What is your Mortgage Exit Strategy?

Unless you have a long term fixed rate mortgage, you should develop an exit strategy.   An exit strategy is a well thought plan on how you’re [photopress:airplaneexit.jpg,thumb,alignright]going to leave your current mortgage.  Every time you board an airplane, the Stewardess reviews the “exit strategy”.   They’re not planning on an actual emergency landing, they are simply preparing you for a worse case scenario and informing you where the exits are and what you need to do in that event.  

You should have a plan if your current mortgage is:

Having a plan (being prepared) does not mean waiting until you receive a notice from your mortgage company that your mortgage payment is hiking because your fixed period on your ARM is over.   You need an exit strategy because once fixed period is over and your mortgage adjusts, odds are that your new mortgage payment will not be desirable or affordable.  

You need to start developing your plan well in advance.    Here’s what I recommend:

  1. Find the Note for your mortgage (deed of trust) and determine what your new rate may be using the worse case scenario.   If you have an ARM, you can figure this out by adding the first cap to your interest rate.   For example, if you currently have a 5/1 ARM with a note rate of 5% and the first adjustment rate cap is 5% (5/2/5 is a common cap structure), your new rate could be 10%.   If the first adjustment cap is 2% (2/2/6 is another possibility); your new rate could be 7%.   If your ARM has an interest only feature and will also be converting to amortized payments (some have longer interest only terms beyond the fixed rate period), you’re in for a double whammo if you’re keeping the mortgage.
  2. Determine what your worse case payment may be.  Your new payment will be amortized over the remaining term of the mortgage.   Use an amortization schedule to see what your mortgage balance will be at 60 months (using the 5/1 ARM scenario) and figure your payment based on the maximum possible rate amortized for 300 months.   This new payment does not include taxes and insurance.  In fact, anyone with an adjustable rate mortgage, regardless how long the remaining fixed term is, should contact their LO to determine what their “worse case payment

97 thoughts on “What is your Mortgage Exit Strategy?

  1. If someone doesn’t have much equity in their home and are facing a large, unafordable, mortgage payment increase in the next couple years might be better off just waiting for appreciation to grow their equity before re-financing. But who knows, maybe appraisers in the Seattle area will see appreciation in even recently acquired homes, allowing people to realize their growing equity (and re-finance) right now.

    Of course, it is unclear if there are many home-owners in Seattle or the Eastside who would face such a problem with difficult re-sets. We have a low number of sup-prime borrowers in this area, and just the fact that a large number of people here have 100% interest loans doesn’t mean the terms on the loans will lead to large resets.

    From what Rhonda and Ardell have said, it sounds like these 2/28s, and Option ARMs, are pretty much a phenomena only in the outlying areas beyond Seattle and the Eastside (i.e. neither of them have done much business with Option ARM customers). So we likely don’t have much to worry about here. Also, so long as we continue to have appreciation then it’s no big deal for over-indebted home-owners to re-finance or sell to work out problems.

  2. I’m 1 year into my 5/1 ARM, my first mortgage. There’s pretty much no way I’m going to live here 5 years. Am I naive in thinking, oh I’ll have sold way before then, and if I haven’t, I’ll just refinance?

  3. “Also, so long as we continue to have appreciation”

    This line of thinking is what’s going to financially harm so many people. I really hope people take Rhonda’s advice and start looking into contingency plans.

  4. Tatarin,

    So long as the Seattle area continues to see appreciation over the coming years then you shouldn’t have any problem either re-financing or selling. Of course, if you have significant equity already that already puts you in good stead.

    The only way people could run into trouble is if they have little or no equity and appreciation slows or declines. In such an eventuality (which everyone says is unlikely in Seattle, even if the rest of the country loses 15% or 30% of value on average) people with little equity will be unable to sell or re-finance.

  5. Hi!
    I’m so glad you brought this up. I thought I was the only one planning their lives around a mortgage exit strategy.

    In 2005 we bought a fixer up in Bellevue for $310k on an 80/20 interest only on a 5/1 ARM. Not long after we refinanced the 2nd to a 15 yr. fixed at a lower rate.

    This is most likely a forever house for us so we had planned on refinancing to a fixed once we got through a portion of the remodel but before the 5 year mark.

    Earlier this month we finally refinanced both into one 30 year fixed. This was looming over our heads the since the day we moved here, we’ve put off vacations and new cars and all kinds of things to work on the house and be able to refinance at 80% or less before the “cut off” date. Which we were so yay!

  6. Shane,

    Two points:

    1) who is going to be hurt in the Seattle and Eastside areas if there is some price deprecation, aren’t most home-owners in this area flush with savings and equity, and able to easily weather a downturn?

    2) From what most real-estate professionals, and commentators, in our region seem to be saying (e.g. Sandy, Deborah, Ardel), the idea of actual depreciation in Seattle or the Eastside is a bit alarmist. Our employers are strong, and the severe shortage of new building to meet the growing (highly paid) population ensures appreciation far into the future.

    By the way, I am NOT saying that I personally believe Seattle area deprecation is impossible, I am just pointing out that I haven’t seen anyone in the local real-estate industry tell people to postpone their purchases because prices are going to be a bit lower in the next year or two.

  7. Sniglet, I don’t believe I’ve ever said “2/28s, and Option ARMs, are pretty much a phenomena only in the outlying areas beyond Seattle and the Eastside”. You are correct that I have never provided an Option ARM to clients. This doesn’t stop someone who really wants one and who doesn’t like my advise from going down the street to another LO who is all too happy to provide a neg. am. loan.

    I have done 2/28s and other subprime mortgages. Here’s a link to a past post I did regarding my business from March 2005-March 2007 http://www.raincityguide.com/2007/03/21/it-may-not-be-your-businessbut-it-is-all-mine/. Approx. 25% of my business at that time could be considered “non-prime” (scores under 680 and higher ltvs). After March, subprime business began to slow down (back in February I did a post regarding that “no love for the subprime borrower” which also addressed this issue).

    Sniglet, are you baiting me with “as we continue to have appreciation”?

    Even if we did continue to appreciate (which it is not and will not stay how it has been in the past few years IMHO) at a modest figure, borrowers still have the issue of having to qualify for fewer mortgage programs. Appreciation does not matter. However, depreciation impacts the situation far more.

  8. Tatarin, you may not need to refinance if you’re certain you’re going to sell in 4 years (the remaining term of your fixed period ARM). Consider your monthly savings with your ARM over the current 30 year fixed mortgage (low 6s).

    I still recommend learning what your worse case payment will be. Information and knowledge is key–even if you don’t plan on having the mortgage at that time.

    Everyone should now the terms of their mortgage.

  9. As I think about this more, I think much of this debate comes down to one thing: is it reasonable for people to consider the possibility of home price deprecation when making mortgage exit strategies?

    If it is recommended that people actual factor home depreciation into their exit strategies there could be people who find they don’t have very good options (i.e. they should just sell fast before it’s too late). But would we really want people to sell their homes just because there is a POSSIBILITY the home could lose 3% of value in the next few years (which could put someone under-water who has little equity, and make re-financing impossible)?

  10. Thanks, Rhonda. Excellent advice. I did this math last year, and I’m comfortable with the worst case on our 7/1, 5/2/5, 5% coming due in 2011. I’m 99.9% sure we will have sold by then, but if the market conditions change radically, that may somehow force us to stay, so it’s nice to know we can still afford it.

    My Q: I don’t have one, but are pre-pays only for refis or would you also be dinged for a sale?

  11. “the idea of actual depreciation in Seattle or the Eastside is a bit alarmist”,

    It’s a real balancing act. No one knows 100% how this market is going to shake out. Seattle has been lucky so far and I think we lag behind other large cities in the nation. Will we escape completely unscathed? I don’t think so. I am hoping that we come out better than others (of course) due to the stats that the “other professionals” you mention state and that we’re lagging behind. Eventually more lending products (more common sense versions) will return and so will the buyers.

    It’s the timing that is uncertain.

    There are still jumbo loans. The rates historically are still low. It’s just a shocker how quickly they increased. Buyers who relied on interest only for qualifying for jumbo loans are SOL.

    FHA is a great option for those who are willing to start out with a true starter home (by my definition) and not a “move up home” that fits the current loan limits. FHA is not credit score sensitive; it’s based on credit history. I have been doing more FHA loans lately to refinance people out of subprime mortgages.

  12. Biliruben,
    It depends on the type of prepayment penalty. There are “hard” and “soft” prepays. Hard prepays penalize you regardless of if it’sa refi or sale. A soft prepay is only charged with a refi.

  13. Sniglet, re: comment 9. This is why home owners with ARMs need to know what their “worse case payment” will be. Then they weigh out all the stats…you need to have as much information as possible before you can make a true decision.

    1) How long do you plan to stay in your home?
    2) How is your credit, employment, equity, assets–do you qualify to refinance now or do you need to do some elbow grease to get in a better position?

    My point of this post is that (even if we weren’t experiencing these current times in the mortgage industry) EVERYONE should know their worse case payment, be a financially responsible home owner AND managing their credit.

  14. Sniglet,
    Of course “no one is telling people to postpone purchases because prices may be a bitlower in next year or 2”.But I think thats going to dawn on them soon.
    The lenders will be taking the D.B. Cooper exit strategy.

  15. sniglet, I agree with Rhonda here. I think owners are worried about more than foreclosure. Appreciation is not going to be enough for many people to stay in their homes if their credit scores and finances aren’t in a good shape. The reason is that they will not be able to qualify for a re-finance and will endup having to sell their homes at best and face foreclosure at worst. I think it’s excellent advice to look over your situation if you have an ARM and how to get out of it independent on what happens to home prices or anything else for that matter.

    And yes, you should absolutely factor in a possible depreciation when making an exit strategy. But it should be based on your own evaluation not anyone else’s.

    I think you are baiting to see if you can push Rhonda and Ardell to admit that depreciation is in the cards. That would be ok if your wording wasn’t at the same time telling people not to worry about a very serious situation.

  16. R Duke, many LOs may not make it that far. Out of the 15,250 LOs who have registered, only 700 have taken the exam. (This is for Licensed Loan Originators. LOs who work for bank-mortgage companies are not licensed).

    If a LO does not pass the exam by the end of the year, they will no longer be licensed and will either need to go work for a bank-mortgage company or go back to doing what ever they were before they were a LO.

    I’ve scheduled my exam for September (cross your fingers for me). 🙂

  17. The other factor, which Maria touches on, is what is your personal tolerence for risk? If having an ARM right now is “looming over our heads the since the day we moved here”, it’s probably not the best program for you.

    Maria did the responsible thing by making choices with their finances like “we’ve put off vacations and new cars and all kinds of things to work on the house and be able to refinance at 80% or less before the “cut off

  18. Sniglet,

    1. Honestly I have no idea their financial condition. Many of them probably do have more real wealth to weather a storm. However this country overall has been living off debt for too long, this housing boom was caused by easy access to credit. I bet plenty of eastsiders bought more house than they can afford, cars they can’t afford and took vacations they can’t afford. Don’t confuse flashy toys with with wealth, some of those people are just buried in debt.

    2. Employment does look ok for now. I work at one of the companies often mention, Boeing, and we are in pretty good shape. Airlines still are not that strong overall, any disruption (Recession) will cause them to go into the red again. Orders can disappear at any time.

    As for Realtors saying everything is fine . . . well they are salesmen. That’s all. Everything is always ok with them, its always a good time to buy and sell. They make money if people are buying and selling. The public panicking and refusing to buy/sell is disastrous to their bank account, therefor the try to maintain the cheery disposition in the face of chaos.

    A good Realtor is probably great for help picking house A or B in some market, but from what I’ve seen on this board and others they seem clueless to the bigger picture. This housing boom was caused by easy credit, easy credit from around the world. That’s why the “housing is local” tag line does not work right now. Investors around the world are wising up and no so eager to loan money to Americans that won’t be able to pay back their mortgage. Watch the credit markets to see where we are going. Maybe we will return to the easy money of the past few years, but I doubt it. This is just starting.

  19. Shane, I would also add that many agents and LOs have never gone through something like this before. These are “historic” times in the mortgage industry. It’s natural to hope for the best or wish this will over soon…I think it’s better at this point to “hope for the best” and be prepared for “the worse”. This doesn’t mean taking action right now (refinancing or selling).

    I do mean: learn about your mortgage now.

  20. I think it has become clear to almost everyone that the loose lending standards is what caused the credit market problems and the distressed home buyers. I take it for for very unlikely that standards will become that loose again in a very long time if ever again. The risk is probably about the same as that we get a dot.com bubble again. We will for sure get other speculative bubbles and probably even more housing bubbles but most probably not due to loose lending standards. At least I would hope so.

  21. For those who believe that the sub-prime market has little impact locally (Puget Sound Area in general) should read this:

    1) 71% of the purchase sales our office closed were financed 100% (82/20 deals or equivalent) in 2005 alone. (many are resetting in the upcoming months). In 2006 100% purchase transactions were down slightly until 4th quarter in which it starting dropping moreso.

    2) As of today our refinance business is down by nearly 70% YOY.

    3) There are colleagues of ours going out of business and/or choosing to leave now.

    4) I am aware of a few situations in which recent borrowers (over the last two years in particular) are facing serious financial problems due to serial refinancing and debt loads.

    5) There are indications of title companies shifting staff and consolidating units. I would expect that if the softness continues, that layoffs will be occuring in the near future.

    6) For many, financial distress due to highly leveraged housing will occur in just a flat plateau for an extended period. That’s all it will take. Forget about slight declines, all it will take is just a no appreciation climate.

    If existing borrowers have the capacity to move out of toxic problem loans, they should be making plans today. After participating in and seeing what our office closed over the last three years, there is no persuading me to think that the housing debt ATM problem will spare our area.

    There are a lot of loan officers as Rhonda mentions, that have ZERO experience in market shifts. Geez, if you think about it, NONE of us really has experience in something like this correction nationwide. But experience we will get.

  22. Tim, why do you think your 100% ltvs were so high? Do you think it’s demographics (I had more zero down in south King County than Seattle/Bellevue)?

    “But experience we will get”. I love that…I’m going to have a few more grey hairs after this market…but I’m planning on sticking around.

    Both of my sisters are wholesale mortgage reps. Both are great (yes, I’m biased) and both are concerned. Who wouldn’t be?

    I had a good friend call me from a bank-mortgage company curious what it’s like to be a mortgage broker. I corrected him and said, as a correspondent, if we have a lender we’re working with who just closed their doors or who is no longer offering a product, we can react quickly usually without the borrower even knowing that we’re jumping through hoops behind the scenes. He then asked claiming he was in no way trying to recruit me 🙂 if I thought I’d be better off working at a “big bank mortgage company” since some are still doing some alt-a or jumbos. We compared products and I still have the same as he does at the same rate (and I would probably lock the loan where he’s employed!)…I told him nope. I like it where I’m at. He was a bit stunned (he’s at a bank that’s doing fine so far). I asked him, how would he feel if he was working as a LO at Countrywide?

    I like where I’m employed at…quite a bit! (Even if I am working for family!)

  23. Well, the majority were Snohomish Co, but I’ve had 100% deals where consumers were employed at BF Goodrich Aerospace, MSFT, Fred Hutch, Amazon, Costco, Boeing, etc…and bought in Ballard, Northgate, Bellevue, Kirkland, Bothell and so on. It’s not like all of it was north of 205th up in Sno. Co.

    For crying out load we even closed 100% deals in Wenatchee and Ephrata.

    And we are a small fry. Think about what the title companies were closing. Makes your eyes bug out.

  24. Yes, I admit to a little “baiting”, of a mild sort… The thing I enjoy the MOST about Raincity is hearing the industry professionals give their own take on the state of the market (on a real-time basis), and I’ll admit to trying to encourage some responses of that nature now and again. 🙂

    I figure it’s more polite to talk about how great things are, hoping someone will challenge me if they don’t feel they are, rather than going on about doom and gloom. To a certain extent I don’t want to be overly negative in my Raincity posts, and thereby bias the responses in that direction.

    But I try and take care not to put words in people’s mouths. I do recall reading posts from a variety of Raincity bloggers who talk about how they feel our economy is good, that they haven’t worked much with people using exotic financing, etc.

    Anyway, I appologize if I have offended anyone.

  25. I’m not offended. I just sensed a wee bit of sarcasm. 😉

    It is interesting to see all the different views and reactions…not just from the RE professionals at RCG but everywhere. Even my neighbors reactions have interesting. I think one wants to start bringing over casseroles because she’s worried about us since I’m in mortgage (she always looks at me very concerned) and the other one thinks I almost predicted this (we walk together in the a.m.s and when I told first told her what was going on, this was not what she was hearing from her r.e. friends. At the time, I sounded nuts to her). Both neighbors still believe that Seattle will escape decreasing values…time will tell.

  26. Perhaps if people had just purchased what they could afford with conventional financing (20% down, 30-yr fixed…remember those?) we wouldn’t be in this predicament.

  27. Jared,

    Unfortunately, many of the people following your advice have just had to stay out of the real-estate market for the last 10 years or so because they could afford to buy. In fact, it was precisely to ensure that these people of limited means wouldn’t be priced out forever that all these new mortgage products were created, and lending standards lowered.

    Actually, it’s hard to think of a good reason NOT to take advantage of easy money and buy the most expensive place you can. If prices keep appreciating you will get rich. If the market tanks, the worst that happens is that the lender takes back the house and your credit rating gets trashed. That’s a small price to pay for the opportunity of living in luxury for a while and possibly making a windfall.

  28. Rhonda,

    You’re right about the FHA/VA loans. I should have been more clear about “conventional” (which may include FHA/VA) as opposed to the “unconventional” ARMs, Negative Amortization, I/O, balloon payments and every other mode of “creative” financing we have seen in the past few years. It would be interesting to see what % of people utilized these products even though they could afford traditional financing verus those who were too strapped to qualify for conventional financing. My feeling is that there were some people in the former category but most are in the latter. It will be interesting to see how all of this affects the Seattle market.


    I disagree to a certain extent that many of the people buying in the last 10 years could not have done so without unconventional financing. I bought in late 2003 when it was still possible to have your ownership costs come out to about where your rental costs would be. Good luck with that today. I know lots of other people who were of modest means and were able to buy 5-10 years ago without any problem and before all of the loose lending manifest itself. Now it’s completely different story.

  29. With all the news and the markets people actually think there is going to be “continued appreciation”? Wow…. very suprising. I more than likely will be buying soon due to certain circumstances but I dont see any appreciation for say the next 3-5 years. It will go negative, It cringes me to buy but its a family home and we will be posting up for a very long time as well as getting a decent deal on the property. Good luck to all but take off the rose colored glasses.

  30. Jared, during the past 10 years, one could also do 5 and 10% down with pmi. I agree, it would be interesting to know how many used interest only to qualify vs. convenience. I’m not aware of stats on that. My first home was FHA and then we used the proceeds for the down payment on our next house and so-on and so-on. I can’t remember how much we put down on the second home or third (and I was in title ins.–not lending those days).

  31. FHA/VA/USDA are definitely on the rise. I’ve seen 5 FHA loans in the past 2 weeks. It’s amazing how fast that’s moved as well.

    One thing people should look into (those buying in Pierce and Sno Cty) is USDA loans. These are better than FHA and are zero down. The morgage insurance premium is a LOT kinder.

  32. magnolia44, I’m not sure who’s commenting about “continued appreciation” (I did a page search and I’m only seeing your quote).

    People don’t always buy homes for investment/appreciation. They are homes to live in and there are other motivations besides financial. I agree, I would not recommend a client counting on double digit appreciation.

    Plan for tougher times and if we just get bumped a bit, count yourself lucky. If what the rest of the country catches up to Seattle, then at least you’re prepared.

  33. You know the advise seems sound on the surface. What troubles me is it seems to gloss over the fact that the problem loans were qualified on lower teaser rates that more often than not will be impossible to service when reset. The resulting payment is simply not remotely feasible regardless of the sacrifice one is willing to make to try. Without appreciation these people are for the most part screwed and any LO with any experience knew it, right?

  34. Stephen, whenever I had an option for caps (such as the the 5/1) I would let the client make the choice if there was a difference at all in rate. Usually there is only a slight difference in fee/rebate. If there was not a difference in rate, I would select the caps with the lower first adjustment (2/2/6 vs. 5/2/5) and explain to the customer why.

    With the 3, 5, 7 and 10 year fixed period ARMs, I would only advise clients to proceed if they were not planning on retaining the mortgage for that length of time. Sometimes a client would insist on the ARM because of the lower rate. I cannot force someone to select a 30 year (or other fixed) program. They understood they would need to refinance out of the ARM if they wound up not selling the home when the fixed period was over.

    And just yesterday one of my past clients called me to refinance out of her ARM. I was in my car so I didn’t have her info handy, I said, “Sally, if memory serves me, I thought we selected a 30 year fixed for your last mortgage?” She replied, “Oh yes, you did. I refi’d later with an ARM and now it’s going up on me”. This was a person who truly needed to stay in the 30 year. I’m not sure how she wound up with another mortgage and I’m going to try to help her…when we helped her out of her last mortgage it was a small miracle and times were easier for lending.

    Some LOs are very slick and I’m sure did not explain caps and provide their borrowers all the information they would need in order to make the right choice with their finances. This is why its so important that consumers select a Mortgage Professional not by rate alone or odds are, you’ll wind up with Slick and wondering what happened later on.

  35. Re: “since the day we moved here, we’ve put off vacations and new cars and all kinds of things to work on the house and be able to refinance at 80% or less before the “cut off

  36. “I cannot force someone to select a 30 year (or other fixed) program. They understood they would need to refinance out of the ARM if they wound up not selling the home when the fixed period was over.”

    But that’s the rub. I certainly am not picking on you personally. There was a time when the lender did force the borrower to have a mortgage they qualified for, meaning for the life of the loan they could be reasonably assumed capable of making the payments.

    The overall approach that investors always want from the folks that are spending their money is that it’s treated like it’s their own. I think we would all agree that the vast majority of the problem loans would never have been written if this fundamental approach had not gotten sidelined.

    At what point did LO’s and lending companies in general become more sales oriented to the point of losing control of the transaction?

  37. “At what point did LO’s and lending companies in general become more sales oriented to the point of losing control of the transaction? ”

    When they stopped holding the loans on their own books and started selling them off as Mortgage-Backed Securities in the secondary market, where it was no longer their problem (to a point). As long as investors were willing to buy these MBS products, there was little disincentive to do anything but pump out as many loans as possible, regardless of the individual’s ability to repay them. Basically, the more loans the institutions made, the more money they made and the risk side of the risk-benefit ratio in any loan transaction all but disappeared for the lending institutions…or so they thought.

  38. What would a good “exit” stategy be for someone who’s home is under-water (i.e. is worth less than the value of the mortgage)? Is it even worth the attempt of keeping up mortgage payments?

    So long as the legal implications aren’t too terrible (which can vary state by state, and particular loan terms) maybe people who are under-water should just walk away: even if they can afford to keep making payments. I have read that lots of people in California are doing just that, and then renting nicer homes with lower monthly payments than they previously shouldered under their mortgage.

    Interestingly, this (i.e. walking away from a home that is under-water) is exactly what Jim Cramer recommended a few weeks ago.

  39. I’m not sales oriented. My objection is to provide my clients with the right mortgage the first time. I don’t want to have to refi them again and again. I was really dissappointed to learn that my past client is now in an ARM when I had her in the appropriate mortgage before. I take a financial planning approach to one’s mortgage and I provide information to the borrower so THEY can make an educated choice. No one can force someone into a mortgage.

    I do think that most LOs are sales oriented. And I’ll bet that a lot of those “mortgage retail sales people” (as Jillayne calls ’em) will be leaving the industry and go back to selling what ever it was before (shoes, hot tubs, cars…what ever).

    I’ll also defend ARMs. They are not bad mortgages when used in the right scenarios…what can be bad is a slick LO dishing out bad advise, if any.

    In defense of some LOs, I’ll have consumers call me insisting on a certain product. A few months ago, I had one wanting 100% 80/20 where the first mortgage was a 3 year I/O ARM with an I/O second. They had excellent credit. They were intending on selling it before the 3 year period and had no intentions of applying additional funds to principal during this time or making significant improvements to the home to where they MIGHT have appreciation. We did not wind up working together. I think they did not appreciate that I was wanting to understand their mortivation so that I could provide my opinion on their mortgage, they just wanted a “mortgage dealer” to provide a rate and program.

    Consumers can be their own worst enemy, too. Regardless of how much good information a Mortgage Professional provides them, some become stuck on an idea of what they want and will not listen to reason.

  40. “There was a time when the lender did force the borrower to have a mortgage they qualified for…”

    The lender doesn’t “force” the borrower to have a mortgage they qualified for…” The purchase and sale contract between the buyer and seller does. If the mortgage contingency doesn’t put some limitations on the type of loan, then the buyer must proceed or lose his Earnest Money, unless he can’t get a mortgage on any terms and at any rate.

    When the norm was for homebuyers to get a 90% loan with PMI, the mortgage contingency would specify the rate at which the buyer was obligated to proceed. Say the “going rate” was 6.25%. The finance contingency had a write in cap rate of say 6.75%, meaning if the rate at time of approval jumped to 7%, the purchaser had a “legal out” to cancel. This way if the approval basis was not “A paper”, the buyer did not have to proceed at a significantly jacked up rate or “exotic” loan terms. The contingency also set the term, like “buyer must proceed if he can get a 30 year fixed mortgage at a rate not to exceed 6.75%. The rate was usually 1/2% higher than the going rate at the time the offer was written.

    When people started using 80/10 mortgages instead of 90% one low rate mortgages, these caps disappeared, as the rate on the second was always in excess of the standard “cap”, to eradicate PMI. This left buyers being forced to accept any loan on any terms, or be in breach of their obligations under the terms of the agreement with the seller. To a large extent, the “culprit” for the sub-prime fiasco is the elimination of PMI and the replacement of PMI with high rate seconds. Though two rate caps could have been used like “no higher than 6.75% on the first or 8.50% on the second, it wasn’t. The borrower protection as to rate and terms was simply removed from the contract in its entirety.

    Lenders can’t “force” anyone to take a loan. The purchase and sale agreement requires them to buy or lose their Earnest Money, if they can get a loan on any basis.

    No one likes to lose their Earnest Money, but sometimes losing the Earnest Money is the lesser of two evils, if the only loan you can qualify for is not acceptable.

  41. Rhonda,

    But where is the financial sense in continuing to make payments on a home that is worth less than the mortgage? Particularly in the case where a similar (or better) home can be had for a lower monthly rent than the mortgage payment, why not cut your losses and take savings that the lower rent would provide?

    Unless there were severe penalties from handing the home back to the lender (which you would have to consult a lawyer about in each individual case), it would seem to be a no-brainer to walk away from a “dead” asset. It’s absolutely true that in many cases lenders can’t come after any other assets than your home (particularly in states like California where laws are favourable to borrowers).

    Sure, your credit rating would get trashed, but that it is a small price to pay if you are able to save a significant amount with lower rent.

    I suppose it likely depends on how deep under-water your place is and the potential savings you would see from renting a different place. If your home is only worth slightly less than the mortgage and rents aren’t much cheaper than your mortgage payments, then maybe it isn’t worth all the trouble a trashed credit score will bring. On the other hand, if your home is worth significantly less than the mortgage and equivalent rents are much cheaper, then I can’t see a good financial reason to keep the home.

  42. By the way, this is the great thing about 100% finance mortgages. You can easily cut your losses if the real-estate market turns down. Putting your capital into a down payment just ties your hands in the case of a down-turn, making it less attractive to just walk away.

    By contrast, a 100% financed loan gives you the opportunity to profit from a possible future gain in the real-estate market while mimimizing your losses in the case of a downturn (i.e. because you can just walk away and let the lender take the loss).

  43. Sniglet, when I have bought homes, believe it or not, it has been more for emotional vs. financial reasons. I have not bought homes thinking, “oohh…I’m going to make $$$ in equity”. Sure, it’s great when you have appreciation and you’re paying down your mortgage and creating equity…but that’s not what it’s all about for me. Therefore, if I can continue to make my mortgage payment, I’m making them and keeping MY HOME. 🙂

    Dan Green recently did an excellent post on his blog: What to do if your home is losing value and you aren’t planning to sell.

  44. There is a material difference between people who have equity and those who don’t when there is a market downturn. I wonder if Dan’s advice might be different to those who are under-water?

    I agree that people might really love their house, and there is certainly value in staying somewhere you love, even if you are losing money on it.

    That said, if it’s possible to get a place that you would like even more for a lower monthly rental payment than your current mortgage, it would seem to be a no-brainer to just walk away from your current home if you were under-water. I know many people who are living in less than their ideal homes right now because their financial circumstances didn’t allow them the opportunity to get a place the really wanted.

    If these people (who don’t really like their current homes) wound up with negative equity I can see little reason for them to keep making their mortgage payments (provided they have verified the lender can’t go after anything more than the house). If you can rent a home you like more for less money than your current mortgage, the decision seems pretty clear.

  45. I’m wondering with the rental markets, what may happen. Rentals and vacation homes are typically one of the first properties that home owners/investors will give back to the bank first (before an “owner occupied” home).

  46. Interestingly, it is owner-occupied homes that can be the easiest to walk away from without complications. Some states have laws that prevent lenders from pursuing people who default on their primary residence. These protections are generally less helpful to second homes, or investment properties.

  47. I think you are right Rhonda, landlords that can sense that they are risking to end-up under water will most probably rush to sell while they can to get out unscatched. Many landlords probably also rent for a loss to later cash in on appreciation, they will also most likely rush to sell if appreciation ends. I think the rental market will even out though from sellers who can’t sell their homes but needs to move and renting out the home is the best option. This would be sellers that are not in a toxic situation that can afford to keep the mortgage. Not everyone who is a homeowner bought with toxic loans or during the last couple of crazy years.

  48. Hmmm… I think the ones who will be hurt soonest are those who have little or no equity in their homes. These people have little incentive to hang on, and have no cushion to allow for refinancing or selling if they run into trouble.

  49. Sorry, the post from “Jared” was really from me. I don’t know why the browser periodically stuffs someone else’s ID in…

  50. Yay–back into the fray.

    How can I put this…I don’t think there is anyone here who is a real estate professional who doesn’t recognize that depreciation is possible. Most of us advise our clients that real estate is like every other market, it goes up and down. I’m sure we have all come to the conclusion that some kind of correction is in the cards, the question is to what extent and how likely is it?

    That’s the question that we can’t answer for you–or at least, not to some people’s satisfaction since we are apparently not freaked out enough about what is essentially a normal market cycle. All we can do is look at current conditions (not just relating to mortgages but the entire picture) and extrapolate. And our opinions will vary pretty widely.

    If I had to give odds on what I think will happen they’d look something like this:

    Continued appreciation at 10 to15% a year–Very unlikely, less than a 5% percent chance.
    Slower but still healthy appreciation, at 5 to 10% a year–still pretty unlikely, I’ll give that a 10% chance.
    Flat market to less than 5% appreciation–very likely. Better than a 25% chance.
    Flat market to less than 5% depreciation–also very likely. I’ll give that a 25% chance too.
    5 to 10% depreciation–somewhat more unlikely given our local economy but I’m not writing it off. 10 to 15% chance.
    More than 10% appreciation–I’m thinking this is pretty unlikely, I’ll call it a 5 to 10% chance.

    I like the OFHEO’s numbers on this. They are predicting 5 to 10% depreciation nationwide, and a return to slow appreciation by mid-2009. Since many areas have been more affected, and others less affected, I would expect to see us at the lower end of the range, but I don’t think we will get off scot-free. I also don’t think that it’s going to be the end of the world as we know it (and I feel fine).

    Lots of things could happen, and we’re all free to come to our own conclusions, but like I said somewhere else around here I prefer to worry the most about the things that are most likely.

    Oh, one other thing. This whole idea of masses of homeowners walking away from their homes because they are underwater have one weakness, and that is, the fundamental difference in the mindset of a person who chooses to become a homeowner vs. someone who chooses to rent. And by choosing to rent, I mean, someone who could do either because for many, it is not even a choice. If a person has chosen to rent, they are probably a person for whom there is no emotional benefit to ownership, who doesn’t attach any value to spending more on shelter in order to be able to pay it off and own it outright (which is, ultimately, the main benefit to owning vs. renting), and feels that their money is better spent on other things, whether they be putting more into their retirement funds, or jet-skis, or whatever.

    Once a person has made the decision to own, they have usually come to the conclusion that for them, there are economic and emotional benefits to it beyond the possibility of appreciation. I think because of this, there are not many homeowners of owner occupied properties who will walk away from their homes simply because of a market downturn. I’m not saying there are none, I’m just saying that among people for whom homeownership was important enough to pay the financial premium that it entails, this kind of “cut and run” attitude is not prevalent.

    Let the fireworks begin!

  51. Whoops, important typo in my odds–“More than 10% appreciation–I’m thinking this is pretty unlikely, I’ll call it a 5 to 10% chance.”

    I meant more than 10% depreciation is pretty unlikely, 5 to 10% chance.

    But, you are free to come to conclusions of your own and act accordingly.

  52. Sandy, I think you are on to something regarding the difference between renters and owners. In fact some home owners will hang to to their house too long if their in a situation where they should sale.

  53. Oh hey–one other thing. Easy lending aside, the last few years have not been a particularly attractive time to pick up investment properties. Really tough to cash flow on anything purchased within the last 3 or 4 years. I know there are some folks who bought into those investment systems out there, but in practice, we really don’t see them that often (maybe loan officers do–we don’t see them much in my office). The large majority of rental properties that I see in my area seem to be cases where the owner lived there for 2 years to avoid capital gains, and then rented them out.

    So, just based on what I see most commonly (which, I admit is probably not a statistically significant sample) I would say that most of the investment/rental property out there has been owned for some period, such that even if an owner chose this time to sell, he would still have enough appreciation on the books to come out ahead. However, an investor would be foolish (IMHO) to sell at this time since with loans more difficult to get, we are now poised for increases in rental rates.

    Most of the investors I know have been in their positions for a while and are planning to stay with it through the downturn.

  54. Sandy, in your renters spending list you forgot the most important item: Saving for a downpayment to be able to purchase a home with minimum risk with an income to cost ratio that can enable them to continue to enjoy their jetskis etc…

  55. tj–I assumed we’d all realize that the list was not intended to be comprehensive. My comments already tend to be too long, so I didn’t really think it would be desirable to detail all the different things a person could spend their money on rather than pay the premium to own.

    Hopefully you were able to get the point in spite of my failure to adequately detail a person’s spending options.

    PS–some people do choose to do without the jetskis. Others do not. Both are okay. Life is full of choices and we all get to make the ones that suit us best. Jet-skis aren’t my thing–water’s too cold around here–but I’m sure they are a lot of fun for those who enjoy them.

  56. Sandy, I think I got your point but I think you missed mine. Many renters are renting since it’s the fiscally responsible thing to do, period. Not because they don’t put any value in owning or that it’s not worth a level of premium cost over renting, it’s just not worth risking your’s and your dependents financial and mental health over.
    They can wait to own until it’s a low risk venture.

  57. No tj, I didn’t miss your point. I think your point is weak based on some misconceptions you and others seem to have about what homeownership is all about. Buying a home is fundamentally unlike renting in that it is all about *willingness to take on risk* in exchange for some perceived emotional or financial benefit.

    There is risk involved with taking on a mortgage–what if you can’t make the payments? There is risk involved with choosing one home vs. another–what if you make a mistake and it turns out to be a money pit? There is risk involved with choosing one neighborhood over another–what if it changes for the worse?

    That’s just the beginning of the long list of “what ifs” that people have to work out for themselves when they choose to become homeowners. But I don’t think anyone who has actually gone through with buying a house has done so without realizing that there are a plethora of risks involved. Some will weigh the risks and choose to rent, others to buy, because that is what feels right to them, financially or emotionally.

    Ultimately it’s a commitment, and commitment entails risk. I believe they call that opportunity cost. Renting also has opportunity costs involved.

    One other thing–I wouldn’t recommend that anyone whose financial and mental health stood to be jeopardized by making the choice to own vs. rent, do so. Each person should operate within their own tolerance for risk and if that means renting rather than owning, so be it.

    Just don’t kid yourself that either choice is without risk–the risks may be different but they exist no matter what you choose.

  58. Wow, sorry if i stepped on a sore foot. I said many renters rent until it’s a low risk venture to buy. I did not say no risk. And to clarify the risk I’m talking about is to take on a high risk mortgage and the possible results of that. Not the inherent risk of any mortgage. You are simplyfying to make a point in way that makes your point weak not mine.

  59. tj–if the only way you can get into a home is to take on a high risk loan, then the risks to you are greater if you buy than if you continue to rent. You made a smart choice.

    The weakness in your point is the idea that buying a home will ever feel low-risk to you. What makes a person decide to buy vs. rent is not the feeling that the risks are low, it’s the perception that it’s worth doing anyway. Right now, for you, it’s not.

  60. On Renting Vs. Buying:

    Speaking from experience, renting a comparable apartment within the Queen Anne/ Wallingford/ Green Lake/ Belltown et al area is way cheaper than buying a comparable condo. I spent some time looking and trying to make a condo purchase work (fixed-rate mortgage, 20% down, reserve funds for a few months) before realizing that renting made my life (financially and otherwise) much better. I’m convinced that most people buying a condo had to be not investing in a 401(k), setting aside money for a rainy day fund or any such thing but were putting most of their eggs in one basket. Sandy points out that this is “all about *willingness to take on risk* in exchange for some perceived emotional or financial benefit.” This “perceived emotional or financial benefit” will prove extremely costly. All these people are *gambling* their financial future based on some emotional gratification that is supposed to outweigh being on a Real Estate version of The Craps table.

    Where did this “perceived emotional or financial benefit” get so pervasive or important that fairly educated professionals happily skip down the garden path and take on so much risk? Look no further than the real estate industry which played this up and starry-eyed buyers who bought into the hype of easy riches. Check out the Renting Vs. Buying guides on the NAR website….

    “As a REALTOR® you know condominiums are one of the hottest segments in today’s real estate market, and for good reason. This brochure is a great tool to present and market to first-time condominium buyers and explains in easy-to-read language why condominium buying is often easier and less expensive than renting. Order this great sales tool today!”

    Oh, the sincerity. Time for a drink…

  61. This is really getting off track. This post is about making consumers aware of what their “worse case” payment could be with an ARM and making sure they’re informed about their mortgage so they can make the right choices with their future. The post has nothting to do about renting.

    I did a post on that a while ago with the Seattle Bubble blog. If we’re going to re-hash the good ol’ rent vs. own debate, perhaps it would be more appropriate on that post? 🙂

  62. “it’s the perception that it’s worth doing anyway.”

    And people thinking like this is one big reason why Rhonda needs to dispense mortgage exit strategies. While I do agree that the reason to buy is not low risk ( I never said that by the way ) it should be the pre-condition to buy.

  63. Hey Rhonda, I think this time you might have initiated the rent discussion with your comment #49:

    “I’m wondering with the rental markets, what may happen. Rentals and vacation homes are typically one of the first properties that home owners/investors will give back to the bank first (before an “owner occupied

  64. tj…oh yeah? How about #48? Looks Sniglet started it to me. Regardless, I would really like to get this back on track for the sake of those home owners who don’t know what type of mortgage they have.

  65. Either decision can be a smart one as long as you have weighed the pros and cons, and are comfortable with your own decision.

    Choosing to buy a home goes beyond which is the cheapest option. Just in terms of dollars and sense, you can always rent a place more cheaply than you can own something comparable. But the point is, you don’t own it. You pay less because there is less reward. Even leaving appreciation and depreciation out of the picture entirely, owning has rewards that renting just doesn’t have. You can paint the place any color you want, you can stay as long as you like as long as you make your payments, etc. Not least of which is that someday, you burn the bank note and never make a payment again.

    Conversely, renting has some benefits that owning doesn’t have. No commitment, leave when you want to, problems are your landlord’s responsibility, etc.

    There are downsides to both paths as well.

  66. Rhonda,

    My sister has a 7 year I/O loan on a house they paid 565,000 for. I believe that they put 20 percent down on the house. They bought the house in 2004 and have 4 more years to go before the rate resets. They are currently paying only the interest. They were thinking about locking in a fixed rate 30 year mortgage but are concerned because their payment would go up as well as the rate on jumbo loans has increased. They went with this loan on the advice of another family member who works for CFC and told them that fixed rate loans only make sense if you are going to be in the house for a short period of time. Originally they had only planned on being in this house for a few years before moving on to a bigger house. Now it appears they are going to be there for a while. Do you think it makes sense to bite the bullet and refi the loan now to a fixed rate loan? Should they be speaking with their loan officer and coming up with a “exit strategy”? They keep asking me for advice and I am afraid to tell them anything that may lead them down the wrong path like my relative from CFC.

  67. I made a typo that should say fixed rate loans only make sense if you are going to be in the house for a LONG period of time, not short. Sorry.

  68. Matthew, I would hope within 4 years the jumbo market will be back. Your sister does have more time on their hands than the others who will be adjusting during this time. If they feel panicky, they could consider a conformng mortgage with a second to make up the difference between their loan amount and $417,000.

    A lot of this does come down to what a person’s individual risk tolerance is. And there is no crystal ball.

  69. Enlarging on Sandy’s comment #71: “Not least of which is that someday, you burn the bank note and never make a payment again.”

    That is a huge benefit of accepting home buying risk earlier in life, that later in life when your earning power is gone or diminished that you no longer have a mortgage to pay, or it is very small compared to the rental market at that time. I would say that reducing the risk of not being able to afford housing later in life when you have a fixed income is a major reason that many people want to “put a lot of eggs in that basket” so they don’t have that worry.

    If you rent your whole life, then you realized more immediate monetary advantages, but those advantages diminish over time as rents go up. Although if the renter has been investing the money saved on the difference between renting and buying a comparable home, and those investments have increased enough in value to provide money for housing later in life then it all balances out. If those investments did not increase enough, or the renter did not invest enough (or spent the money on lifestyle choices) then they will have problems with finding affordable housing when they are older and have limited means.

    We all have to make choices as to what kind of risk, how much risk, when to assume risk, and how we manage it. Risk is always present.

  70. Rhonda,
    Actually I’m not so sure the rent/own debate is that far removed from your post. In planning exit’s from bad loans people will have to weigh the benefits of continuing to pay for their home. I just spent four years in the rental market and hated every minute of it. To me it was worth a few hundred dollar premium (30 year fixed at 6.5-no PMI) and going from a half hour commute to an hour. People feeling pressured need to understand that if you walk away or sell under pressure, at the end of the day you have lost your home. To some that may seem to be no big deal, but it is.

  71. Stephen, I know you’re right. I’m just concerned about people not understanding their mortgages (specifically ARMs) and then having them be whammo’d without a chance to have made a decision or to have done any credit (or other) modifications to improve their situation.

    Options for exiting do include selling, however if someone wants to keep their home, they can refi IF they’re qualified to do so.

    Right now I’m going through my data base trying to track clients with ARMs. I’m sending out reminders of when they will adjust, what their payment will be…etc. Even though it’s disclosed and discussed at the application and escrow…you unpack your boxes…move in and forget about your mortgage.

    I’m like you. I’ve always made a mortgage payment/owned a home. It may not have made dollar sense or maybe I was lucky with my purchases…but it was just something I had to do. (I grew up in rentals and I’m the first in my family to own…so maybe that’s why).

  72. Rhonda I tend to agree with your first assessment, the rent/owning debate probably has little bearing on your post. Isn’t it so that in today’s environment it would be nearly impossible for a distressed owner to re-finance into another high risk mortgage? You are talking about exit strategies of toxic loans and not if you are going to stay in your home with the toxic loan or not, right? That is what Stephen and Sandy got into and it’s an interresting discussion but it’s another topic.

  73. Rhonda, I have a friend (really it’s a friend and not myself) who bought a house for $650k with zero down 5 year I/O ARM. At that time he and his wife grossed ~$300k. Now they have one income of ~130k. I think the home is now appraised at close to a million. They hope to have two incomes before the loan resets in two years. If not, are there in your estimate any loan product that will cover the $650k mortgage that they would qualify for if things stays status quo with lending standards, income and home value?

  74. Jumbos are very restricted presently. I don’t believe it will stay this tight with jumbos for two years. Right now, you better be full doc, great credit and have a down down payment for loans over $417,000.

    My concern, which I’ve been blogging about since February, is just that: “it would be nearly impossible for a distressed owner to re-finance into another high risk mortgage.”

    People need to start looking at this now so they can work on any issues to be in the best position possible to refi if they don’t want to sell.

  75. Actually the topic is the exit strategy of an adjustable rate mortgage. Not toxic by definition. A lot of people will choose to live with it if they cannot re-fi or sell and can figure out how to make the new payments.

    Several post touched on just walking away, leading to the rent versus own arguments. I just commented that I didn’t see it as too far removed from the topic, still don’t.

    There really are just four options:

    1) Pay the new payment
    2) Re-fi
    3) Sell
    4) Walk away (voluntary or forced)

    If I’m on topic I think the point is that if you have a “toxic” loan, meaning you don’t think you will be able to pay the new rate then now is the time to formulate a game plan and a little soul searching on how important it is to you to stay in the house is a great place to start.

    It’s been my experience that when faced with a seemingly insurmountable financial difficulty people often put off dealing with it. Penciling out various options, including all of the above is the only way to make a thoughtful decision. Those with ARM’s that are going to be a problem may have skipped this step when they got the loan to start with.

  76. stephen, you’re right on topic. It does not have to be a toxic loan, alt-a or subprime. Just your normal ARM that’s going to adjust eventually. People may have thought at the time they were selecting this mortgage that they were not going to still have the property or they just really really wanted that low rate…regardless, they need to start thinking and preparing for what their next move is. Steps 1-4 that you outlined above.

  77. Sorry I should have said ARM instead of toxic since that is what I meant. I didn’t think staying with your ARM was an exit strategy from your ARM and that’s why I said it wasn’t on topic.

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  80. Hi Rhonda,

    Hope you’re well! This is Joe Buyer (hint hint!). I was just checking out your writings, and while we have no plans or need to get out of the 30-year fixed rate mortgage you so excellently provided, I would add to this conversation that I think a key contingency plan is to keep the house in a ready-to-sell condition. The time you live in the house, even if it’s 30 years, you get to live in a nice well-kept house with the landscaping up to date. If you skimp on these things and you need to sell fast, you neither have the funding or the time to make your house ready to sell, which could cost your tens of thousands in reduced sales price for a house that doesn’t present well. The house we bought was new, and many things, especially the landscaping, but a ton of other stuff wasn’t finished properly. The garden will be a large project, but we’ll do it now, because should we ever need to unload the house for whatever reason, all that needs to happen is that it’s cleaned up, clutter removed, and staged. In that case we wouldn’t be faced with an overwhelming and expensive task that could take months. So by keeping the house read-to-sell, we have an exit strategy should we ever need or want one. And in the meanwhile, we get to live in a well-kept house!

  81. Hi Joe, thanks so much for stopping by! Keeping your house “staged” or “ready to sale” is a point I didn’t consider–that’s excellent!

    You also bring up another issue that many home buyers don’t think about…how much it costs after you move in–even to a new home. At least you can do projects “in time”. Houses can be “one big project”!

    All my best to you and your family. 😉

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