Home Value has Dropped – What to do?
I got a question from a friend recently who is planning on moving out west. He and his wife are trying to sell their home. But the value has dropped since they purchased it. My friend wanted to know if I thought he should sell the house now or wait. This is a situation that many people are facing right now due to the recent housing market bust. In this post I will provide my opinion to the question “My home value has dropped, should I Sell Now, Wait, or Should I Rent my home until the market improves?”
I have actually been asked this question several times in the last year. What these people are really asking me is will home values increase in the next year or two. My opinion is no, I do not think homes values are going to increase for several years. And I say this as someone who owns a lot of real estate. But I do not have a crystal ball. I do not know for sure. However, if I had to make a large bet about when the real estate market will return to its mid-2000s high, I would bet it will take 15 years or longer. The good news is today (2011) five years have already passed.
Why do I think this? The main reason is history. The recent housing market boom and bust is the third one I have lived through. In the late 1970s the Washington, DC area saw a real estate bull market. It ended in the early 1980s when the Federal Reserve rapidly increased interest rates to combat double digit inflation that the US was experiencing at the time. For example, in 1981 30-year fixed rate mortgages got as high as 18%. That quickly cooled the housing market. In the late 1980s the DC area went through another real estate boom that ended with the savings and loan crisis. In both cases, after the market bust, home prices did not return to their previous highs for about a decade.
However in the 1970s and the 1980s home prices did not get nearly as overvalued as the most recent housing bubble. There were no “Sub-prime” or “No Documentation” loans. Lending standards got so lax in the years from 2000 to 2006 that, short of being a felon and still in prison, virtually anyone could get a loan to buy a house. This created a much bigger housing boom and has resulted in a much bigger bust. The fact that the recent housing bust was much bigger than the two previous housing downturns and the fact that mortgage loan qualification standards are much stricter now makes me think that home values will take much longer to reach the high water mark attained in the mid-2000s. This is why I feel that, from a purely financial standpoint, there will be no advantage to waiting to sell your home a year or two from now.
That being said, the next question that arises is, rather than sell your house, should you convert the property to an investment by renting it out. This is an option, but in my opinion, there are three things you need to ask yourself before doing this:
- Do you really want to be a landlord?
- Can the property be rented out for more than the expenses to operate the investment?
- Are you prepared to keep the investment for the long term (meaning at least 7 years)?
If you cannot answer “yes” to all three questions, then I think it is better to sell your home today and try to get as much as you can for the property. Remember, you may sell your current home for a lower price than you bought it, but when you go to buy another property, it will also be lower in value than a few years ago. In reality you will not gain or lose money if you sell now and then buy another property to live in.
What should you do if your home value is “underwater?” That is, your home has dropped in value so much that the value is lower than the outstanding mortgage balance. Being underwater means in order to sell the property the owner must bring cash to the settlement table to pay off the mortgage as the sale proceeds will not provide enough funds. This is a very difficult situation that many people find themselves in.
Every person’s situation is different so there is no one right answer. However, if I had a home that was underwater and I was offered a decent job in another city and I did not want to convert my home to a rental, I would make my best effort to sell the property using a professional realtor. If, after a period of time, it is obvious that the property value is significantly underwater; I would then have a conversation with my lender.
Many lenders are now agreeing to “short sales.” A short sale is where the lender agrees to allow you to sell the property at a price that will not provide enough funds to pay off the current mortgage balance. The lender takes the loss on the difference from the sales proceeds and the outstanding mortgage balance. This allows you to lower the property sale price to a point where you can attract buyers. This is good for you because now you can sell the property and you do not need to bring any cash to the settlement to complete the sale. Getting the lender to agree to a short sale before finding a buyer would be best, because most buyers will not want to wait what could be a lengthy period of time for the lender to give an approval to a short sale.
Upon your short sale request, the lender will evaluate your particular situation. It may take several weeks or months to get an answer back from the lender. Because of this I would start the process early after listing your property for sale. If the lender even considers allowing a short sale, they usually want to you to try to sell the property first to be sure you cannot sell the property for enough to pay off their loan.
Why would a lender agree to a short sale? Well, of course, they do not want to do this and many will not agree to it. But each lender is unique. So it is worth asking as some will agree to it. Lenders are business people and they are looking to minimize their losses. If the lender comes to the conclusion that they will have to take back your property in foreclosure and then sell it for the lower price anyway, they may lose even more money than if they allow you a short sale. By the time the lender takes a property back in foreclosure, the property often needs a lot of repair work. Lenders do not want to deal with foreclosed properties. They are in the business of lending money not managing and selling vacant houses.
If your lender does agree to a short sale, it is not cost free to you. You will take a hit to your credit rating which will bar you from buying another house for a few years. You also could incur a tax liability as loan forgiveness is considered a taxable event for the borrower by the IRS. This is why I would not do this if I only had to bring a small amount of cash to the table to sell my house. I would only go the short sale route if I my home value were significantly underwater by an amount that I could not pay off at settlement and the amount would take many years to pay down. Asking your lender for a short sale approval is something you should think very seriously about before going this route as your credit rating affects many areas of your financial life not just your ability to obtain a mortgage.
The last few years have been a very difficult time for real estate and many people have soured on owning any real estate. But home values will eventually recover; I just do not think it will be anytime soon.
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