Q: I am trying to figure out what path to take regarding a duplex I purchased jointly with a friend in 2006. It has been a great place for us to live, but I have since gotten into a relationship and plan to move in with my boyfriend. My housemate/co-owner also would prefer to move in with her new partner, so the property no longer works for either of our life needs.
Even though we put 20 percent down, we are seriously underwater on the mortgage, as the property has lost about 50 percent of its equity over the last few years. Our loan was fixed for only five years, so the interest rate adjusts next year and the second mortgage comes due then, too.
My co-owner would like to keep the property as an investment and has offered to buy me out, including a lump sum to pay me back the 20 percent I put down. She also applied to the bank to assume the loan and have me removed from it, but that was rejected. Can you give us some information about our options — i.e., short sale, foreclosure, etc.?
A: While the situation on your home may seem dire, you actually have quite a large number of options, due to the fact that your co-owner apparently has the means and the inclination to buy you out. The route you should take will depend largely on your priorities, especially on which you prioritize more: cash or closure.
From your question, including your references to short sale, foreclosure, moving in with your boyfriend, and the fact that you and your co-owner have apparently already seriously explored the option of her assuming the loan entirely, I gather that closure is quite high on your priority list. It sounds like you’d like very much to be done with the property, so I’ll assume just staying put and renting your unit out is not an option in which you’re interested.
As we explore the other alternatives available to you, I’ll focus on cash and closure — you’ll need to talk with local professionals to get a fuller briefing on all the other implications of your various options.
It also sounds like the impending reset of your interest rate and a balloon on your second are the motivating factors. Note that it’s highly likely that your interest rate would actually fall if you were to allow it to adjust, although you may be required to begin paying toward the principal if your loan is a typical interest-only adjustable-rate mortgage (ARM) that was fixed for five years.
If, for whatever reason, you were to hold onto the property, you might consider applying for a loan modification or short refinance on your first mortgage and a simple loan modification extending the term of the second; the second mortgage modification has fairly good chances of succeeding. But that’s just FYI.
As one option, you could allow your co-owner to buy you out. If cash trumps closure in your priority ladder, this is probably the way to go. The way this would work is that you two would consult with a real estate attorney (or each of you could retain one of your own) and they would prepare a buyout agreement under which she could buy your interest in the property.
You’ve said she is willing to actually pay you back for the downpayment you put down in cash; even if that’s all she was able to pay you, that would actually be much more than you would be able to recoup from the property on today’s market, from your description of the current equity status.
However, because the property is so upside down, and because the bank has already rejected her efforts to assume the entire loan, it would be difficult or impossible for her to finance a payoff of the property such that would allow you to be removed from the loan. So, the buyout agreement would also need to involve her agreement to assume all the obligations of ownership, including payment of your share of the mortgage, taxes and insurance. However, your name would remain on the loan and the loan would remain on your credit report until it was repaid or refinanced.
If your co-owner were to default for any reason, the bank would be able to come after you to collect; you, in turn, would have to sue her to collect. Of course, her lump sum payment to you does show that she’s investing more — not less — skin in this property, which reduces the risk of a later default.
Your other two options are as you called them: short sale or foreclosure. In a short sale, you would put the place on the market and sell it at the fair market value, assuming the bank signs off on it. If, as it sounds, you and your co-owner both have significant cash and other assets on hand, it might be more difficult to get the bank to green-light a short sale without requiring you to chip in to make up the difference between what you owe and what the property is worth.
A short sale has a similar impact to your FICO credit score as a foreclosure does, but a short sale would allow you to buy another home using a federally backed home loan in two years, while a foreclosure would take five years.
With a short sale, the process itself is long, convoluted, opaque and may not close at all, without the bank’s approval. It’s not at all unusual for a short-sale application to take four to six months or longer, even, to work its way through the bank’s loss mitigation department. If you want to fully evaluate the short-sale alternative, talk with a local real estate broker or agent who has a strong track record of listing and closing short-sale transactions in your area.
Walking away and letting your home go to foreclosure should be seen strictly as a last resort. Often, people will put their homes on the market in an effort to do a short sale, stop paying the mortgage and taxes (which does give you leverage against the bank, who may not approve a short sale if you have money in the bank and are on time on your payments), and allow it to go to foreclosure if and only if they cannot find a buyer or the bank refuses the short sale. I would encourage you to at least attempt a short sale before throwing your hands up and walking away.
While you might assume that divesting of your home via short sale or foreclosure would ensure closure in terms of no future involvement with the property, it is quite possible that your second lender will seek to collect from you at some point in the future, and perhaps even your first lender, if your state’s laws allow lenders to pursue deficiency judgments.
For this reason, if you two are fairly cash-flush, you might consider paying the second lender, or negotiating a settlement with them for less than what you owe on the second mortgage. And one thing you can be sure of — you will see zero cash out of either of these prospective solutions (short sale or foreclosure).
The nuances of your loans and your life will dictate which route makes the most sense to follow; definitely consult with a local real estate broker, a local real estate attorney and a certified public accountant (CPA) before you make a decision about whether to let your co-owner buy you out, offload your home via a short sale, or walk away and let it go back to the bank via foreclosure.
Each of these options has myriad legal, financial and credit implications of which you should be aware, and you also deserve to have information on the simpler, but important, logistical issues like how long you and your co-owner can stay in the property under the various alternatives.