las Vegas attorney Samuel Schwartz has seen the housing downturn prompt an increase in bankruptcy filings among owners of multiple properties.
Current law allows judges to modify or “cramdown” mortgages on second homes or properties bought to rent out, but not on primary homes.
One client, Schwartz says, had three rental properties and moved into one of them, letting her primary home go back to the lender as part of the bankruptcy proceeding. The modifications allowed her to better afford the rental properties.
Bankruptcy, which stains your credit for about 10 years, could be the only option in areas like Las Vegas where sales listings bulge with unsold properties and owners hoped to make profits from multiple properties within the last decade.
“Bankruptcy is a last resort,” says San Francisco financial adviser and attorney Benningfield. “If someone reaches that point, they are not worried about their credit; they are in survival mode.”