Apart from the emotional considerations that surface whenever a foreclosure is threatened (see our article on the emotional part of foreclosure), 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 answer a few questions about your financial situation—which has no doubt changed since you bought your house.
Do You Have Equity in Your House?
To a large degree, your options depend on whether or not you still have equity in your house. When you bought your house, presumably it was worth more than the amount you borrowed to buy it. If your house is still worth at least as much as you owe on it, it may make a lot of sense to oppose the foreclosure or maybe to sell it and get out from under the loan.
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, you can use http://www.zillow.com/, http://www.realestate.com/homevalues/, or similar websites. Local real estate brokers and agents can also give you an estimate by looking at similar sales in your neighborhood.
If there are other foreclosures going on in your community, a house similar to yours may have sold for far less than you could get for your house if you could afford to be patient. Also, buyers will pay substantially more for a well-kept home than for one that has been trashed, as many foreclosed homes are.
In truth, even professional appraisers have difficulty in telling what a house is worth when prices are plunging as they have been recently. Although prices have fallen 10% to 20% nationwide, many of my clients in California report home price decreases of 50% to 60%. Similar “hot spots” are being reported in other areas of the country, such as Florida, Nevada, Arizona, and parts of Texas. The only real way to find out your house’s market value is put it up for sale and see what you can get.
That said, take the best estimate you can come up with and use our Homeowners' Equity Worksheet to help you determine what, if any, equity you have in your house.
Can You Keep Making Your Monthly Payments?
There is no point in putting time and effort (not to mention emotional energy) into trying to hang on to your house if you really, truly can’t afford it. If, for example, you were one of the many homebuyers in recent years who were counting on your house’s value going up so you could refinance your way out of an unfavorable mortgage, you may have no choice but to move.
Many of my bankruptcy clients report that they are current on their mortgages but just about to go under. It’s not uncommon for them to have been paying upwards of 50% of their gross (not take-home) income towards their overall mortgage debt. That leaves little or nothing left for food, utilities, transportation, out-of-pocket medical costs, and the like. Quite simply, their economic position is untenable.
Here’s how to think about whether or not you can really afford your current loan.
Use the Standard Ratios
For decades, the conventional wisdom was that you shouldn’t pay more than 25% of your gross income for shelter. Slowly that figure crept up as lenders relaxed their rules to underwrite ever-increasing numbers of mortgages. Under the new Making Home Affordable program, this percentage has settled in at 31%. Under this thinking, if you are paying more than 31% of your gross income on your first mortgage, you are at serious risk of default. So, for example, if you are paying $3,100 a month on your first mortgage (including tax and insurance), your gross income should be in the neighborhood of $120,000. If your income is $75,000 a year, your first mortgage payment (including tax and insurance) shouldn’t exceed about $1,937 a month.
While this is obviously a cookie-cutter approach, it’s been adopted by the Obama administration to determine whether people are at risk of default on their mortgage and so eligible for government subsidies to help lower their monthly mortgage payment. (See our article on modifying your mortgage under the Making Home Affordable program.) To learn more about mortgage affordability, read our article When Foreclosure Threatens: Can You Afford to Keep Your Home?
In terms of deciding whether your home is affordable as a factual matter, there may be times when you can throw the 31% figure out the window. If, for example, you have a child with special needs or two kids in college, your payment might not be affordable even if it’s below the 31% threshold. And if you have few other expenses (for example, you live simply, don’t own a car, and grow some of your own food), you might be able to afford a mortgage payment that is a higher percentage of your income.
|How Much of Your Income Should Go to Your Mortgage?|
|Annual Gross Income||Maximum Mortgage Payment|
|25% of monthly income||31% of monthly income|
Use an Online Calculator
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 they make some assumptions that might not quite work for you.
- your mortgage payment is no more than 33% of your income, and
- your total non-mortgage debt payments (credit cards, student loans, and the like) aren’t more than 36% of your gross income.
For other calculators, Google “home affordability calculators.”
As I said, these formulas tell you how much you can borrow, according to the general opinion of the housing finance industry. They may be somewhat dated given the current chaos of the mortgage and credit markets.
Do a Budget
You can 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.
Don’t know where to start? You’re not alone. (Once upon a time we all had to learn about budgeting before we could graduate from high school. No more. Most of us are clueless.) But as you might guess, lots of websites offer budgeting software and spreadsheets. One that offers a combination of free and low-cost services is www.debtsteps.com/budget-calculators.html. Or just search for “online budget planning” to come up with a list.
Ask a Budget-Counseling Agency
Everyone who files for bankruptcy must, by law, take a budgeting class. To meet this demand, hundreds of companies, for-profit and nonprofit alike, have set up shop to deliver debtor education classes. These organizations can also 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 http://www.justice.gov/ust/eo/bapcpa/ccde/de_approved.htm. Consumer Credit Counseling Services of San Francisco (https://www.cccssf.org/, 800-777-7526), is an excellent choice. Because budgeting is pretty much the same no matter where you live, and because you don’t need to show up in person, you can use a service even if it’s far from where you live.
Last but certainly not least, HUD-approved housing counselors can also provide budgeting help to people trying to save their homes from foreclosure. (See our article on using a HUD-approved housing counselor.)
Could You Reduce Your Debt Load?
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. Basically, you need to either get the mortgage payments reduced or get your hands on more cash.
Here are the main ways to go about this:
- Modify your mortgage. Use the mortgage modification (Home Affordable Modification Program, or HAMP) part of the federal Making Home Affordable program to lower the payment on your first mortgage (including tax and insurance) to 31% of your gross monthly income. Under this program, your payment would first be lowered by decreasing the interest rate on your mortgage to as low as 2%. If that didn’t bring it down to 31%, the next step would increase your loan period to as long as 40 years. If that still didn’t work, your servicer would allow you to go short on your current payments and make them up at the end of your mortgage term in the form of a balloon payment. Our article on modifying your mortgage under the Making Home Affordable program provides a more detailed look at this program. If you aren’t eligible for HAMP, you can still negotiate with your lender for lower payments using this same basic approach.
- File for Chapter 13 bankruptcy and come up with a repayment plan that will let you reduce the amount of your monthly payments on your other debts and get rid of them altogether in three to five years.
- File for Chapter 7 bankruptcy to get rid of your unsecured debts such as those from credit cards, medical services, or signature (personal, unsecured) loans, so you’ll have a greater share of your income to devote to your mortgage.