Tuesday, May 22, 2012

Being Underwater (the no home equity syndrome)


While many "experts" talk about the foreclosure crisis and vacant homes as the major problem facing South Florida, I believe that another phenomenon is also causing the extreme economic problems we have related to the failure of the real estate market to recover.  That is the problem of "underwater homes."  Underwater homes are homes whose value is less than the debt owed to any lender who has a lien on the property.

For example, in the simplest case, a person who has a house worth $260,000.00 and a mortgage to a bank in the amount of $278,000.00 is considered underwater.  The sample property has negative equity of $18,000.00, and will remain underwater until either the value rises or the principal balance of the loan declines.

Statistics by various groups show that in Florida, of the roughly 4.5 million homes, over 2.1 million are underwater, or 47% of all owners.  This is more than double the national average of 20%.  With this many homes underwater, only one in two owners can consider moving to a new home, whether to upsize or downsize, or to move for a better or new job.  Owners are literally trapped in their homes, without the ability to move.

As stated above, the only way this issue will be resolved is if values rise or, over time, the mortgage balance goes down.  However, in most cases, especially over the next five years, neither factor will likely have an effect.  Currently, values continue to fall, meaning the home above will likely be worth even less come next year, when most experts expect the prices to bottom out before a slow, gradual rise over the next ten years.  If prices decline another ten percent and then rise at three percent for five years, the example home will be worth about $275,000.00 in 2017.  If the person continues to pay their original $300,000.00 mortgage at 6% they took out in 2006 they will owe about $244,000.00.  So, wait six years and you have positive equity of $31,000.00.

Unfortunately, when the experts talk about homes being underwater they forget one crucial issue in South Florida, the cost of sale.  For a typical seller in Palm Beach County, they will have to pay a myriad of closing and proration costs in order to sell their home.  These costs include a real estate commissions, documentary stamp tax, title insurance premiums, real property tax prorations, and unpaid interest (mortgages are paid in arrears, so that June 1 payment you make is for interest in May).  So, given a $275,000.00 sales price, here is the breakdown at a June 30, 2017 closing:

Sales Price:                                                     275,000.00

          Commission                                           16,500.00
          Title Insurance                                         1,800.00
          Documentary Stamp Tax                          1,925.00
          Tax Proration Credit                                2,500.00
          Loan Payoff (includes unpaid interest)  245,221.00
        
          Net to Seller                                          $7,054.00

So while our patient homeowners will get about $7,000 at closing, they will be $33,000.00 short of the minimum twenty percent down payment due on their next $200,000.00 home.  For many people, the figures are worse, as they carry both first and second mortgages.  With these problems, most people who use their homes as springboards to new homes are stuck, which only further deflates the market.  With a total cost of sale at almost 9% it becomes clear that more than half of all homes in Florida are underwater.

For homeowners in this current situation, there are some actions that can be taken to address this dilemma.  First, a program of accelerated payment of the mortgage debt can be made.  One option is a bi-weekly mortgage payment, rather than paying monthly.  This will result in an annual payment of one additional payment per year, which could reduce the loan pay-off over five years by almost $10,000.00.  However, most banks charge fees and costs for these programs which eat into the savings, especially in the shortfall.

Paying additional principal each month can also act as a forced savings plan.  For example, if the monthly mortgage payment is $1,700.00, paying a round $2,000.00 per month will result in $18,000.00 in principal reduction over five years.  Refinancing to a lower interest rate (anyone over 5.75% should consider this) would accelerate principal reduction as well.  If you are underwater due to a large second, but the first mortgage is less than 80% of your house value, you can still refinance if the second mortgage holder cooperates.

Finally, making small changes to the home over the next five years can increase value.  Paint, cabinets, tile and the like increase value, plus make the house more enjoyable.  After all, with the home underwater, you might as well enjoy it as you will be living there a long time.

Michael Posner, Esq., is a partner in Ward Damon a mid-sized real estate and business oriented law firm serving all of South Florida, with offices in Palm Beach County.  They specialize in real estate law, and can assist owners and lenders in all real estate matters.  They can be reached at 561.842.3000 or at www.warddamon.com

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