If foreclosure looms because you've missed some payments, or you think you will soon, it's time to face what's probably the toughest question of the whole process: Can you afford to keep your house?
Apart from the emotional considerations that surface whenever a foreclosure is threatened, there are economic factors you just can't ignore. Before you can decide whether or not to try to keep your house, you need to take stock of your financial situation -- which has no doubt changed since you bought your house.
Here are the basic steps:
To a large degree, your options depend on whether you have equity in your house. Generally, your equity will be the difference between what you owe on the house and what you can sell it for. Unfortunately, many homeowners have negative equity -- that is, selling your home would get you less money than what you own on your mortgage and other home loans.
These days it's not so easy to know what your house is worth. Estimates of real estate values are traditionally based on the amounts that similar houses in the neighborhood have recently sold for. To find out that information, check out websites such as www.zillow.com or www.homepages.com. Local real estate brokers and agents can also give you an estimate by looking at similar sales in your neighborhood.
Unfortunately, as property values continue to decrease, it becomes next to impossible to determine the value of your property, especially if no houses in your neighborhood are selling. Or, if there are many foreclosures going on in your community, a house similar to yours may sell for far less than if you sold it outside of foreclosure. The only real way to find out your house's market value is put it up for sale and see what happens.
If you have some equity in your house, it's probably worth it to try to hang on to your house, if you think you can afford future monthly mortgage payments (see "Are Your Monthly Payments Too High?," below, for more on this). If you can't afford the payments, see if you can reduce your debt load so that you can make them (see "Can You Reduce Your Debt Load?," below, for ideas on how to free up more of your income or change the payments themselves).
If you find yourself significantly upside down (negative) when it comes to equity, and you are behind on your mortgage payments, there's not much point, from an economic perspective, in trying to keep the house. What is significantly upside down? It probably makes sense to give up your house if its current value is 25% less than what you paid for it. That's because your house's value would have to appreciate by as much as it dropped for you to come out even, and that will likely take several years
However, if you are upside down on your home and still want to keep it, you might be able to reduce your mortgage payments by working something out with your lender or taking advantage of a favorable refinanced loan under one of the federal government's Making Home Affordable plans. (See, "Can You Reduce Your Debt Load?" below, for more on this.)
If you are upside down on your mortgage or have little equity in your home, take stock of the real estate market before making your decision to keep or walk away from your home. If the market is slumped, and appears to stay that way for some time, your best option may be to let your home go. If the real estate market appears to be perking up (meaning prices may rise quickly), it might make sense to try to keep your home even if you have negative equity.
But how to know what the market will do in the future? Even if the market is a bust, judging by history, home prices will ultimately rise again. As Mark Twain is reputed to have advised a young man, "Buy land! God isn't making any more of it." Of course, knowing when prices will rise is the key question.
No formula can predict how soon a particular real estate bust will be over. But watch for signs that the market is either improving or stagnating. If some or all of the following factors are present, there's a good chance the market is not headed for a speedy recovery:
Remember, there is no guarantee that your house will ever recover its original value. As the old saw goes, you don't want to throw good money after bad. If the housing market doesn't rebound quickly, every sacrifice you make now to keep your house could be for naught if you ultimately lose it.
Many folks face foreclosure because their income has substantially decreased since first buying their home. Some were counting on the house's value to increase, allowing them to replace an unfavorable mortgage with a more affordable one. Regardless of the reason for your troubles, before you decide to try to keep the home or move, you must determine if you can truly afford your current loan, or a refinanced loan. If you can't, it may be time to let your home go.
There are several good ways to make this determination. Choose the one that works best for your situation, or use a few methods.
As a general rule, the housing industry considers a loan affordable if your overall monthly mortgage payments do not exceed somewhere between 29% and 33% of your gross monthly income. This is frequently called your income to mortgage debt ratio. For example, if your annual gross income is $75,000, then your mortgage payments should not exceed $2,062 if you use the 33% figure. They should not exceed $1,562 if you use a more modest 25% income-to-mortgage debt ratio.
You should tailor these numbers to your particular situation. If you have a child with special needs or two kids in college, for example, your mortgage payment might not be affordable even if it's below the recommended 29-33% income to mortgage debt ratio. On the flip side, if you have few other expenses (perhaps you live simply, don't own a car, or grow some of your own food), you might be able to afford a mortgage payment that exceeds the 29-33% figure.
The Internet is chock full of calculators that purport to tell you how much house you can afford. They're very easy to use, but use caution -- they may make some assumptions that won't work for you. Here's a few to try:
To find other affordability calculators, go to www.google.com and type "home affordability calculators."
When using these calculators, remember that the housing industry used them to determine what size loan you qualify for. They may be somewhat dated given the current chaos of the mortgage and credit markets.
Another way to determine if you can afford your mortgage is to make a budget. Take a no-nonsense look at your income and expenses and see whether there is room in your budget for your current or projected mortgage payments. If the numbers don't add up the first time around, see what you can trim. (For help on budgeting, read Nolo's article Budgeting: How to Make a Budget.)
Many websites offer budgeting software and spreadsheets. One that offers a combination of free and low-cost services is www.DebtSteps.com (click on "Budget Calculators" in the Worksheets & Tools section.)
You can get more information on handling your debt load and creating a budget (which will help you decide if you can afford your mortgage) by taking a class. To do this, take advantage of the law requiring bankruptcy filers to take a budgeting class approved by the Department of Justice. Hundreds of companies, for-profit and nonprofit alike, have set up shop to deliver debtor education classes. These organizations can help you with budgeting, even if you're not planning to file for bankruptcy.
The courses are taught online or by telephone and mail. The fee averages about $50. For a list of agencies that have been approved by the Department of Justice for bankruptcy purposes -- although you don't have to file for bankruptcy to use them -- go to the Department of Justice, U.S. Trustee's website at www.usdoj.gov/ust/eo/bapcpa/ccde/de_approved.htm.
Sometimes it's helpful to get an opinion from a financial counselor. HUD-approved housing counselors can provide you with budgeting help and help you determine whether you should keep your home.
You can find a list of HUD-approved counselors at HUD's website (www.hud.gov, click "Talk to a Housing Counselor") or by calling 800-569-4287. The Homeownership Preservation Foundation website, at www.995hope.org, also offers free online counseling, among other things. Or you can call 888-995-HOPE and talk with someone. Finally, The National Foundation for Credit Counseling will get you to a nonprofit counselor (typically HUD-certified) through its toll-free hotline, 800-388-2227.
If you don't have enough cash each month to keep making your existing mortgage payments, there are a few ways that you might be able to make them affordable.
First, consider negotiating better terms with your lender. (For tips on doing this, read Nolo's article How to Avoid Foreclosure.) One of the programs under the federal Making Home Affordable (MHA) program, such as the Home Affordable Modification Program (HAMP) or the Home Affordable Refinance Program (HARP), may also help some homeowners modify or refinance their mortgages. MHA was designed to help homeowners who are considered to be at-risk for foreclosure. Homeowners who qualify may be able to refinance their currently unaffordable variable rate mortgages into affordable 15- or 30-year fixed rate mortgages or modify the terms of their current mortgage loans by reducing the principal, lowering the interest rate, or lengthening the term of the loan.
You can also try to reduce your overall debt load through bankruptcy. (To learn more, see Nolo's article How Bankruptcy Can Help With Foreclosure.)
Finally, sometimes it is possible to stop paying your second or third mortgage -- thereby allowing you to afford your first mortgage. (For more on this, read Nolo's article Reduce Your Mortgage Obligations to Avoid Foreclosure.)
If you determine that it no longer makes sense to keep your home, take heart. Although it's always painful to give up a house, keep in mind that doing so may make things much easier for you and your family in the long run. Also, if your house is subjected to a foreclosure sale, you will probably be able to stay in the house for months (in many states) without making any more mortgage payments -- giving you time to save some money to move and secure new housing.
For a comprehensive guide on foreclosure, including what to do if it's inevitable, get The Foreclosure Survival Guide, by Stephen Elias (Nolo).