Q: We are saving to buy a second home to find better schools for our kids and because we are 50 percent upside down in our current home. We plan to short sell our current house once we get into the new home. Our current loan is an FHA loan.
Does it make sense to short sell the current home first so that we only need to come up with 3 percent down versus 5 percent as a down payment? Or should we stick to our original plan? My concerns are the impact of the short sale to our credit histories versus the financial impact of carrying two mortgages and what kind of changes will we see to local housing market conditions by next summer.
A: Your questions are important and speak to the intrinsic problem many Americans are facing as they try to move forward with homes that are seriously underwater (worth less than the mortgage amount).
Let’s start with your credit issues. When you short sell a home, you are frequently asking your current lender to accept less money than what the lender is owed to allow a sale to go forward. If the lender agrees, your credit will be seriously damaged by the short sale. Moreover, you may not be able to purchase a new home for several years. Many mortgage lenders will put you in a “timeout” until several years has passed since your short sale (or foreclosure).
So if you do the short sale first, you may not be able to purchase your new home in the better school district in the near future.
Your financial question is important, too. You are making two big assumptions when you consider buying a new home without having sold your current home. You are assuming you will qualify for a new loan for the purchase of a new home without having paid off the mortgage on the old home. You are also assuming that you will be able to get your current lender’s permission to sell your current home in a short sale without that lender requiring you to pay off the balance of any outstanding balance you might have on the home after you sell it.
You mentioned that you are currently upside down by about 50 percent on your current home. If you are current on your mortgage payments now, you appear to have the means to pay your current mortgage and most lenders will want to see some sort of hardship to enable you to walk away from the home and the debt on that home without a payment plan of some sort. Furthermore, if you have made all your payments on time, you probably have a pretty good credit score to qualify for a new loan.
However, for you to qualify for a new loan, you might have to prove to any new lender you want to have fund your new loan that you have enough income available to you to carry both mortgages. If you don’t have that sort of income, the new lender might make it a condition of your purchase that you sell your current home and pay off that lender before they give you money to buy the second home, particularly if you are looking to buy the new home with only three or five percent down.
If your income has not changed and your main reason for wanting to sell your current home is to move to find a better school district, your current lender may not be too sympathetic and may deny your request for a short sale.
And, don’t forget the tax consequences. If the lender actually forgives your debt, and allows the short sale to go through, the deal has to be done by December 31, 2012. Current tax law provides that mortgage debt forgiveness will only be treated as nontaxable by the IRS through that date. Starting on January 1, 2013, mortgage debt that is forgiven will once again be treated as income and subject to federal and possibly state income tax.
Given all this information, you have to investigate whether a short sale is available to you, whether you are willing to take the hit on your credit score and credit history from the short sale, and whether you can find a lender now or after the short sale that would be willing to finance the purchase of a new home.
With this information and these issues, you should talk to a real estate salesperson in your area to get a better idea of the state of the real estate market in your neighborhood. You should also talk to a mortgage lender and a mortgage broker to discuss your options and get a better understanding of where you stand with your current lender and any future lender for the purchase of a new home.