A plugged-in “Stu” seeks some ideas for a friend:

I have a friend who’s…in this scenario: ~150K combined income, 5% down on a 700K peninsula condo bought in late 2005. Interest only on a 5% first mortgage and 3% second (company sponsored, 5/1) mortgage. The monthly cost of owning was probably about equal to renting with the low rates. I think they might have had some trouble refinancing in a few years, but I bet they would have been able to make it work out. Recently, however, my friend decided to change careers, move out of state, and take a substantial (combined 1/2 current salary) paycut. Perhaps a poor financial decision but apparently there’s more to life than money.

So after 4 months on the market they’ve had one offer that fell through due to financing. Now they have a solid offer at 10% below what they paid and the buyers want a fast close. My friend is planning on taking the deal and liquidating the entirety of both of their 401K’s (between 100-150K I estimate from what I’ve been told) to make up the loan balance and pay the sales commission. This should get them free and clear with a few thousand dollars in the bank to start their new life.

What other options are available to them? I hate to see them use 401k money to get out of this jam, because of the taxes and 10% penalty, not to mention the time value (present stock market conditions notwithstanding…) of that money. Being in your late 20s / early 30s with no retirement savings isn’t the end of the world I guess. They have no other substantial assets besides the condo (i.e. cars are leased). The best I could think of was to somehow wait until 2009 to liquidate the 401K to lessen the tax hit in their new (3% ) state and presumably lower fed tax bracket. That and to talk to a financial professional.

Any ideas would be appreciated.

It’s not a “friend” as far as we know (not that we’d care). We’ve moved a couple of early responses to get things started. And please try to add value (or back away from the keyboard).
UPDATE (8/22): Stu responds (and thanks).
San Francisco Affordability: Is C.A.R.’s New Reality Already Old? [SocketSite]

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Comments from “Plugged-In” Readers

  1. Posted by chuckie

    Stu,
    That’s a heartbreaking situtaion… but unfortunately all too common in South Bay.
    I think it is a big mistake for your friend to dip into his 401k to make the greedy lenders whole. He should try to get a short sale accepted by the bank, and if unsuccessful, just mail the keys to the bank. The 5% downpayment they lose is more than enough penalty for their mistake. The lenders/bank need to just accept the net proceeds and their part of the loss. The realtors involved should accept reduced commissions. The 3% company sponsored should be a write-off.
    Many here will talk about honor, morals, ethics, responsibility and so forth. I think your friend has bigger obligation to himself/his family and should use all tools/protections available to him under the law to protect his nest egg. This is especially important considering your friend is taking a huge cut in pay (from 150k to 75k). It will take him forever to build 150k in 401k on a 75k combined salary.
    I will probably get beat up by some on here, but would love to hear what others think about this issue.

  2. Posted by NoeValleyJim

    That’s right, California is a non-recourse purchase money loan state, so your friend can just walk away, as long as he has not re-fi’ed. It will put a dent in his credit for a few years.

  3. Posted by Satchel

    Stu,
    That’s a real sad story about your friend and puts a face on the bubble. He (or she) was suckered by bubble pricing, foolish bubble financing schemes, and equally foolish corporate policy (don’t people out here get the fact that the reason that these companies run these sucker schemes – 3% financing – is because they don’t want to PAY MORE in salary? same thing for the BMR scams, teacher “bonuses”, etc).
    Your friend should definitely talk to a pro, but it’s hard to find anyone with a brain who will talk to retail clients. If *I* were in that position it would be a no brainer. It sounds like the mortgage is purchase money only – no recourse. Not sure about the corporate *loan* and how that would play into it. I’d throw the keys on the granite counter and walk out the door, and keep walking. I might try to stay for a while for free while I was packing up, and I might say, “so long, and thanks for all the bananas on the way out”.
    There is no way I would liquidate 401(k)s. Absolutely no way. In the worst case, most pension assets are bankruptcy remote.
    There will be a credit hit of course. So, if I walked I would be like literally millions of other foreclosees (there may be 10s of millions before this is over). When I get to the new state, if I have a problem getting a nice rental, a little cash should clear it all up. Stopping my mortgage payments early will now appear a good strategy to me. In the worst case, I could always liquidate $10K of my 401(k).
    It’s just business. I wouldn’t let the fraudsters try to convince me that I was morally obligated to pay my mortgage. I signed a contract, now I am breaching it. The contract and the laws spell out the lenders’ options, and they don’t involve my liquidating MY retirement assets and giving them to the realtors and lenders.

  4. Posted by dg

    dare I say it? Jingle mail..

  5. Posted by ex SF-er

    the problem with waiting until 2009 to lessen tax burdens is that they have to pay the substantial mortgage until then… so they lose thousands of dollars a month to the mortgage, and then are not gauranteed of selling the home (it may sell for less in ’09 than their current offer).
    I’d be hard pressed to give up this sale.
    that said, taking from their 401k is a tough pill to swallow as well, due to taxes.
    when are they moving out of state? if they are moving in 2009, they could see if they could get a LOAN from their 401k now, then move in early 2009. once they quit their jobs their loan on the 401k comes due, but next year presumably they’re in a lower tax bracket so they can take the money out of the 401k to pay their loan balance off.
    the other option would be if family would be willing to lend them the money.
    unfortunately, this family hasn’t left themselves enough wiggle room.
    that said: they should minimize how much they take from their 401k.
    by my calculations:
    they bought at around $700k, but put 5% down, so loan balance should be around $665k.
    the offer sounds like it is for $630 (10% less than purchase).
    that leaves them $35k short plus commission. (is commission like $35k?) so around $70k total.
    so to borrow from 401k it’s like $70k plus $7k penalty plus tax on that $77k.
    so I would have them do this
    1) sell the house
    2) BORROW $70k from their 401k but keep working their current jobs
    3) move into a dirt-cheap rental in the slummiest of slumlands for the rest of the year
    4) eat ramen ramen ramen only
    5) see if they can get out of their leases and into cheap cars (buy a car for like $3000 or something) or use public transport.
    6) save up every penny from living cheap Sept through January
    6B) consider each of them taking second jobs (both here and out of state)
    7) in early january, take out money from their 401k to cover the loan balance and the penalty and taxes due on the withdrawal ONLY. (don’t take out extra to cover “bills” out of state). Then quit their jobs. (the loan on a 401k is usually due when you quit your job)
    8) move out of state using the money that they have saved up from Sept through Jan
    9) live dirt cheap out of state making their new salary.
    10) don’t buy a place again until they have a substantial emergency fund of 6-18 months as well as no debt and only buy a house they can easily afford.
    ===
    alternatively, they could consider this:
    1) recognize that they are not financially in a good place right now
    2) dump both leased cars ASAP, and instead use public transport or buy beaters
    3) sell the house now and borrow the 401k money as we discussed.
    4) move into the slums to raise cash
    5) eat ramen
    6) do this until they can pay off their 401k loan AND build up a little Emergency Fund
    7) then move. this might take a few years but they’ll be in better financial condition when they move
    that said: depending on where they are going they have a huge possibility of living like kings on $75k/year. My sister makes around $40k/year I think (household) and she owns her house on a 30 year mortgage (1400 sq ft, nice), she owns 2 late-model cars (minivan and jeep wrangler), she is a stay-at-home mom, and they have enough to do most of what they want (but they’re pretty frugal). but it’s because they live in an area where you can buy a starter home for $60k, and where middle end home is $120k and a McMansion for $250k. (the highest homes are still in the Millions though).
    so the plan depends on how low COL they are going.

  6. Posted by buck

    “apparently there’s more to life than money.”

  7. Posted by Trip

    Have they tried talking to their lender about approving a short sale? That would take some time and effort (be persistent) but may very well be worth it and avoid the whole problem of having to dig into their 401(k)s.
    Also, any tax gurus out there? Can’t they offset any capital gains with the loss from the sale of the home? Not sure if they have any capital gains, but they may be able to carryover the loss and get some benefit over time. Sad story — I saw similar things with friends who bought at the last peak in the early 90s when we had all just graduated from undergrad. In one case, a college roommate had to turn down a better job out of state because he couldn’t afford the loss — stuck in his underwater house for four years.

  8. Posted by dub dub

    These folks need to get on with their new life, and fast!
    You mentioned the rent/buy was similar “before reset” (an amusing concept); if that is actually true, they could try renting *after* renegotiating the loan (where presumably they might eke out a positive cash flow as a result, without having to worry about a subsequent reset). They might have issues later if rents fall in a tech recession, however.
    If that fails, walk away from the loan.
    Having crappy credit in your late twenties/early thirties is no big deal either. It’s like the old .com boom — there was no shame in losing your job because “everyone was getting laid off” too.
    Of course, the biggest mistake your friend could be making is taking indirect advice from anonymous folks on a message board :)

  9. Posted by Satchel

    “Also, any tax gurus out there? Can’t they offset any capital gains with the loss from the sale of the home?”
    No. IRC is pretty clear (as clear as the US Tax Code gets!) that loss on sale of a personal residence is a nondeductible personal loss. See IRS Pub 523.

  10. Posted by ex SF-er

    “Have they tried talking to their lender about approving a short sale?”
    they could certainly try, but I doubt a lender would agree to it when the borrower has such easy to pick assets (the 401k). Also, it often takes a long time to get the lender to approve a short sale and it sounds like this offer is “urgent”. but they could try for a short sale for a future offer.
    The other problem is that a short sale would only really affect the second lender, which was EMPLOYER SPONSORED (not sure if that means the employer will be affected or not though). maybe not the greatest thing to ask your employer-sponsored lender if they’re willing to take a 33% haircut on their principal, but I’m not sure how the employer sponsored deal worked. it might have just been that the employer paid down points or something for the second loan and has no relation to that lender. that would be less dicey. but if the employer itself has a working relationship with the lender then it can get hairy.

  11. Posted by beedub

    Your friend has a stronger negotiating position with the bank than is suggested here. Talk to the lender about a short sale– a negotiated short sale is better for the lender than foreclosure.
    Relating to ex SF-er’s doubts about the bank’s reluctance: 401(k) and other ERISA governed accounts are non-attachable. The house is the collateral for the mortgage; liens can’t be attached to retirement accounts. If they truly have no other assets, then the bank may/should want to play ball.
    If not, just walk away from it. Their credit will suck for several years, but so long as they keep current with all their other obligations, they’ll still be in a better long-run situation with a well funded retirement account.

  12. Posted by beedub

    Your friend has a stronger negotiating position with the bank than is suggested here. Talk to the lender about a short sale– a negotiated short sale is better for the lender than foreclosure.
    Relating to ex SF-er’s doubts about the bank’s reluctance: 401(k) and other ERISA governed accounts are non-attachable. The house is the collateral for the mortgage; liens can’t be attached to retirement accounts. If they truly have no other assets, then the bank may/should want to play ball.
    If not, just walk away from it. Their credit will suck for several years, but so long as they keep current with all their other obligations, they’ll still be in a better long-run situation with a well funded retirement account.

  13. Posted by diemos

    I have to concur that any plan that involves touching those 401K assets is a mistake.
    Foreclosure is the new black. Your friends will be lost in the crowd.

  14. Posted by chuckie

    Editor,
    What happened to my thoghtful response from yesterday? Negative value add? :)
    [Editor's Note: Not at all. Please see our comment below. And thank you for an appropriate query (versus simply screaming “censorship!”).]

  15. Posted by cooper

    Do not even think about touching those 401ks. Go short sale imo.
    The other question i had was what does it rent for? you seem to indicate that the rent is somewhat close to the monthly mortgage. If that’s true why don’t you just rent it out if there is no short sale approval.
    Touching the 401k is a big mistake. please dont do that.

  16. Posted by fluj

    Rent the condo out. Five percent and 3%? Rent the condo out.

  17. Posted by cooper

    I bet those are teaser rates, thats probably whats forcing them to sell. Otherwise that’s my advice as well.

  18. Posted by diemos

    Rent eh? And have your friends checked on how much similar condos in the area are renting for and whether that’s enough to cover the mortgage?

  19. Posted by Mark D.

    “Recently, however, my friend decided to change careers, move out of state, and take a substantial (combined 1/2 current salary) paycut. Perhaps a poor financial decision but apparently there’s more to life than money.”
    Your friend should reconsider this decision.

  20. Posted by luvinmissionbay

    There are a number of responses that suggest foreclosures and I don’t necessarily disagree with such an approach IN THE RIGHT CIRCUMSTANCE.
    The problem that I have is that people assume and advise that California being a non-recourse state is a one size fits all solution when in reality it might be a bit more complicated when you start including non-purchase money “second” mortgages, revolving equity loans, employee sponsored second mortgages, or ANY second mortgage for that matter.
    Maybe someone here on Socketsite could advise on all the differences because they don’t all simply disappear in foreclosure. At the very least, someone considering foreclosure on a property that includes anything other than a purchase money first mortgage should consult an attorney.

  21. Posted by MakeMeDrink

    I guess what I don’t get about all these “walk away from the loan and property” is where is personal responsibilty to play here? Taking the “big bad” realtors, corporations and lenders out of the picture — our friend made several personal decisions and should own up to some responsibility for those decisions.
    One, he decided to purchase when it made sense to do so rather than rent. Why did he do it? I assume because he DECIDED that there were advantages to owning rather than renting (tax deductions, possibly create wealth, etc.)
    Two, he DECIDED to sell and move. His timing may be very personal but the timing also occurs when the prices had fallen. If he had timed his decision a year or so earlier and made money would you all have not congratulated him?
    I think the number of folks who advocate walking away from a financial responsibility is quite amazing and speaks volumes about the greed and LACK of personal responsibility that got this country into the housing bubble, then burst. The lenders may have lead the horses to the water, but a lot of people like your friend (like many others) drank it up.
    Sad state of affairs for the entire country not just this friend.

  22. Posted by SocketSite

    As we wrote above, “We’ve moved a couple of early responses to get things started.”
    As a tipster writes this morning, “I think you moved them to the wrong thread.”
    As we write right now, that we did but the wrong has now been righted above.

  23. Posted by cooper

    To Makemedrink:
    Personal responsbility has to do with fraud, lying on your ap or whatever. It has zero to do with the market dropping out from under them.
    They signed up for a loan that has at its recourse the property they lived in. Turns out the bank is on the bad side of the deal here. They should asked for more money down. They assumed markets would go up forever, it turned out ot be a bad call.
    You Sir, are confusing people who lied on their apps or had bad underwriting with this couple. It’s a really common and really bad misperception.

  24. Posted by Homeowner

    How about a counteroffer?

  25. Posted by scurvy

    MakeMeDrink, a few years ago I might have halfway agreed with you. But let’s analyze a few facts:
    1) We live in California, where the laws are friendly to consumers and consequence-free living. We pay for this protection in the form of higher prices across the board (businesses have to compensate, too).
    2) If it were ever in their favor, the bank would walk away from you. Oh wait, they already did that with securitization on a massive level (well, subprime only, not Alt-A).
    3) Money is debt. It sounds crazy, but once you learn how “money” in our fiat society is created, you’ll learn that all money is debt. That’s what led to the housing bubble — now it’s just reversing a little.
    Knowing how the game is played, (1,2,3 above) why would they ever *not* walk away?

  26. Posted by luvinmissionbay

    There are going to be alot of disgruntled people who walk away from a house (after hearing all this about CA being a non-recourse state and relying on such) who then come to find out after the fact that non-recourse status DOES NOT apply to every single loan secured by real property and they could very well still be on the hook for a deficiency.

  27. Posted by anon

    If he can’t rent it out, he should forget the relo and the career change until he can afford to get out from under this albatross. Don’t raid the 401K!
    IMHO, not having a 10% cushion means they couldn’t afford it in the first place. I suspect this person is not the brightest bulb on the tree and whatever they end up doing will be a disaster. (C’mon, 5% down, IO loan and now a career change?!)

  28. Posted by 11223

    Rent it out, and withdraw a little bit of money, each month, to cover the gap if rental is not enough to cover mortgage

  29. Posted by enonymous

    Sorry makemedrink, you’re off base here.
    Financial decisions are inherently greedy. Do I need to channel Gordon Gecko here? Just because it is a house doesn’t make it somehow ‘special.’ Is it the circumstance that offends you? Well what if there was an earthquake and the property was damaged, thus lowering its value? Then is a walk away more appropriate?
    Yes, our unfortunate soul(s) above made a mistake. We all have. The question is, should they make a bigger one?
    On the one hand, staying faithful to this nebulous concept of social responsibility. To who, and for what? OTOH, money, and the obvious value that it provides.
    Please don’t get high and mighty that ‘if so and so signed a document they should honor it.’ This should be viewed as a solely financial decision. Assuming this is purchase money and the employer sponsored second is not a complicating factor, the optionality of the 5% down is wonderfully liberating here. This is why low downpayment loans are/were a horrible idea for banks, especially for non recourse loans. Why oh why would you take this sale, tamper with 401k funds with the attendant compound tax deferred growth loss along with the associated tax penalty, simply to put yourself in a worse financial position? It just does not make sense.
    IF the second mortgage is not going to complicate this matter, just walk away. The hit to their credit score will be worth something, but far far less than the hit they are contemplating to their 401k.
    As Satchel stated, they will breach their contract, and the ramifications of a breach were known to both parties PRIOR to the notarization of the papers. There is no other responsibility here.
    Walk away. and good luck.

  30. Posted by Satchel

    I disagree strongly with the idea that this place should be retained and rented out.
    First, rents are likely to go down, or at least be under pressure, as the recession deepens, which is a certainty IMO. This is the South Bay, and absence of rent control means that there is no artificial shortage of rental units as there is in SF. I bet rents down there have not even gotten back to where they were in 1999-2001.
    Second, they will be out of state landlords. Thats a losing proposition for someone whho will be an “accidental landlord” IMO. I know it can be done, and has been done, successfully, but the odds favor avoiding this scenario.
    Third, these people will be going down to $75K per year HH income. Do they really want $650K of I/O debt hanging over their heads? Looks to me like they would just be delaying the eventual foreclosure and credit hit. Better to take the medicine now.
    Fourth, as a landlord, they will lose the owner occupied mortgage and property tax deductions against active income. Nevertheless, to the extent that their income remains within the passive loss rules (<$100k – $150K), they may be able to use depreciation, prop tax and interest deductions to get them roughly back to where they were. But any tax losses here will be limited to $25K per year, which is likely less than the owner occupied tax benefits they are enjoying right now. And they will have to deal will depreciation recapture on sale. All in all, a tricky wrinkle that is not worth it IMO for someone “restarting” their life in greener pastures.
    Or, of course, they could just cheat and run the risk of audit. That’s what most people I seem to run into in CA do. But note, this would likely trigger the inference that they have remained CA residents for tax purposes, subjecing them to the usurious and unconscionable CA income tax system.
    Last, on the subject of short sales. It may be possible, but these usually take a long time from what I understand. This short sale would require some interaction between the first lien holder and the corporate entity that loaned the money. The corp entity will be very aware of the 401(k) assets, since it administers the plan. The potential buyer here is looking for a quick close. I guess it’s worth a try, but I wouldn’t get my hopes up.
    If it’s going to go belly up anyway, it’s worth noting that many people like to sell the appliances out on craigs, thereby picking up some additional green. I guess the thought is that the home remains “owned” by the “homeowner” and there is really nothing wrong with selling “my” appliances (as opposed to “fixtures”), is there? Especially if the teams of lawyers who drew up the security documents were not smart enough to foresee this posibility ?

  31. Posted by fluj

    At 700K, they are also squarely in the augmented conforming zone right now. If the rates are indeed teasers, perhaps they could borrow against the 401K to put money down in order to obtain a fixed rate, and then rent it out? Keeping a rental property on the Peninsula is not a terrible thing, is it? Depending upon location they could look at more lucrative options such as vacation rental or corporate rental.

  32. Posted by Willow

    “Your friend should reconsider this decision.”
    Very valid point. I can understand the difficulty of the situation but this is not a “sad” story. Your “friend” has made a reasoned decision that will effect his or her ability to meet financial obligations. As grown ups we have to do this all the time. It’s called life!
    I hope I’m not being too harsh but I’m actually amazed that this made it through the Socketsite BS radar…

  33. Posted by dch

    makemedrink — the lenders agreed to lend money to this person knowing what their legal rights would be should the borrower decide to walk away from the house. they bet the borrower wouldn’t, or that property values would go up. that was a bad bet, but they knew the potential downside going in included this exact possibility.
    the friend is going to exercise his legal rights in an open and transparent manner. if the lenders didn’t want him to be able to do that, they shouldn’t have lent him the money.

  34. Posted by Brutus

    The worst thing that they could do is what MakeMeDrink is suggesting – viewing this as something other than a simple business transaction. This isn’t a moral issue or a “personal responsibility” issue. If you loan money to a friend on good faith with nothing more than your word, that can be considered one of the above. This is a business transaction that is covered by laws of all different types. Not trying to maximize your profit or minimize your loss would be absolutely stupid (and you can be guaranteed that the bank will do EXACTLY the same thing).

  35. Posted by dub dub

    @MakeMeDrink — If they intended this outcome *from the beginning*, then there’s a moral issue.
    Otherwise, this is simply part of the contract, and the consequences of walking are spelled out. You might as well be upset at someone for taking insurance money after his/her house accidentally burns down (“you should have been more careful!”).
    As for the one-sided nature of this transaction, that’s what larger downpayments used to be for (and will be for again).
    One choice which Mark D suggested (and I misinterpreted as flip) was simply not to change careers (folks live with crappy “high paying” jobs all the time), but it sounds like they are going to have issues when things reset anyway.

  36. Posted by cooper

    Pretty good answer enonymous.
    Like yours too satchel. Those are some good points on not renting.

  37. Posted by anon

    I’m kind of surprised at all the “don’t worry about it, it’s just a business decision, screw the greedy lenders, walk away comments.” The guy bought a place he couldn’t afford and now he wants a do-over. Sorry, doesn’t work that way. I think it’s ridiculous. If he had lost his job, or had a major medical disaster I would be a whole lot more sympathetic. But from the sound of it he sounds like a d**k, and no amount of advice he gets is going to change that.

  38. Posted by Brutus

    The guy bought a place he couldn’t afford and now he wants a do-over. Sorry, doesn’t work that way.
    Sorry, anon, but that’s exactly how it works (unless there are different circumstances with this particular loan). The lenders are aware of the risks and price those risks in.

  39. Posted by wished I had held

    Wow, does this sound familiar.
    A little over 6 months ago we put our home on the market and sold in a week in one of the few “stable” markets in the US. We had only owned the home for a little over 1 year and managed to sell in a week. (I know, I know, we must have priced it low, but that’s another story.) Essentially, we made back all the money we put into the property along w/ realtor’s fees and made a few dollars that have now been mostly spent in the move and transition. So here we are 6 months later in our new city, in new jobs and we aren’t at all happy with either.
    Yup, you guessed it, we’re moving back.
    It sure would have been great to have rented the property (quite likely at a price which would have come very close to covering the mortgage) while we made sure this was where we wanted to be.
    Why would this have made sense to us? Because we’d have a home to return to (it seemed very unlikely at the time, but ya never know what the future will bring and why sell low?), the financing terms we had are unlikly to happen again anytime soon or ever, and the home was in a market that has historically been very stable and appreciating even in the face of downtowns elsewhere.
    So now we head back with no house, less cash, and no real apparent opportunity to buy again.
    My advice? While a pay-cut and new careers in a new city may all sound somewhat romantic – and final – it may not live up to your expectations, and suddenly, they may want to be back in the Bay Area. If you can, rent the property for a year until you are SURE this move will stick.

  40. Posted by fluj

    @ wished I had held,
    What areas are you speaking of if you don’t mind sharing?

  41. Posted by ex SF-er

    If you can, rent the property for a year until you are SURE this move will stick.
    and if it drops another 10%? that’s another $60-70k (almost an entire year’s income in their new location)
    the problem with holding out (by renting etc) is that we don’t know what the market will do. If it’s flat or goes up, then you’ll do ok. but if not then you’re in trouble.
    and if its not rented the whole time they’re in trouble as well. (Imagine having an empty unit as an out-of-state landlord… now it’s thousands of dollars A MONTH that they don’t have).
    in the end, the primary problem of course is that these people are overextended (if they exist). unlike Jake or Rillion, they could not afford this house.

  42. Posted by ZapBrannigan

    MakeMeDrink,
    Chalk another person that completely agrees with you. I’m also very surprised by the “blame the bank” mentality here. So far, the bank has held up it’s end of the bargain, so why should it be held accountable for this person’s bad financial decisions? Don’t get me wrong, I think the banks are stupid in the first place for letting a loan like this to even happen. But it’s definitely people like this guy that contributed to the ridiculous boom and is now contributing to the continued financial downturn.
    With all of that being said, he’d be an even bigger idiot if he were to liquidate his 401K. Yeah, money isn’t everything in life, but it sure as heck does make things easier.

  43. Posted by ex SF-er

    Relating to ex SF-er’s doubts about the bank’s reluctance: 401(k) and other ERISA governed accounts are non-attachable. The house is the collateral for the mortgage; liens can’t be attached to retirement accounts. If they truly have no other assets, then the bank may/should want to play ball.
    beedub: it is true that the bank can’t go after 401K money… however do you think a bank will go ahead with a short sale if it will wipe out 33% of their principal, when they know that the owners have ACCESS to the 401k and when they are making the payments?
    in general, what I’ve seen is that the bank (second lender) will put up a stink about it trying to get the couple to dip into that 401k. you do this by forcing the couple to “fall behind” in their payments ruining their credit score
    imagine you are the banking person, and a couple walks in and says:
    “we can afford our monthly payments, and we have 401k money that we could access, but we want to move and take a paycut and we don’t want to dip into our 401k. can we have a short sale now?”
    obviously you wouldn’t go for it. first the lender has to see serious threat that they won’t get paid, THEN they might consider the short sale. as it is they have a performing loan. why turn that into a non-performing loan and take losses????
    I’m not saying that the couple CAN’T get a short sale, I’m saying that they should try it, but not to hold their breath because it is unlikely they will be able to get a short sale QUICKLY (like for this current buyer). There are short sales around my hood, and NONE of them have gone through… and some of these borrowers have lost their jobs and haven’t made payments in months and months, and still the bank won’t allow the short sale.
    It’s DEFINITELY worth trying, but I wouldn’t hold my breath.

  44. Posted by SocketSite

    I hope I’m not being too harsh but I’m actually amazed that this made it through the Socketsite BS radar…
    We considered that possibility (that this story is BS). But even if this friend is fabricated, we’re fairly certain that there are others who are in this same situation and would benefit from the discussion and debate.

  45. Posted by ex SF-er

    the more I think about it, the more I like my “alternative” plan…unless there’s some reason why the have to leave the Bay Area now.
    this way they’re not dipping into their 401k. (they’re getting a loan, but not a withdrawal).

    1) recognize that they are not financially in a good place right now
    2) dump both leased cars ASAP, and instead use public transport or buy beaters
    3) sell the house now and borrow the 401k money as we discussed.
    4) move into the slums to raise cash
    5) eat ramen
    6) do this until they can pay off their 401k loan AND build up a little Emergency Fund
    7) then move. this might take a few years but they’ll be in better financial condition when they move

    I forgot to add in the original: during this time of frugality they should NOT contribute to any retirement funds. All money should go to paying off the residual on their cars, the 401k loan, and then building the Emergency Fund

  46. Posted by tipster

    Attack your retirement account to make the lender whole? They need to have their heads examined.
    As for “sorry it doesn’t work that way” (anon at 9:41), um, I hate to break this to you, but yes, it does. There are implied terms to every contract: one of those terms is what happens in a breach situation. The lender and buyer both accepted the risks of that contract term, whether it was written or implied. The lender knew full well what the risks were and chose to ignore them.
    The contract had an implied term that said: “if the buyer wishes to walk, he can. Lender has protected itself adequately from the risks of buyer doing so and has priced the loan accordingly.” The buyer is now exercising a right that was agreed on by both parties. If the lender didn’t adequately plan for it, well, the lender is a big boy.
    The buyer has a right to walk. I’d use it.

  47. Posted by anon

    I like how the sentiment on this site oscillates between the “greedy lenders knew what they were doing and should have to pay” to “greedy buyers knew what they were doing and and should have to pay.”
    This guy was in no way a victim of anything but his own lack of planning and impulse control. Can he walk away? Of course. But I still say that we’re in this mess in large part because many, many people acted like idiots, and this guy is just another example of that.

  48. Posted by condoshopper

    “This guy was in no way a victim of anything but his own lack of planning and impulse control”
    By a similar token, the bank is not a victim of anything either. They made a calculated bet with clear terms. Otherwise how can it be moral for them to lend mortgages at a higher interest rate than they return on people’s savings.

  49. Posted by San FronziScheme

    Using a 401k to pay up a mortgage? I bet this won’t happen to them twice.
    As they say: “fool me once, shame on you…”.

  50. Posted by Dave

    I’m just shocked at how many people think that it’s okay to screw the lender and walk away.
    Isn’t anybody raised any more to believe that a person’s word is his bond, let alone his/her notarized signature on a contract?
    I sign a contract promising to pay back money I have borrowed. Oops, now I change my mind and want to do something else. Sorry, “greedy lender”, that’s my right under the law, tough cookies! This is SO wrong. So far as I’m concerned, anybody pulling this ploy should have their credit blacklisted for life.
    We make decisions in life and we have to live with them. It’s called PERSONAL RESPONSIBILITY. All the people that think differently represent everything that’s wrong with our society today.
    We’re not talking here about someone who was coerced into a bad financial decision by a predatory lender. We’re talking about someone who made a reasoned decision to go out on a financial limb and purchase a home that was at the edge of their means. If they want to make a complete lifestyle change, they need to pay the price of satisfying the commitments they have made.
    To do otherwise makes them no different than a con artist. Sooner or later, those of us who are honest and committed to repaying every dime we borrow won’t be able to get loans either because of all the crooks that think it’s okay to renege on payment if they can get away with it.

  51. Posted by eddy

    Discussion is good, but I smell the BS too.
    This is a walk away situation if I ever saw it. The only reason to hold this property (note I didn’t say continue paying mortgage) is to wait for the appropriate bailout package to pass that will absolve your ‘friends’ sins.

  52. Posted by Animo

    1. Your friend is crazy if he takes advice from
    strangers
    2. subject to the above caveat, he hardly sounds like a candidate for a short sale, as he is not in default and, until he decides to fulfill his dream of being a cowboy, has sufficient income to pay (nb. the foregoing does not apply if he is, or is related to, a California Congressperson)
    3. he should speak to an attorney who specializes in debtor/creditor. The best ones do not advertise on TV; the better ones generally serve as section officers of the CA Bar Assoc.
    4. For those who approve of the friend breaching his contract because he can somehow “get away with it” keep in mind (a)TANSTAAFL, and (b) our economic system (sort of) works because parties to a contract are expected and obligated to act in good faith. The consequences of “I’ll do whatever I can legally get away with” are quite evident every day.

  53. Posted by fluj

    You all realize that “The Peninsula” is a little vague, right? The degree to which people are going out on a limb here with “walk away” is eyebrow raising to say the least. If it is in an area that commands good rents, walk away? Really?

  54. Posted by luvinmissionbay

    Wow!! “Ethics” versus THE LAW…quite a slippery slope the people are on that are supposedly taking the moral high ground.

  55. Posted by anne

    Agreeing with fluj’s 12.19 comment. There is a world of difference between a condo close to downtown Palo Alto and in a good school district, and somewhere like South San Jose. Rents are not coming down anytime soon in the former area.

  56. Posted by John

    I smell troll
    “The monthly cost of owning was probably about equal to renting with the low rates.”
    Why do they want to sell? They can simply rent it out and have the rent cover the mortgage.

  57. Posted by resp

    Cooper (above) got my blood pressure up the most:
    “Personal responsbility has to do with fraud, lying on your ap or whatever. It has zero to do with the market dropping out from under them.”
    No dude, personal responsibility is learning that 1) investments can go down a lot (10% is hardly disasterous), 2) you could lose your job anytime, 3) interest rates can actually go up, etc. Personal responsibility is doing a little more math homework before you lever up 20x to buy the biggest investment of your life.
    I totally agree that walking away is probably the best option for this person. That was the deal with the bank, but don’t try to tell me the outcome isn’t his personal responsibility.

  58. Posted by ZapBrannigan

    “To do otherwise makes them no different than a con artist. Sooner or later, those of us who are honest and committed to repaying every dime we borrow won’t be able to get loans either because of all the crooks that think it’s okay to renege on payment if they can get away with it.” -Dave
    Spot on Dave. Selfish actions like this always end up hurting other people: good borrowers, tax payers, etc… It peeves me SOOO much to know that our tax money is going to bail out idiotic banks and borrowers like him. We’re basically paying the Countrywide and Bear Stearns CEO to live in their mansions. We’re also paying for this guy to go fulfill a dream. WTF?!?! We have dreams too.
    Like I said before, it’d be a momumentally stupid financial decision to raid your 401K to pay off a lender….but the pissed-off-me hopes he does do that instead of walking away.

  59. Posted by amused

    This is simple personal responsibility.
    Raid your 401(k) if you must. I did, when I quit my job to start a company.
    Walking away from the loan is an admission that your word is worthless, and you’ll end up blacklisted. As an employer, I check credit reports as well.

  60. Posted by unearthly

    I’m amazed at the whining about contract failure as though a mortgage contract is different from any other contract. Is there some sort of divine force to protect lenders or does this site attract bank lobbyists. Lenders have their recourse as stipulated by the contract and state laws; end of story.

  61. Posted by Wai Yip Tung

    My opinion: Stuck it out and stay put for a few more years. Keep their 150k job and save money. If the market improves you can sell at a more favorable price. If it tanks, default. At least you have done your best and the market is just not on your side.
    I doubt the out-of-state move is a once in a lifetime opportunity. It may well be an illusion. If they give it all up and leave now they will sell low and become a failure. I hope their don’t find their life in Bay Area is so bad.

  62. Posted by Salarywoman

    What a person feels emotionally about debt and its obligations is an important factor in decisions such as this. In the long run, I’d say it’s more important than any rational argument or pragmatic analysis.
    Some people are perfectly comfortable walking away from a mortgage or any other debt. It’s just business. If they were somehow talked into giving up an asset (such as a retirement account) to pay it off they’d feel like suckers. And hate themselves.
    Other people are horrified at the idea. It’s irresponsible. If they were talked into walking away they’d be terribly ashamed of what they did. It could haunt them the rest of their life.
    Since these “friends” apparently feel that some things are more important than money, I’d wager that they fall into the second category. But in any case, I’d advise them to take a long hard look at how they’d feel about themselves before deciding on any course of action.

  63. Posted by amused

    I can only imagine that if this all were to happen five years earlier, they’d give back their windfall profits out of a sense of fairness.
    Whiny, entitled douchebags. Honor your commitments.

  64. Posted by Satchel

    I’ve got my own ideas about the morality of the whole thing. Suppose, just for a second, that the banksters, financial fraudsters of Wall Street, and the Fed encouraged a massive asset inflation solely for the purpose of creating fictitious pools of “wealth” from which they could skim a few % basically without anyone noticing?
    Think about it. Banks create money. That is how it is done in our system. How honest and ethical would the average businessman be if he could simply “print” his inventory at no cost. This is how Wall Street works. A basic truism – which will always ground your thinking – is that nothing can grow faster than the economy indefinitely. Nothing. If it could it would eventually overwhelm the entire economy. Through the magic of the exponential function, it wouldn’t even take too long, depending on the “spread” between money/credit creation and the “real” economy. Continuous credit inflation way in excess of real growth in the economy has created the perfect cover for a massive wealth transfer from the population to these fraudsters.
    I don’t have the exact figures handy, but I think the % of profits from financial companies in 1982 (the beginning of this great credit inflation – the last began in the late 1910s) was something like 6% of total corporate profit of S&P 500 companies. By 2007, that figure had reached 30%.
    The guys on Wall Street love this talk about “ethics” and “personal responsibility” almost as much as they love the palpable fear that if the taxpayers do not “bail out” the fraudsters, the financial system will come unglued and it will be bad for everyone. Maybe that’s right, but it’s coming anyway, with or without bailouts.
    For the people with this Peninsula condo (if the story is true), they should endeavor to minimize the bad that is going to happen to them. Don’t be suckers, and don’t raid your 401(k) to repay fraudsters who cynically understood that you wouldn’t understand the game they were playing.

  65. Posted by anon

    For the people with this Peninsula condo (if the story is true), they should endeavor to minimize the bad that is going to happen to them. Don’t be suckers, and don’t raid your 401(k) to repay fraudsters who cynically understood that you wouldn’t understand the game they were playing.
    Huh? There’s no evidence there was any fraud in this. It sounds like he can afford the place, he just doesn’t want it anymore. I have no sympathy for him at all. If this was some poor cleaning lady who was give some massive neg am loan, maybe. But this is just some schmuck who just wants it to all go away.

  66. Posted by John

    OK, math time
    700K x 80%, at 5% interest, $2333/mo
    700K x 15%, at 3% interest, $262/mo
    Plus $300 HOA
    Property tax, $729/mo
    Total: $3600/mo
    All of those are considered cost of rental property.
    If they rent it out at $3000/mo, the net cost for them is $400/month after the tax deductions.
    Now, that 100K 401K they have will last them 20 years at this moment (assuming the rent never increases for 20 years).
    If they want to throw away their 401K, I would throw it away during the 20-year period (at I listed above). Anyone want to bet that they can sell the property for 1.4M by then?

  67. Posted by into the breach

    Breach is implicit, if not an explicit right in every contract, and is thus a negotiated term. It is a simple business decision. Don’t breach, and continue with the terms or, when it makes more financial sense, breach and assume the penalties. It is a reality and a judgement that business entities make without compunction. It is not about honor in this context — it is rational decision to weigh the penalties for breaching against continuing the unfavorable terms of the contract. Sometimes the penalties for breaching are explicitly negotiated into the contract — that is, a specific $$$ is stated in the contract as the agreed to penalty for breaching. I repeat, ALL SOPHISTICATED BUSINESS ENTITIES BREACH CONTRACTS WHEN IT IS TO THEIR ADVANTAGE. I don’t disagree in concept with the posters who are talking personal resp., but I think that comes up in contexts different that this one. That being said, breach in this context does come with a penalty that the borrowers name is publicly besmirched (creditwise, jobwise, employerwise) for years. (in their all-imp. credit rept.) However, in this heavily negotiated, regulated & litigated millieu, it is a straightforward decision and it is not about honor, duty, or being “good”.

  68. Posted by enonymous

    thank you into the breach. especially for the part in caps.
    the moral high ground arguent, is quite frankly, not appropriate when it comes to contracts.
    i love the idea of personal responsiblity, but unfortunately not everyone believes in it.

  69. Posted by SausalitoRes

    I agree with the people who say “don’t raid the 401-K, let the bank eat it.” That’s probably the correct advice/answer on a micro level.
    However, the rest of us are eating it, along with the bank (or more likely the eventual purchaser of the securities that contain the debt).
    On a macro level, there’s no good answer here. We’re all getting hosed…particularly those who behaved responsibly.
    I guess the answer would be to let the lenders take financial responsibility for poor lending decisions while making it next-to-impossible for defaulting debtors to obtain even a credit card for a lot of years. It would give them something to think about every time they want to rent a car or buy something without cash in their accounts.
    Come to think of it, that’s probably the ultimate “recourse” for non-recourse debt.

  70. Posted by cooper

    Resp Said on August 21, 2008 12:46 PM
    Cooper (above) got my blood pressure up the most:
    “Personal responsbility has to do with fraud, lying on your ap or whatever. It has zero to do with the market dropping out from under them.”
    No dude, personal responsibility is learning that 1) investments can go down a lot (10% is hardly disasterous), 2) you could lose your job anytime, 3) interest rates can actually go up, etc. Personal responsibility is doing a little more math homework before you lever up 20x to buy the biggest investment of your life.
    I totally agree that walking away is probably the best option for this person. That was the deal with the bank, but don’t try to tell me the outcome isn’t his personal responsibility.
    ———————————————————-
    It’s a business contract. If they default the penalties are spelled out beforehand and they lender gets the property back. It’s non recourse—the lender made a bad bet by not asking for more up front and making assumptions that property values would not fall.
    This couple should rent it out until a short sale can be arranged and walk away with zero guilt.
    NOTE this is not Credit Card debt. Or some kind of personal loan. They put up the house at collateral. That’s what collateral means. They should walk away–GUILT FREE.
    Me personally? I don’t sign up for stuff i can’t pay for… but if I was in that particular situation, i would not be tapping my 401k to bail out the bank.

  71. Posted by flaneur

    Agree with John.

  72. Posted by chuckie

    John,
    Good job with the numbers except, in the expenses column, I would add $250 a month for property management(they are moving away), $250 a month for vacancies( can’t be rented all the time) and $100 a month insurance (gotta have insurance), $100 a month other routine repairs (plumbing backing up, dish washer giving up the ghost). Conservatively, I would say the expenses will be $4300 a month.
    And I doubt they can rent for $3000 a month.
    After a year or two of being used as a rental, the place will need some rehabilitation ($$$) to bring it back to a condo. Even without taking this cost into account, I can see them bleed $1200 to $1500 a month.

  73. Posted by cooper

    To John–I think I was the first one to suggest renting it out but no way the 5 and 3 are 30 year rates. those look like major teaser rates. So what if that 5 goes to a 7 or higher? or the 3?

  74. Posted by Animo

    Much sloppy use of the term “fraud” ’round here. Unless the lender intentionally misrepresented the terms of the loan, no fraud was committed. If the borrower feels the need to justify his breach of contract for his own peace of mind, it is convenient and fashionable to blame someone else (Wall Street, hedge funds, the illuminati)for his decision to walk. That decision is neither irrational nor fraudulent; it is, however, completely without legal justification, and those who blithely advise there are no legal or financial consequences attached to booking may wish to talk to a few Californians who lost their homes in 1982 and 1991. They may also wish to talk to a lawyer about exceptions to limited liabilty under a non recourse loan.

  75. Posted by John

    Chuckie,
    Minor maintainance are normally handled by the renters. Property management is necessary if they cannot handle it themselves. However, if they work for a big company (very likely since the 2nd loan is sponsored by the company), a quick email to the coworkers may be enough to find them a tenant.
    There will be some vacancy, but leases normally start from 1 year, and in reality, few people move every year. Every place I rented, I stayed for about 2.5 years. Assuming 1 mo vacancy every 2.5 years, that’s 100$/mo cost.
    So, yeah, add insurance, vacancy, and $100 other misc. Their cost is $3900, so it is -$900 after the rental income, or -$600/mo after tax deduction.
    Oh, by the way, assuming they have $100K in 401K, put them in risk-free investment (CD?), they will get 4000/year interest income, or $300/mo.
    See what I am getting at?
    The whole thing depends on the rent. “Stu” said the cost is about the rental, and I already gave a low estimate on rent.
    If they cannot get at least $3000 on rent, then Stu was wrong to say “The monthly cost of owning was probably about equal to renting with the low rates.” Stu’s information is all we have, so that’s what I am using).
    In any case, even if they have negative cashflow on the property, that 401K is enough for them to last 20 years (at least, 10yo), that’s enough to experience the next RE bubble, the next RE burst, and maybe the next next RE bubble.
    It is stupid to sell. That’s all.

  76. Posted by Foolio

    “Minor maintainance are normally handled by the renters.”
    Are you serious??? I call my landlord to plunge my toilet or change light bulbs in my apartment. It’s one of the best things about renting, IMO.

  77. Posted by into the breach

    Agree with Animo, penalties for breach should be well understood. If I remember correctly, there are circumstances where the lender can go after the borrower if the collateral doesn’t cover the nut — but it would have to be worth it for them to pursue that.

  78. Posted by John

    Foolio,
    Is your time so worthless that you call your landlord for lightbulb change?
    And the cost of lightbulbs surely add up right? ($250/mo, according to chuckie). $3000 worth of lightbulbs per year. Must be expensive.
    My current rental costed the landlord probably $400 over the last 2 years(heater starter failure, then shower faucet leak). Big deal.
    The lease contract can easily contain the language to ask the tenant to do minor repair. If it is not standard, they can add to it easily

  79. Posted by Satchel

    “Agree with Animo, penalties for breach should be well understood.”
    I totally agree as well. I thought we were all talking about purchase money mortgages here. In that event, the lender(s) should not have any recourse against assets of the borrower other than the house or condo. Of course, this should be checked prior to anyintentional breach.
    A quick check with a tax professional would also be warranted. Under the recent Mortgage Forgiveness Debt Relief Act, there should be no Federal tax implication. I don’t think California has harmonized its code with the Feds, and so there is a potential CA tax issue. To the extent that the homemoaners leave the state and establish domicile and residency in another state prior to foreclosure, arguably the forgiveness will not be a CA taxable event (although it *might* be in the new – 3% income tax – state; sounds like Illinois or maybe one of the southern states). Again, it’s worth a quick check with a tax guy. There are literally hundreds of thousands of foreclosures – the knowledge is out there, and shouldn’t be too hard to track down.
    As to the question of credit rating for employment prospect purposes, well, the friend already HAS a new job in the new state (it sounds like). Of course, it’s a risk having a foreclosure ding on one’s credit report, but this is a blemish that will be shared among millions of Americans before this is all done.
    Ultimately, too, as I pointed out in my first post on this subject, to the extent that a simple foreclosure can’t absolve the debt, the homemoaners could always consider bankruptcy. Of course, the stigma would be greater. But at least they would still have their 401(k) balances when the dust settles (these are generally not reachable by creditors in the bankruptcy procedure).

  80. Posted by Mike

    It is very interesting reading the various comments above. It’s not very heartening to think that there are so many people that think it’s okay to walk away from a debt, merely because they can.
    I guess I’m old school in that I believe that if you incur a debt, you pay it back using whatever means at your disposal. The fact that the contract has an out, or that banks and other financial institutions are just as irresponsible is not relevant.
    I’ve always conducted my business on a handshake basis and I’ve only been burned a couple of times. I guess I need to rethink how I do business given the number of people who think it’s acceptable to shirk responsibilities based on contract language, or rationalizing their behavior because “others do it”.

  81. Posted by [Prime]

    It’s very interesting how this “friend” and other like revel in other’s financial difficulties. I guess it is human nature to make oneself feel better by harping on other’s less fortunate.
    The answer is really simple, rent the place out. I have been a landlord for over 15 years now, and the magic number is THREE. It takes 3 years in the Bay Area for rent to start paying for all your property tax, mortgage, etc and be cash flow positive. They are at year 4. Rent it out, and let someone else pay your bills. After 5 properties in 15 years, I don’t even have to work and live off my income. That is not to mention what I’d get if i sold the properties.
    You’ll never get rich in property renting, and that is what this guy needs to do, rent it to someone.
    [Prime]

  82. Posted by [Prime]

    Also, walking away from your debt is 100% legit. That is capitalism at its finest. It’s important to let others hold the bag if you can do so by law. It happens in the stock market all the time.
    We pay enough taxes. Time to let other taxes bail ourselves out.

  83. Posted by unearthly

    Mike, what business are you in? In large publicly traded corporations they do what’s best for the shareholder. If that means stiffing a small timer to go with someone else then so be it. Contracts are entered and broken every day; just because it’s a individual on the other side doesn’t make it all that different from the larger C-Corp. Buying a house is a business transaction, on both sides.

  84. Posted by ex SF-er

    john:
    Your calculations omit important things
    1) you didn’t calculate principal repayments. Just interest.
    2) these are IO loans, the interest rate on the second mortgage will reset on them in 2010. It will clearly reset much higher (think it’ll reset to 3%? no way).
    there is no info on the reset date of the first mortgage, but 5 years is most likely. (most common IO loan is 5 years). could be 7 or 10 years though.
    so let’s take conservative numbers.
    I’ll calculate
    95% mortgage of $700k x 95% at 30 year fixed rate of 6% amortizing over 25 years.
    (I feel that 6% is a reasonable guestimate for reset interest rate… using 5.5% interest rate would shave off $200/month)
    Principal plus interest: $4284/month
    Taxes: $729/mo
    HOA: 300/mo
    Insurance; 100/mo
    property management?: (they are out of state)
    turnover costs (it costs money to credit check your prospective clients)
    total: $5413/mo
    -$5212/mo if you use reset of 5.5%,
    -$5016/mo if you use 5%,
    -there’s little possibility they’ll reset to lower than 5%
    -this does not include property management or turnover costs
    -it does not include mortgage deduction (remember, their income will go DOWN to $75k/year out of state… so the deduction won’t be as generous as it is at $150k/year)
    -it also does not include INCOME taxes on rental property.
    -also, if they sell after 5 years they LOSE their capital gains exclusion.
    so it depends on a lot of variables.
    but it needs to be shown how “just renting it out” can be a risky endeavor. especially when the overall mortgage may run as high as $5400/mo, MORE than they will take home each month when they are out of state.
    even $3000/month will be close to their total take home pay when they are out of state… so just 1-2 empty months will break them
    the point (that everybody is suddenly realizing): PRINCIPAL MATTERS, and one shouldn’t base affordability by teaser payments

  85. Posted by ex SF-er

    also:
    given the current credit turmoil if they keep and rent out their current place they will be unable to buy in their new locale. (debt to income will be way too high, even with the rental… lenders are VERY wary of “landlords” these days, and for good reason).
    also:
    keeping costs low depends on the couple lying and not being honest with the lender or the govt that this is indeed a rental, and not owner occupied.

  86. Posted by Satchel

    ex SF-er.
    “-it does not include mortgage deduction (remember, their income will go DOWN to $75k/year out of state… so the deduction won’t be as generous as it is at $150k/year)
    -it also does not include INCOME taxes on rental property.”
    If these guys do not want to cheat on their taxes (running the risk of audit), they CANNOT use the “standard” mortgage deduction that they could when they were CA homemoaners. It is no longer a personal residence, but rather a rental business.
    Most people in my experience DO cheat, of course, but as an out of state landlord, it would be worth it to think through the risks of cheating and audit, especially as claiming an owner-occupied principal residence mortgage deduction (the “standard” sort of dedcution taken by homeowners) might subject them to the inference that they have remained CA residents. CA takes a VERY broad view of residency, and this would almost certainly subject them to CA income tax. Certainly CA income tax on the rental income (as the source is CA), and perhaps on the entire W-2 income from out of state (an offset for state taxes paid to the other – lower tax – state would likely be available to lessen the CA tax impact, but they would in effect remain CA taxpayers if this analysis is right). This is tricky, and a tax professional really should be consulted. At $75K, these guys will have no wriggle room. Dump this place is my advice (again).
    In really broad terms, the way rental real estate is *supposed* to work for tax purposes is like this. Rental income is income (Sec. 61 IRC)subject to income tax. However, the owner of the rental property can use mortgage interest, property taxes, most expenses (some might have to be capitalized and amortized) and noncash depreciation (generally 1/27.5 I think of the value of the property) and noncash amortization of capital improvements to offset this income.
    In CA, because rents are so low relative to current purchase price, this calculation will almost CERTAINLY generate a tax loss. However, this tax loss cannot be used to offset other wage (or active) income of the owner of the rental property. Only in certain circumstances (the passive loss rules) can the owner use up to $25K of these losses annually to offset active income. This generally makes landlording much less attractive for the average person from a tax perspective than a principal residence mortgage deduction, and this distinction SHOULD NOT BE GLOSSED OVER. Any person interested in casual landlording should know these passive loss rules COLD. I’m surprised (not really, hehehehe) that the realtors like fluj and [Prime] who are engaged in landlording never mention these tax implications.
    The depreciation deductions that are taken on the rental property reduce the basis of the property, cumulatively. Once the property is sold, the owner will generally have to “recapture” this depreciation, by paying income tax (special rates, but still high) on the cumulative depreciation PLUS capital gains tax on the difference between the sales price and the adjusted basis after recapture. Of course, many owners choose to defer this tax treatment by rolling the asset into another like property by doing a 1031 exchange.
    The tax implications are convoluted, but conceptually pretty straightforward. The net IMO for these out of state landlords would not be good. I made these points in a different way (with less tax detail) above at “Posted by: Satchel at August 21, 2008 9:27 AM’ above.
    I hope all that helps some people out there!

  87. Posted by ex SF-er

    I agree Satchel.
    but in general IMO people take the mortgage interest deduction and don’t declare that the property is a rental for tax purposes. (depreciation or income tax).
    that is why I did not figure in mortgage deduction or taxes or any of that, because it will depend on how the owner structures the deal. it’s also why I said keeping costs low depends on the couple lying and not being honest with the lender or the govt that this is indeed a rental, and not owner occupied.

  88. Posted by Stu

    Thanks for the alternatives to consider. I think that there are some good ideas here and I appreciate the thoughtfulness of most of the replies. When I posted my initial query the other night, it was at the end of a 120 comment thread and my intention was to elicit a few ideas from some of the more savvy folks that were still actively posting on the C.A.R. affordability topic. I got quite a response it turns out. I probably owe you all more feedback for your thoughts, but it’s a massive task at this point.
    The rental discussion is pretty interesting, you guys could probably use some more details to keep it going. I have to back away from my statement that the rental costs and ownership costs were about the same. I really don’t know that, not at the level you all would. Sorry for the vagaries of “a peninsula condo”, but while I don’t doubt the anonymity or the international appeal of Socketsite, as I think about it today this is very much a local website. The last thing I want is someone to post an MLS listing “oh, you mean THIS place?” and then 10 seconds later somebody else comes up with a property shark record. Yes, I’m a bit paranoid, but you are a resourceful bunch. So please don’t do that. I feel conflicted about posting about my friend’s situation in the first place. Stu doesn’t feel much like a friend in this respect.
    I appreciate that most people have been able to sidestep the shaming and focus on what to do. My friend is under no illusions about how they got themselves into this situation, and strangely to most, want to take even more responsibility. I think salarywoman nailed it when she said that some solutions just might not work for certain types of people. Closure has a real value.
    But we’ll keep trying. Lots of new ammo. Ex-Sf’er,, my friends are taking many of the steps you initially suggested (related to paring down expenses). Thanks again.

  89. Posted by ex SF-er

    cool… good luck to your friends.
    If they stay at their current salaries and really pare down expenses they can really rack up savings fast. they can even rack up savings quickly at their lower salary depending on how low the COL will be where they move.
    this may take the pressure off somewhat.

  90. Posted by The Milkshake of Despair

    I’ve got experience to back up what unearthly and others state about corporations breaching contracts when it is in their interest. Years ago I had a consulting partnership who worked exclusively for a very large multinational. We arranged a fairly detailed SOW and contract before starting and sealed it with a nice handshake.
    About half a year into the project our client’s accounts payable department (in a different city and country, natch) discovered a contract loophole that allowed them to suspend payments indefinitely. We tried all of the usual channels to resolve this conflict to no avail. We were forced to use the only leverage that we had left : we stopped working.
    Yes a white collar strike, much to the chagrin to our peers with whom we had a great working relationship. It made for a really awkward situation since we had such a good vibe on this project. Our peers were forced to escalate the problem through their org and pressure the accounts payable department to stop throwing acid on the relationship (and get us paid !)
    If Stu’s friends breach, expect those on the other end of the contract to use whatever leverage they have to oppose their decision. Sounds like they might not have much though due to the no-recourse law.
    Personally I try hard to never get into a position that would motivate me to breach a contract. That’s actually the main reason why I dropped out of the buyer’s pool in the SF RE market. Escalating prices ate too deep into my safety margin.

  91. Posted by mike

    unearthly,
    “In large publicly traded corporations they do what’s best for the shareholder. If that means stiffing a small timer to go with someone else then so be it. Contracts are entered and broken every day; just because it’s a individual on the other side doesn’t make it all that different from the larger C-Corp.”
    And that is why I choose my clients carefully. Just because large corporations elect to act unethically, doesn’t mean it should be condoned. Perhaps I would make more money behaving as others, but at least I sleep well.

  92. Posted by unearthly

    If I break my cell phone contract I pay $200 to my provider plus any subsidies. What’s ‘unethical’ about breaking such a contract?

  93. Posted by af

    @wished I had held
    I am in a similar position, contemplating a move, think I could sell my house (or rent it out) and break even
    Very curious where you moved to and how much research you did beforehand?

  94. Posted by mike

    “If I break my cell phone contract I pay $200 to my provider plus any subsidies. What’s ‘unethical’ about breaking such a contract?”
    If, in doing so, you know that the cellular provider will lose money on the breaking of the contract, yes it is unethical. Of course the cellular company would likely have assured that the fee would cover their costs as would have the lender if not for CA non-recourse statutes. Just because there is a legal restriction doesn’t make defaulting on one’s mortgage appropriate or ethical.

  95. Posted by mk92

    “If, in doing so, you know that the cellular provider will lose money on the breaking of the contract, yes it is unethical. Of course the cellular company would likely have assured that the fee would cover their costs as would have the lender if not for CA non-recourse statutes. Just because there is a legal restriction doesn’t make defaulting on one’s mortgage appropriate or ethical. ”
    This is just wrong. The $200 provision is a liquidated damages provision. It exists so that both sides know in advance what the remedy is for breach. There is nothing unethical or inappropriate about breaching a contract that has a liquidated damages provision in it. (I also don’t think there’s anything wrong with breaching a mortgage contract, but that’s much more complicated than a contract that has such a clear remedy for breach built into it).

  96. Posted by Trip

    “Of course the cellular company would likely have assured that the fee would cover their costs as would have the lender if not for CA non-recourse statutes. Just because there is a legal restriction doesn’t make defaulting on one’s mortgage appropriate or ethical.”
    But the lender knew all about the CA anti-deficiency statutes. Unlike a mobile phone service provider, this lender chose not to add further protections, such as requiring a larger downpayment before approving the loan. And, unless the lender is truly nuts, it charged HIGHER interest on the loan because it was assuming a greater risk upon a default. Both the bank and the borrower bargained for who is left holding the bag in this situation, and there is nothing at all unethical about walking away as the contract permits.

  97. Posted by Satchel

    These ethics discussions are fun, but miss the true point IMO.
    Any normal person can figure out how much a phone service will cost them over the course of a year, and their estimate of usage charges – even if wrong – will not break them.
    Now, how much is a house truly worth? What is the interplay between “real” and “nominal”, between ex ante financing costs and ex post foregone invetment return? What have been the cycles between credit inflation and credit deflation? How long have they been with us? What is the role of fiat as opposed to hard-backed currency here? Why do houses in the SF Bay Area now cost 6-8 times median income, when in 1910 they cost 1.5-2.5 times? If the area has gotten so much better, the workplace so much more productive, the prospects so much more rosy, why didn’t income rise just as fast as the asset prices (thereby keeping the median multiple constant)?
    My point is, how many purchasers of homes can answer these questions, or have ever even thought about them (a little unfair, there’s no real *answers* here)? How many even understand how to formulate the questions or how to go about answering them?
    And yet people are supposed to devote an enormous percentage of their wealth (for most people, this wealth consists solely of the value of their labor) to an asset with these characteristics. They do it because there is larceny in their heart (you can’t cheat an honest man). They all believe in this idea that “inflation” will bail them out because that’s what happened in the late 1970s through 2007 (with some wiggles, of course). Most in my experience don’t grasp that what had “bailed everyone out” was CREDIT inflation (which leads to higher asset prices in real terms), and they are confusing it going forward with PRICE inflation (which always leads to LOWER asset prices in real terms, and often in nominal terms as well).
    Wall Street and the Fed have thought about these questions. Sorry if this sounds condescending, but they understand these questions at orders of magnitude higher levels than the average buying public. And they know how to manipulate the prices. It’s not exactly a conspiracy, but rather a natural result of the type of system we have created.
    The “fraud” is the price. Without the crazy schemes that the financial system has dreamed up (to enrich themselves) houses would be far less risky; they would cost FAR less; and they would likely be smaller and less luxurious in general (although they would be pretty much the same in SF, as the housing stock here has basically been frozen well before the most pernicious effects of this credit inflation have occurred).
    The law gives you an out. Don’t let ideas of personal ethics get in the way of protecting yourself in a basically fraudulent system.

  98. Posted by mike

    “Both the bank and the borrower bargained for who is left holding the bag in this situation, and there is nothing at all unethical about walking away as the contract permits.”
    We are all “holding the bag” given that the Fed and the Treasury are bailing out FNM and FRE. No personal responsibility in action on a much larger scale.

  99. Posted by The Milkshake of Despair

    To paraphrase Satchel’s statement : a home purchase entangles the buyer in a macroeconomic game where the rules are unfairly stacked. The banks have intellectual and financial power that dwarfs mere homeowners.
    So when your in the ring with such a heavyweight and he wants to take you down it is fair game to kick ‘em in the ‘nads. In fact the law allows it. But you’ll be branded is a nut knocker for the next decade and that might be a detriment.

  100. Posted by Publius

    I can’t believe I initially missed this thread. Two things. First, there is strong policy behind the antideficiency statutes in California. Second, refinance does not necessarily mean that you do not enjoy antideficiency protection.
    To all of the people that talk about “personal responsibility” with the loan and a obligation to by the borrower consider this. Without the antideficiency statutes lenders are more likely to overvalue a property. They will lend and expect payment on an asset whether there is real value there or not. That is the first main rationale “overvaluation-prevention.”
    The second main rationale is that the antideficiency statute acts as a “depression-cushion.” The thinking is that if deficiency judgments were permitted, debtors would be unduly susceptible to losing both their property and their personal assets at the same time. Rampant personal judgments against debtors would greatly exacerbate the economic downturn and hinder recovery.
    I’m not an economist, perhaps Satchel can weigh in on the validity of the rationales. However, my perspective is that the general public has no real knowledge of the financial markets and must rely on the lenders to make a loan that they can afford to pay. Arguing that borrowers should educate themselves before buying only affects those that are the most unsophisticated and least affluent. Lenders will not take the proper care, especially with the people that need it most.
    Yes, some unethical investors may also benefit. However, the benefit to the general public far outweighs the harm suffered by lenders by unscrupulous investors.
    If anyone is interested the policy is explained in a old 1963 case called Roseleaf Corp. v. Chierighino.
    On a related note, everyone in the real estate industry will tell you the if you refinance you do not enjoy antideficiency protection. THIS IS NOT TRUE. If you refinance with the same lender for the purchase price amount you still enjoy protection. If you refinance with another lender for the purchase price amount you probably still enjoy protection. There is no case that has decided the issue of whether a refinance for more than the purchase price enjoys protection or not. However, I think there is a strong argument that only those amounts over the purchase price are subject to personal liability. There also a strong argument that any loan on a personal residence is subject to the statute.
    Nothing in this comment should be considered legal advice. However, if a lender tells you that you are liable on a loan for a personal residence regardless of whether you have refinanced or not, find an attorney who is familiar with these issues. DO NOT use your personal assets to benefit the lenders.

  101. Posted by Publius

    mike -
    There is nothing “unethical” about a breach of contract unless there is bad faith. Parties contract with certain expectations based on present circumstances. If circumstances change the parties may or may not be able to honor the contract. That is why each party has a duty to mitigate damages.
    Anyone can think of situations where a contract should not be enforced because of a change in circumstances. Of course, if circumstances do not change parties should honor their contracts.
    People make promises to each other frequently and they should be held to those promises, but not at all costs.

  102. Posted by mike

    It truly is interesting how many people believe it is fine to stiff a lender (and consequently the investors/taxapayers/etc.) because of a personal choice to move and take a lower paying job. There are certainly valid reasons for the non-recourse statutes for situations beyond an individual’s control, however I don’t think they were intended to provide for a no-risk real estate purchase (ie: if the property appreciates great, if it depreciates, toss the keys).
    The entire real estate industry is filled with self serving individuals who take no responsibility for their actions. This includes the homeowner who thinks he/she can walk away on a whim, or the real estate agent who truly only represents themselves in any transaction, or the lender who merely packages the loans and sells them off to the investment bank, or the investment bank who slices the loans into various tranches and then creates derivatives on the assumed value of the loans.
    It should always be remembered that this is a zero sum issue. If a borrower defaults on a loan, then an investor somewhere is losing some principal. If that investor is an individual, then their portfolio has taken a hit, if that investor is a corporation, then they will likely raise prices to compensate for their loss, and if that investor is an investment bank or sovereign wealth fund, they will obtain a taxpayer guarantee of their principal.

  103. Posted by anon

    sounds like Satchel is bitter that he/she couldn’t get a high paying job on Wall Street and is now throwing around highbrow macroeconomic chatter. Home buyers don’t have to understand a fraction of what you suggest. A lot of problems could have been avoided if buyers simply considered things like:
    - housing values don’t always go up
    - 5.5% of x = y and my loan docs say the rate could go to 10% so 10% of x = z. Hmmm can I afford that given the future prosepects for my job?
    - it might be worth investigating why the nice loan man in the suit didn’t want any proof of anything on my loan application
    Yeah the banks that made loans and the investment banks that securitized them had a lot more information than Joe Public but Joe had quite enough basic info to keep him out of trouble. Whoever said this was a zero sum game is right. Everyone was greedy and everyone’s gonna pay.

  104. Posted by Trip

    Even if this is a zero sum game, why does that mean the borrower should take the hit? The lender or whomever bought the loan from the lender should take the hit for failing to properly protect itself from this circumstance which is permitted under the contract and under the law. Mike argues that “if that investor is a corporation, then they will likely raise prices to compensate for their loss.” That is fundamentally flawed as a matter of basic economics. Corporations cannot simply raise prices at will. Prices are determined by supply and demand, not investment losses or other costs of the seller (believe me, if this hypothetical corporation could raise prices, it would have done so already). As between the various entities who might take the hit in this situation, the most just result is that the lender (or purchaser of the loan) do so because it priced the loan (or subsequent purchase) specifically to account for the likelihood of a default.

  105. Posted by Publius

    “Joe had quite enough basic info to keep him out of trouble”
    I couldn’t disagree more. Attorney Generals from over 30 states also diagree. Lenders purposely targeted minorities and elderly Americans for subprime loans. As a result, several lenders suffered millions of dollars in fines over the last several years. There are several ongoing class actions involved. To avoid liability many of these companies have passed these loans to others on the secondary market. They have been packaged as securities and sold off. Joe Public has been left holding the bag and the rest of us are now going to pay for some sort of bail out plan.
    Just because some members of the public are sophisiticated enough to stay out of trouble, the vast majority of the public has no idea of how the housing market works. In fact, before I was involved in several of these cases I had no idea myself.

  106. Posted by Jimmy (Bitter Renter)

    Optimistic buyers of highly-leveraged assets losing their shirts?
    This merits 105 posts?
    NEXT!
    Although I am impressed/amazed that they would compromise their retirement in order to make the lender whole… that is truly, shockingly stupid.

  107. Posted by wished I had held

    AF … To answer your question, I did a fair amount of research on what my home was worth and what I thought I could rent it for. I knew that the market was changing fast in most of the country (both home values and mortgage) and it seemed likely that we would be waiting at least 2 years before buying again in our new city.
    I moved from a very desirable small college town where rentals are well priced and clean homes in good neighborhoods are very rare so was fairly confident that I could find a reliable tenant. I was moving to a city that (at least so far) is also emerging from the housing crisis in relatively good shape. What I hadn’t counted on was a change of heart. Now that I’ve come out of the closet so to speak on this geographical about face, I’m hearing from all kinds of people that this happens all the time. It seems like people often move somewhere hoping for some better life and then realize they were better off before.
    My advice is simply that given the turmoil in the housing market, the credit markets, changing employment situations, and most Americans ever increasing mobility why sell a home now if you CAN hold it?
    I am not as experienced as some SS readers but isn’t selling a primary home now a bit like trying to unload your SUV? Just leave the thing in the driveway, take the train to work and take it out only on Sunday … like our grandfathers did with their Cadillacs back in the day.

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