Q: I just read an article in my local paper about a company that offers a service that guarantees the rent of an existing home for three years (and covers many of the fees during the first year) for homeowners who qualify for, and wind up purchasing, a new home from one of their new home builder partners.
I currently live and own a home that is underwater in Tucson, Ariz. and am going to need to relocate to San Diego for work. I am trying to determine the legitimacy and reliability of the process they offer and would like to know your opinion of it.
A: Let us start by staying that we don’t know the specific company to which you refer and that’s why we’ve taken out the company name from the letter. We can’t comment on their reliability and since we haven’t worked with them directly, we can’t recommend companies that claim to offer these sorts of services.
That said, we’re seeing the same sorts of ads all over the country, as builders struggle to get people to make the move and buy a home. With the prices of property down by as much as 50 to 60 percent in some areas of Arizona, New Mexico, Florida, Georgia and Michigan, the new construction developers that weren’t wiped out in the housing crisis of the last few years are trying to think of innovative ways to encourage folks to buy new homes.
Research tells builders that not being able to sell (either because there is no demand or because homeowners are underwater) means people aren’t in financial condition to purchase the home. What would make the difference? Being able to rent out the property, so at least the mortgage, insurance, and real estate property tax payments are covered.
For a builder, that might cost $12,000 per year, or $36,000 over the three year commitment – if the property can’t be rented. The builders are probably banking on the fact that someone will turn up in that time period to rent the property, taking them off the financial hook. You, the owner, will feel as though you’re protected enough from the downside to take a risk and sign a contract for a new home.
But there are some inherent risks here that we want you, and other homeowners considering this sort of deal, to think about.
Let’s start with the decline of real estate prices. One question to consider is whether three years will buy you enough time for local market conditions to change and whether at the end of that guarantee period if you would have an easier time selling your home. You might, or the local market might get flooded with more foreclosures, keeping prices steady and making it tougher to sell.
But here’s another issue to consider. Let’s assume the company is legitimate and you decide to do the deal. So, you buy a new home and rent your old home for three years. Those three years could take a toll on the home, which might then require substantial repairs in order to make it salable.
Let’s say that while home values have gone up in three years, you’re still underwater with your mortgage. If you can’t sell for what you owe, and for some reason you can’t rent, then you’ll be stuck with the cost of your new home and the cost of maintaining the old home. You could be in worse shape under this scenario than you are now, particularly if you want to keep your credit history in good shape.
In this scenario, you might have try to sell the home in a short sale. This wouldn’t be so bad, but now the home may not be considered your primary residence (according to the IRS) and depending on where tax rules sit, you may have a substantial tax to pay when you complete the short sale.
At least through the end of 2012 (and longer if Congress extends this law change), you don’t have to pay tax on phantom income. When a home lender forgives debt you owe – the amount you are underwater on your mortgage – that amount, which is known as imputed or phantom income, can be considered income to you.
Let’s say you’re $100,000 underwater on your mortgage. If you short sell the home and that amount is forgiven, you may have to pay as much as $30,000 in federal income tax on that amount, plus any state taxes that are owed.
Today, lenders are mostly releasing the deficiency owed (the difference between what you owe and the net sales price), and waiving any right to go after homeowners for that deficiency. In three years, lenders may not be so forgiving, and not only will you have a huge tax to pay, but you might also have the lender chasing you for the deficiency for the next 20 years.
And, what happens if the developer goes out of business and stops making those rent payments? If the company is unable to honor it’s obligation to make those rent payments, your financial situation will deteriorate quite rapidly.
In the best case scenario, you’d buy a new home and sell your home three years down the line after receiving rent payments for three years. The home would stay in great shape and a buyer would walk through the door and purchase the home at a price that pays off all your debts.
The real question is whether you’d want to become a landlord on a home that is underwater. If you want to move to a new home, you might consider asking for some sort of cash break on the price from the developer (something less than $36,000 but more than nothing), and selling the home. It’s better to cut your losses today rather that push this problem down the road by several years.