Suze Orman's Action Plan (21 page)

It’s also important to know that money you have in a 401(k) or IRA is protected if you ever have to file bankruptcy. You get to keep that money no matter what. This isn’t a pleasant scenario to ponder,
but let’s think about what happens in a really dire situation: You have $20,000 in your 401(k) that you withdraw. After tax and the 10% penalty, you are left with about $15,000. That helps pay the bills for another few months, but once you have used it up, you are back where you started: You can’t afford the home. So you lose the home. And now you have no retirement savings.

If instead you kept the $15,000 invested for another 10 years and it earned even a conservative 5% return, you would have nearly $25,000 saved up. And that money will never be taken away in a bankruptcy.

ACTION:
A loan is no better than a withdrawal in this situation. Don’t do it. You probably know I am not a big fan of this move. Taking out a loan means you end up being taxed twice on the money you withdraw. And there’s the risk that if you are laid off you typically must pay back the loan within a few months. So if you take out the loan, get laid off, and can’t pay it back ASAP, you will run into another tax problem: The loan is treated as a withdrawal and you are stuck paying the 10% early-withdrawal penalty (if you are under 59½) as well as income tax.

ACTION:
Push your lender to agree to a short sale.

In a short sale, the lender accepts whatever you can sell your house for in today’s market, even if that is less than the outstanding balance on your mortgage. The lender is agreeing that once you hand over all proceeds from the sale, your mortgage will be considered settled; any shortfall between the sale price and your balance will be forgiven.

Lenders may be open to this arrangement if they believe what they can get from the short sale is more than the cost they will incur if they foreclose on your home. That said, it is by no means easy to get lenders to agree to a short sale. But it is worth asking. The impact on your FICO credit score is no different from what it would be if you went through foreclosure (see details below), but it is a less traumatic way to walk away.

ACTION:
It will, but it is better to be honest now than hang on and make your financial life (and
credit score) even worse by trying to stay in an unaffordable home.

The mortgage you took out was a legal contract in which you agreed to repay the amount you borrowed (the principal) plus interest. In a short sale, you are allowed to repay less than the amount you borrowed. You did not live up to your end of the contract, and that is going to hurt your FICO score. A short sale will stay on your credit report for seven years (though you won’t see the term “short sale” on your credit report; lenders use different terms, sometimes describing short sales as “settled”), the same as a foreclosure. The impact of a short sale (and foreclosure) on your FICO score lessens as time goes by.

If you anticipate you will go through a short sale, it becomes extra important to keep your credit card balances paid off. I know this is difficult, given the fact that you are dealing with serious financial issues, but you need to make this a priority, because once your FICO score drops because of the short sale, your credit card company may get nervous and that typically leads to raising your interest rate. And the last thing you can afford is a credit card balance with a 32% interest rate. Please note that this tax break is only for a short sale of a principal residence. If you use a short sale to get out from under a losing rental property, you can indeed be hit with the tax.

ACTION:
Relax. You will not owe income tax on the amount of the debt that is forgiven, as long as the short sale occurs before 2012. Up to $2 million in forgiven debt is shielded from income tax for married couples filing a joint tax return ($1 million for individuals).

ACTION:
Probably. Your only other option is a “deed in lieu of foreclosure,” where you hand over the deed to your home to the lender, who then takes the house without going through the formal foreclosure process. While this is an option, it is not widely offered by lenders. Short sale or foreclosure is a more likely alternative.

ACTION:
Foreclosure law varies by state. Lenders will typically start the foreclosure process once you are three months behind in payments.

In about half the states, foreclosures must go through the court system; the other half use procedures that don’t require judicial action. For example, some states allow for what is known as a “power of sale,” in which mortgage companies—or whoever is empowered under the mortgage document—can handle the foreclosure process. In either type of foreclosure, you will receive notification from the foreclosing party that the foreclosure process has started; typically you will have from a few weeks to a few months (depending on your state’s laws) to reinstate the loan by paying up what you owe. (For a roundup of state foreclosure statutes, see Stephen Elias’s
Foreclosure Survival Guide
, Nolo Press, 2008; updates to the list will be published in the legal updates area on
nolo.com
.)

If you do not get current on your mortgage in the allotted time, the foreclosure proceeds, and your home is sold or the lender takes possession. Though you have the right to remain in your home until you are ordered out by a court after the foreclosure sale, many lenders encourage foreclosed owners to leave by making a “cash for keys” offer, money paid for your leaving voluntarily instead of requiring the new owner to obtain a court eviction order. A good overview of the foreclosure process is at
www.credit.com/life_stages/overcoming/Understanding-Foreclosure.jsp
.

ACTION:
Don’t fall for this. Legitimate foreclosure consultants do not seek you out; you go to them. The huge number of at-risk borrowers has created a whole new opportunity for scam artists who can easily find victims by scouting public records for notices of default. The most common ploy: They’ll offer to negotiate a deal with your lender if you pay the fee first; once you pay, they’re gone. An even nastier scam involves getting you to sign documents for a new loan that will supposedly make your existing mortgage current, but instead you’ve been tricked into surrendering the title to the scammer in exchange for a “rescue” loan.

If you’re facing foreclosure, get help you can trust. Start with the National Foundation for Consumer Credit Counseling, which will put you in touch with a housing counselor in your area: call 866-687-6322. More information on foreclosure scams is available at their Homeowner Crisis Resource Center,
housinghelpnow.org
, and at the FTC site,
www.ftc.gov/bcp/edu/pubs/consumer/credit/cre42.shtm
. If you think you’ve been a victim of foreclosure fraud, contact the Federal Trade Commission at
ftc.gov
or call 1-877-FTC-HELP, or your state attorney general’s office.

ACTION:
You will be eligible to buy a house in the future if you take steps today to start rebuilding your FICO score. There is no sugarcoating this: A foreclosure, as well as a short sale, will be a big negative mark on your FICO credit score. But it is not a permanent stain. The foreclosure stays on your credit report for seven years; each year its impact on your FICO credit score lessens. This is no different from a short sale.

Because you will likely see your FICO score drop, you want to do your best to reduce any unpaid credit card balances if you anticipate going through foreclosure. I know this is going to be hard to pull off, given that you are obviously dealing with some serious financial challenges. But please do your best to keep your credit card balances low. When your FICO score goes down, your credit card company may become nervous that you are in trouble. That might result in the card company’s lowering your credit line. And as we discussed in “Action Plan: Credit,” that starts a vicious cycle that can lead to a huge increase in your interest rate.

ACTION:
I still believe that over time a home can be one of the most satisfying investments you can make, but you have to make sure you can afford it. By “afford it” I mean not just being able to meet the monthly mortgage payments and expenses, but you have to be able to make those payments for at least eight months if you don’t have income coming in. Why eight months? Because if by chance you were to lose your job, it could take many months to find a new one. I certainly hope you would find a great new job quickly, but if we find ourselves in a deep, slow recession, it could take longer to find a job than you anticipate. I want you to be in a position to know you have savings set aside to cover the mortgage while you job-hunt.

As for timing: I recommend buying only if you intend to stay put for at least five years, preferably longer. I don’t care what sort of deal you think you can get, it makes no sense to buy a home today if you suspect you might move in a few years. If you buy today, prices may not go up much over the next few years; in fact, in some areas they could still go down. And it’s important to remember that when you go to sell you will be responsible for paying an agent a sales commission of 5–6%. That could wipe out any appreciation you might see over the next year or two… or five, depending on where you live.

And don’t even think about buying if you have yet to save up at least 10% of the purchase price
for a down payment. Did I say 10%? I should add that 20% is even better. Though there are some government programs that require smaller down payments, the new reality is that the only way many homeowners will qualify for a regular mortgage is if they can make a solid down payment.

The last requirement I have for potential buyers is that you can buy your home with a standard 30-year, fixed-rate mortgage. Instead of “betting” on an adjustable-rate loan, or that you will have enough equity in three or five years to refinance, I think it is smarter to stick with a 30-year fixed-rate so you never have to worry about your payment rising.

ACTION:
The days of no-down-payment loans are gone, and with any luck they will never return. You have to realize that if the millions of homeowners who bought a house with no down payment during the housing boom had been required to make a down payment, we would not be in this mess right now. Without the down payment, those people would not have been allowed to buy in the first place.

And I have always said that if you can’t afford to make a down payment, it’s a sign you can’t afford a home.

As of November 2009 many lenders typically insist you make at least a 10% down payment, and in some markets you may need a 20% down payment. You can secure a low down payment option if you qualify for an FHA-insured loan. The Federal Housing Administration loan program allows home purchases with down payments as low as 3.5%. And you can use gifts from friends and family to fulfill the down payment requirement. But please remember what I said: Being able to use some of your own savings for a down payment is an important signal to yourself that you are ready to own. It is a sign of commitment and responsibility. If you can’t put anything toward the down payment, I think that’s a good indication that you should slow down and save up for a year or two.

In the past the FHA mortgage program had low loan limits that made them impractical for many buyers. But for 2010 the limits are as much as $729,750 in some high-cost areas. You can ask an FHA-approved lender what the current limit is in your region, or check the FHA’s website at
https://entp.hud.gov/idapp/html/hicostlook.cfm
.

ACTION:
The $8,000 First Time Home Buyer Tax Credit has been extended through April 30, 2010. To claim the credit you must be in contract by the end of April and the deal must close by June 30, 2010. Individuals with income below $150,000 and married couples with joint income below $225,000 are eligible for the credit. The home you purchase must be your primary residence and the purchase price must be below $800,000.

Members of the military who are deployed for at least 90 days outside the United States have until June 30, 2011, to claim the credit.

ACTION:
First-time buyers must understand that paying $1,000 in monthly rent does not mean you can afford a mortgage of $1,000 a month. In addition to the base mortgage, you will also have to pay property tax, home insurance, and, if your down payment is less than 20%, private mortgage insurance. You also have to be ready to pay for repairs and maintenance costs—you’re the landlord now! If you add up all those other non-mortgage costs, your monthly bill can be 30% to 40% more than the basic mortgage. So if you were to take on a $1,000 mortgage, your monthly housing costs could actually be closer to $1,300–$1,400 a month. Yes, it is true that you will get a tax break
as a homeowner; the interest on your mortgage payments is tax deductible. That’s a help, but not a solution.