Q: My husband and I live in a house that I own on my own. I paid $500,000 for the house in 2005.
I took out a 100 percent loan with a 5-year fixed rate first mortgage for $400,000 and an adjustable $100,000 home equity line of credit as the second loan. After about a year we refinanced the house to make improvements. We now owe $400,000 for our first, $100,000 for our second and $100,000 for our third. That means we owe a total of $600,000.
I was wondering how much our house is worth. So, I looked on Zillow.com and it says our house is only worth $470,000. Our house is nice, but we are only in an okay neighborhood with houses selling, or not selling, as low as $350,000.
We’d like to stay in the house, but we’ll need to refinance within the next two years. We do not have enough documentable income under the new guidelines to be able to afford the house, and we’re worried that we won’t be able to find anyone to refinance the house when it is worth so much less than we owe. I would really appreciate any help you can offer.
A: So you owe $600,000 on a home that Zillow.com claims is worth $470,000. Let’s start with that estimate. Many websites have gotten into the business of estimating real estate values. In some cases those valuations are accurate but in other cases they are not.
We have written several articles on these companies quoting executives and outside real estate observers talking about how the mathematical models and information on which they base these models can be completely off the mark.
What could go wrong? In your case, Zillow.com may not have recorded the improvements made to your home or may estimate your home as being smaller than what it really is. Or, the tax and sales information for the neighborhood might be spotty. On the other hand, it’s quite possible that your home is worth even less than what Zillow thinks.
If you really want to know what your home is worth, you need to have a better understanding of the real estate market in your area. Are prices stable? Have they declined? Or, have they increased since you bought your house? Are homes selling relatively quickly or are they languishing on the market month after month? The best people to help you figure out that information would be the real estate agent who helped you buy the property or an appraiser.
Next, you need to know how your house compares to other homes in the neighborhood. Just because some homes in your area are selling for $350,000 doesn’t mean your home would sell at that price. You’d have to know whether those homes are comparable to your home in size, condition and amenities. If they are, you have a problem. If you’re comparing your house to the homes that are for sale and at this time they all happen to be smaller than your home, then the comparison might not be a fair one.
Right now, it’s quite difficult to evaluate what your home might be worth in this market. The good news is that you have another two years before you must refinance your primary loan.
A more important question is can you afford to make your payments on each of the three loans? If your variable rate second and third mortgages start to rise, will you still be able to make these payments?
Many 5-year adjustable rate mortgage (ARM) loans include a cap that would restrict the increase in your loan when it adjusts. Some ARMs have a cap of 2 percent on the first adjustment period. So if your loan rate you obtained in 2005 was 5 percent, the maximum your loan could go up to would be 7 percent.
At 7 percent, your rate would still be historically low but not as low as the rate you currently have. But to get to that 7 percent rate, interest rates would have to increase quite a bit from where they are now.
For example, if your ARM is tied to either the one year US Treasury rate or the one year LIBOR (London Inter Bank Offered Rate) and it has a typical margin of about 2.75 percent, the LIBOR or the Treasury rate would have to be 4.25 percent or higher for you to pay 7 percent.
Currently the rate used to compute the one year Treasury rate is about 2.50 percent and the LIBOR rate is slightly higher.
If your loan were to readjust today, your new interest rate would only be slightly higher than the 5 percent rate you might have obtained in 2005.
Of course you didn’t supply all of the information and we’re making some assumptions about your loan and the terms that it includes. You should take a look at your loan documents to determine what index your interest rate is tied to and what the margin is on the loan. That will help you figure out what kind of payment adjustments you’ll face down the line.
You have about two years to get your finances into shape, improve your income, and make sure your credit history and score are as high as possible. If your income isn’t high enough to refinance the loans, hopefully you can either figure out how to bring in more income, or you may be able to find a loan that will allow you to stretch your debt-to-income ratio.
The big question is whether your house will have enough value to allow a lender to refinance it. If property values stay low over the next several years, be sure you understand what is the worst case scenario in terms of your mortgage payments. You may simply have to pay more on the loans if you cannot refinance because of your home’s current value.
If you can afford that, then hopefully you can stay in this house for many years to come. And when you sell, hopefully you’ll walk away with a significant amount of equity.