Three Barriers Trapped Homeowners Face You have to understand the power these barriers have before you can decide what is best for you. Make your decisions based on what is best for you without the influences of what is best for someone else.
By Howard Bono
www.MyFinancialRevival.com Copyright© Financial Revival Group,Inc. 2011
Table of Contents Introduction………………………………………….…….... 3 Case Study: Mark and Sara ………………..…………….... 5 Barrier #1 – Damage to credit………………….……….….. 6 Barrier #2 – The Moral issue ...……………………………. 11 Barrier #3 – Pride …...…………………………………...… 14 Conclusion…………………………………………………....15
The Lawyers require this: The Financial Revival Group, Inc. provides legal information not legal advice. Your situation and/or circumstances may require specific legal answers to specific legal questions. We recommend you consult an attorney if you want professional assurances that our information and your interpretation of it, is appropriate for you.
Introduction Most of the homeowners in the country with a mortgage on their homes will ultimately end up underwater. As of this writing, the most agreed upon figure of the number of underwater homeowners in the country is 28%. There are no official figures available. Any administration that puts out that figure is either too dumb to be in charge or they will lie about it anyway. So that leaves us with educated guesses from companies like Zillow and Case Shiller. In our research and work with underwater homeowners, the 28% figure seems low. In any case, we expect that figure to rise above 50% by the end of 2012. Underwater homeowners have lots of options available to them. Unless they want to continue to pay and be on the hook for more money than they can ever hope to repay, they will HAVE TO take some kind of action. Most of these actions will have adverse effects in one way or another. So how do you decide on what you are willing to do in order to right your financial ship? That is one of the toughest questions we can ask ourselves. If you are not in the situation, your answers will differ from those who are experiencing the pain that comes from being in a financial situation that there are no easy answers for. As we work with people who absolutely have no idea what to do, we encourage them to look at everything without judgment and without condemnation. We all have a code of conduct for ourselves that we believe we would not violate for anything. For example, would you stand at a freeway ramp with a sign asking for money? Most of us say no. But would you do it if you had no money, no prospects for getting any today and your family needed food? I donâ€™t know about you, but under those circumstances, I would do just about anything. Without some action on your part, your underwater home could put you in a situation like that. We talk to people all the time that have to choose between buying food and making the house payment. It may seem out of the realm of possibility for you today, but I can tell you, there are millions of families that thought that too. Now they are there. I want you to realize the severity of the situation and the fact that it is going to get much worse before it gets better. As we discuss the three main obstacles that hold people back from making the decision that could save them financially, keep in mind that what you would do in the best of times is different than what you will do to survive. There are three main barriers that stop people from making a potentially lifesaving move when it comes to their underwater home. These three are: 1. DAMAGE TO CREDIT 2. THE MORAL ISSUE 3. PRIDE We are going to go in depth into these barriers, the reasons they are there, who put them there, the consequences and what happens when you get through the barrier.
For the purposes of this discussion, letâ€™s create an example so that we can really understand how this all plays out in a real family scenario. The example we are going to use is a real family with real issues. Here is their story. We have changed their names to protect their identity.
Case Study: Mark and Sara In 2006, Mark and Sara bought a modest home for $295,000. They used an FHA loan and put 3 ½% down. They had saved up a total of $12,000 to put down and got the seller to help them with part of their closing costs. They got a 30 year fixed rate at 6 1/2% and their total monthly payments are $2,300.00 which includes their taxes and insurance. They have not refinanced their loan because when rates declined enough to make sense, their house had already dropped in value so they were denied a refinance. Mark is a union electrician who wires new houses. He used to work full time and made $30.00 an hour. He used to bring home about make about $5,200 on his regular wages. With over time, he would bring home about $4,500 per month. When they bought the house, the kids were 10 and 11. Sara works part time and brings home about $1,000 per month. When things were rolling along well, they made it just fine, they didn’t have “lots” of extra money, but they were able to save some money each month. Where the house is concerned, they did not overbuy and they have no other debt but are driving older cars that they own outright. Their situation today is much different. The house they bought five years ago for $295,000 is now worth $185,000. There are several empty houses in their neighborhood and a similar house down the street that had been foreclosed just sold for $165,000. They have never made a late payment and they currently owe $277,000 on their house. They are easily upside down by $100,000 and the prospects for that changing for the better anytime soon, are slim to none. Since the construction business is way down, Mark has taken another job that pays him considerably less. He now brings home just enough to cover the house payment. He is still a member of the union and when building picks up, he will go back to wiring houses but for less money than he used to make. Sara’s hours have been cut so she is down to about $800 a month take home. She has tried to find full time work but has not been able to. The kids are in high school and the house seems small. They have burned through most of their savings and have already used up the retirement money they could get at. The financial strain is taking its toll on their relationship and they have to work really hard to keep a positive attitude. They are at the end of their rope and wonder what to do.
Barrier #1 - DAMAGE TO CREDIT Letâ€™s talk about the credit scoring system and how why that was barrier number one for Mark and Sara. The banks make credit decisions without emotion. These decisions are strictly done using statistical data from the credit scoring model. In a personal relationship, if circumstances beyond your control come up (like a lost job and an underwater home) you get an opportunity to go back the person you made the agreement with and you can make a new agreement. When dealing with banks and the credit scoring system, that is not possible. You are not dealing with a flexible entity like a friend or a neighbor. You are dealing with a machine that has no ability to be flexible or understanding. It charts its course and that is the way it will end up. No variation at all. The banks took this lack of flexibility to a new level about 20 years ago when they jumped on the credit scoring band wagon. The banks wanted an easy way to make credit decisions without doing any homework. Their goal was to remove the personality out of the transaction and reduce you to a number, representing the probability of whether you would pay them back or not. By eliminating the human element on both sides they would lower their costs. Side note: The government was the original driver of the credit scoring system. They wanted a way for credit decisions to be made without any kind of discrimination. What they got was an impersonal system that the banks used, not as a tool to eliminate discrimination but as a stick to beat the general public with. The modern credit scoring system captures all of your past financial life and loads it into a computer. It then constantly adds updates of your current financial transactions. The system is programmed to weigh certain activity negatively and certain activity positively and therein lies the rub. Anytime the banks and the credit companies want to achieve a different result, they change the algorithm (the formula) that spits out your number. To charge a higher interest rate, just reprogram the system to yield a lower number. Discrimination is now a built in feature and hidden from view. Of course, they will tell you that the formula is a closely guarded secret to prevent people from learning how to cheat it. Once they established that they can control your credit score and change your life based on your number, they had to establish in the hearts and minds of the American public that this number was critical to your success or failure. A low number could mean that you will not achieve the American dream. A high number means that all doors are open to you. The banks and credit companies have done an excellent job of giving your credit score a psychological value. They have figured out how to use your credit score for their own purposes that is far beyond their original intent. The banks now us it as a control factor for people making financial decisions. However, we are quickly approaching the time for many people where they will have to choose between their credit scores and financial 6
survival. From a financial perspective, the consequences of damaged credit are far less severe than you think and we believe before too long will be irrelevant. Here is what the DAMAGE TO CREDIT issue looks like for Mark and Sara. Most of us have grown up with the belief that if you agree to pay something you should keep your agreement. Mark and Sara were definitely in this camp. At first they would only look at the options (see: 9 Options for The Underwater Homeowner) that would not damage their credit. Since they did not have a big wad of cash, they didn’t have any options that would not damage their credit to some extent. They decided on option number three, to get a loan modification because that was what the banks and the government told them to do. Their lender/servicer (the company they make their payments to) told them in the first phone call that unless they were 2-3 months behind in their payments, the bank couldn’t and wouldn’t help them. So much for the idea of not damaging their credit. They looked at option number six, short sell their house. Fortunately for them, their real estate agent told them the truth about short sales. The chances of getting the bank to accept a short sale if they weren’t behind on their payments is next to zero. They decided to take a hard look at option number nine. Give the house back on their terms and keep the money. At first this did not sit well with them so they did some research. Here is the breakdown of the financial aspects of it based on their specific situation.
Mark and Saraâ€™s worksheet.
Giving it Back
Current Amount Owing:
Current Amount Underwater
Expected Value in 4 years:***
Monthly Payments Over 4 years
Tax Benefits of Owning
Total out of Pocket next 4 years
Amount still Owing in 4 years
Underwater Amount in 4 years****
Here are some of the assumptions made in the worksheet. *They would live in their house without making payments for a year before they had to move. If the banks acted as quickly as they could, the time could be shorter. If Mark and Sara knew how to stretch this process, it could be longer. We decided that one year was a good average. ** Mark and Sara did some research and found that they could actually rent a larger home than they currently have for $1,500 per month. This figure is based on renting for the remaining 3 years of this 4 year example. *** This is the value that Mark and Sara believe their house will be worth in 4 years. Your figures may vary based on your locale and your optimism.
**** As you can see here, Mark and Sara will spend $54,230 (over $1,100 per month more) to keep their house and actually be worse off in 4 years because they will be more underwater then than they are now. This shows you the actual costs associated with not damaging your credit, over a thousand dollars per month. In fairness to the argument, let’s look at the additional expenses in the future with damaged credit. At some point in the future Mark and Sara are going to need some different cars. If they financed those cars before they stopped paying on their house, there would be no additional costs. Another option is that they could use $1,500 of the $2,300 they are not paying on their house for a year and pay cash for a couple of newer model used cars. Let’s say they didn’t do any of those things and they had to pay a higher interest rate on two cars that they paid $15,000 each and financed for 60 months. They got $3,000 trade in on each of their old cars so they have a total amount financed of $24,000. If their interest rate was 5% higher because their credit is damaged, they would be paying an additional $100 per month for the next 60 months to cover damaged credit. That is a total of $2,400 in additional interest. Double this figure if you like. It is still a good trade off. Now let’s say they needed to use their credit cards. The credit card companies can no longer change the rate on your credit cards because your credit is damaged on another debt you owe. So as long as Mark and Sara have a credit card in good standing before they stop paying on their house, there will be no difference in the rate on the card. Again, in the interest of fairness, the credit card company may lower the amount of credit they have available to them. A little proactive move on Mark and Sara’s part in advance would take care of this. The big question on Mark and Sara’s mind was what would happen when they went to buy another house? Let’s look at that. First off, we fully believe that the credit scoring system that we have today will not look at all like the credit scoring system of the near future when it comes to buying a house. The banks are going to end up with between 10 and 15 million houses that they are going to have to sell. They need money, not houses. We believe they will change whatever rules they have to in order to sell these houses to anyone that can buy one. This is business and they have already proven this is the way they operate. The banks will change the rules to fit their needs. So they will change the rules so they can sell these houses to anyone who wants to buy them. They can change the credit scoring model very quickly, just by changing the formula. Let’s say that they decide to sell Mark and Sara a house like they used to have. In four years, the kids will be gone, (they hope) and the house they used to have, would work for them again. Mark and Sara decide to buy the same house back from the bank. But now they pay $145,000 for the house instead of the $295,000 they paid back in 2006. Interest rates are up to 7% and the bank wants an additional 2% because they defaulted on the previous loan. They do the same FHA loan they had before but the interest rate is at 9%. Their house payments are now $1,500 per month including taxes and insurance. If the bank 9
really wants to sell the house, they won’t charge the extra 2% which would make Mark and Sara’s new payment about $1,325 per month. Let’s say we are wrong and the banks hold it against every defaulting homeowner (over 15 million. That is a pretty big market the banks would have to alienate) and charge them a big penalty to buy another house. Even if Mark and Sara paid the penalty for a few years on the new loan, they would be able to refinance as their credit healed and get the best rate available in a relatively short period of time. So over the course of the 4 years, they damaged their credit and gave their house back. They saved over $54,000 in that time, rented a house that better suited them, got out from under the $100,000 that they were underwater and bought the same house back with a much lower payment. This is a much more accurate picture of the “damage to credit” barrier. You save so much money giving your house back that the minimal costs of damaged credit are insignificant in comparison. Again, it is about the money. Do the math.
Barrier #2 - THE MORAL ISSUE Sara said, “We agreed to buy this house and pay for it. No matter what happened, we agreed. We gave our word.” That is mostly true. In actuality, they signed a contract (promissory note) to buy the house and allowed the bank to use that note to put a lien on the property. In the olden days, when you wanted to buy a house, you went to your local bank and sat across from the local banker and he said, “You are going to pay us back aren’t you?” You said yes and you may or may not have signed something (Depending on how far back you go) explaining the agreement. You got your check and away you went. You knew the banker and you looked him in the eye and gave him your word. Today’s transactions are very different than that. The banks brought in their lawyers and they wrote up an agreement. The agreement contained all of the financial implications of the deal and what would happen in case of… The “in case of” is designed to protect the banks. They determined on their own, the terms of the deal, how much risk they were willing to take and what they wanted if things didn’t go as planned. When you went to buy your house, you did not get any say in the “in case of” section. You were presented with a huge stack of documents and you were told, “If you want the house, you have to sign all of these papers.” Chances are overwhelming that you didn’t even read them. Even if you did, you did not get to negotiate on any item in the whole thing. You signed what the bank prepared and put in front of you or you didn’t get the house or the refinance. If you did read all the documents, most people don’t understand all of what they are reading anyway. So what did you actually agree to? Of course there was the financial part explaining the interest rate, the amount you borrowed and the payment schedule. But along with that, the paperwork included the details of what happened in case everything didn’t go well. I am not going to put in the actual legalese (lawyer speak) in here. It gives me a headache to read it and it makes my fingers hurt to type it. In a nutshell, here is what you agreed to… 1. I the borrower will make my monthly payments and you the bank will leave me alone and let me live in relative peace. 2. If I the borrower don’t make my monthly payments, you the bank get the house and whatever other remedies this state allows you to have. Simplified, but accurate. The banks decided that they would make their underwriting standards tough enough that if they had to take the house back, they would be OK. You agreed to it, they agreed to it. That’s the deal.
Now back to Mark and Sara… They had to decide whether they were OK with choosing number 2 instead of number 1. Too many people wait until there is no other option and they don’t get to take full advantage of the financial gain they can make by living in the property for free. But now they had to ask themselves, “Can WE choose number 2 or does some outside situation have to choose it for us?” I recommended that they read Underwater Home: What should you do if you owe more on your home than it’s worth? By Brent T. White. Like most people, they didn’t want to spend hours reading a book reminding them of the trap they were in. I told them an example that Brent uses in the book. Do you have a cell phone? Most people do and if you do, chances are that you have a contract on the cell phone. The contract says you will get a certain amount of services each month for a specific amount of money. Let’s say that you pay $100.00 per month for your bundle of services. You have had the contract and phone for 2 months and you have 22 months left to go. You get a call from a competing company saying they will do exactly the same bundle of services and include an identical new phone for $50.00 per month. Wow, that is a much better deal, but you have a contract. (An agreement) You call your cell phone carrier and tell them about the better offer you just got and ask them to match it or at least make yours better. They flatly refuse. You have a contract with us and we are going to hold you to it. They go on to tell you (because chances are good you didn’t read that one either) the contract you signed has an “in case of” clause. If you want to get out of the contract, there is a penalty. You think to yourself, oh no, “I don’t want that,” but you force yourself to ask. “What is the penalty?” (Thinking that it has to be something really bad.) The person on the other end of the line says, “$250.00”. So now you know what the downside is and you can make your decision based on Option #2 and make a change. 22 months more on my current contract is $2,200.00. 24 months on the new contract is $1,200.00 plus the $250.00 penalty for a total of $1,450.00. I would save $750.00 for the same service. I’ll pay the penalty and change over. The question that Brent raises in his book is, “Is making this decision with the cell phone company a moral dilemma?” If this one is not, then why is there any moral dilemma in dealing with your house? The numbers are bigger and you live there but in terms of the agreement itself there is no difference when the moral issue comes into play. There are consequences to getting out of a mortgage just like there is on a cell phone contract. If you are willing to pay the penalty, why does the moral issue even come up?
Side note #1. Comment: You probably didn’t read that contract either. Please don’t think I am picking on you or talking down to you about whether or not you read the contract before you signed it. Almost nobody reads these things. However, that is the defense “they” always use when they want to hammer you. (Insert sarcastic tone) “Did you read the contract you signed?’ (Here is what they don’t say) We wrote it in lawyer babble so even if you read it, you wouldn’t understand it. We put you in a circumstance where there really wasn’t time to read it. Even if you did read it, the person asking you to sign it hasn’t read it and couldn’t answer any of the questions you had about it anyway. Finally, unless you have Superman vision, the print and the type are designed to make it really hard to read. If you are over 40, you would need a magnifying glass anyway. Side note #2. As we mentioned, each state has their own statutes regarding any other remedies the bank may have in coming after you if you decide to choose Option 2 and let them have the house back. If you are in a non-deficiency state, (for the most part, those states that allow non-judicial foreclosures) the only thing the bank can do is take the house back and damage your credit. They cannot come after you for any money they lose. If you are in a deficiency state, the bank can come after you if you stop paying and they lose money on the house. Do your homework so you know what can happen.
Barrier #3 – PRIDE Here is the dictionary definition-
pride [prahyd] noun, verb, prid·ed, prid·ing. –noun
1. a high or inordinate opinion of one's own dignity, importance, merit, or superiority, whether as cherished in the mind or as displayed in bearing, conduct, etc.
As Mark and Sara worked through barriers number 1 and 2, they were finally able to look at them with a forensic eye. They eliminated the emotion and took them on one at a time based purely on their merit. It was actually easy for them to choose to move beyond those barriers. They originally thought that the pride barrier would be the easiest of the three. However, they kept going back to what other people would think of them. They wondered how their family and friends would react. And, what would the neighbors say? They realized that the pride factor was the only barrier that was external to them. It involved the attitudes, opinions and beliefs of others. Pride is the mental game you play with yourself and other people. You want to think certain things about yourself and you want other people to buy into those beliefs. The question here that no one can answer for you is, what is it worth to YOU? The situation you are in with your underwater home is real and could be real expensive too. You will either have to pay the costs or you will have to deal with what others might think or say about you. In this world, if you have enough money, what others think or say may not matter. If you don’t have, then you have to settle in your own mind what is important for you and your family. Then make your best choice and move on from there. I don’t know a lot of younger people who are “comfortable in their own skin”. I do know a few older people who are. One of them told me this Chinese ProverbA wise man makes his own decisions, an ignorant man follows public opinion.
Conclusion Barriers are those blocks that get in the way of us being, doing and having the things in life that we say we want. For whatever reason, they are there to force us to consider the options and chart our own course of action. The deliberate effort necessary to overcome a barrier makes it monumental when we do finally overcome them. In our work with underwater homeowners, we spend a lot of time making sure that their situations and solutions are well thought out. Their future success and peace of mind both depend on it. As you take a hard look at your solutions for your underwater house, the barriers that naturally come up need to be investigated and not overlooked. It is for that reason that we put together this information. Over and over again, these three barriers surfaced and people needed to talk through and think through how each one would affect them. As you can tell from the information provided here, we donâ€™t believe that any of them should stop you from doing whatever you need to do in order to protect your family and your financial future. There are those that would disagree with us, but we have found that they disagree with us for reasons that are in their own best interests, not those of the underwater homeowner. Please consider your options carefully and get all of the information available before you act. Donâ€™t allow someone to give you one or two options and offer partial explanations on those. This is a big decision and not one to be take lightly. For more information about how we can help you develop your own strategy and put it into use to give you a Financial Revival too, call us at 888-656-8850 or visit our website at www.FinancialRevivalGroup.com. If you a facebook user, you can like our page to get updated information about changes in the laws and our newest strategies. www.facebook.com/financialrevivalgroup.
As a special bonus for homeowners who need some help, we offer a 15 minute no obligation phone consultation with one of our coaches. We will discuss your particular situation and answer your questions about the 9 options you have in dealing with your upside down mortgage. Call our office at 888-656-8850 and schedule yours today.