This entry was posted on Tuesday, September 16th, 2008 at 1:00 pm and is filed under Credit Cards, Debt, Household, Planning, Rental Property, Risk, Saving and Investing, Stories. Both comments and pings are currently closed.
In Part I one this story, I told the story of how we came to own our current home, how we financed it, and how we found ourselves upside-down on our mortgage.
The original loan on our house had a clause that said that we could not refinance or pay off the loan for at least 6 months. Recognizing that we got a rather lousy interest rate because of our lack of documentation, as well as the fact that we would have to refinance anyway, we went ahead and refinanced as soon as we could. Just about 6 months and a day after we signed our original home loans, we signed two more loans — one for 80% of the value, our first mortgage, and one for 10% of the value, our 2nd mortgage. Because it was only 6 months into the original mortgage, the appraised value of the house did not change. Both of these mortgages are 30 year fixed loans with decent interest rates.
In the time since we refinanced, rates came down considerably, and we tried to refinance again into a lower rate. The appraisal that we got in the process was the first strong clue for us that trouble was brewing: the appraised value was about 10% lower than what we paid, despite the fact that we had undertaken substantial exterior cosmetic improvements (curb appeal). We were unable to finance into the very low rates that we available a little over a year ago since we now owe more than the property is worth.
Having unknowingly saved ourselves from the current mortgage crisis, we also did the smart thing and consolidated the 3 credit cards that I talked about in Part I into one card. Every few months or so, I get a set of checks from my Chase Platinum card with offers for 0% interest for a year, 3.99% for 2 years, or 4.99% for the life of the balance. We opted for the 4.99% deal. Since half of the improvements made with the money on this card are for a legitimate business expense, we can deduct half of the interest payments on our taxes, which further reduces the effective interest rate. In the time since we completed this balance transfer, we have paid down 3/4 of the original balance. Because the interest rate is so low at this point, and half tax deductible, we have slowed our aggressive pay down of this account in favor of building up some savings.
So while we are not in any trouble with respect to continuing to make our mortgage payments or servicing the debt or our improvements, we are still in a pickle. We are looking down the road at the needs we have for housing, especially in light of our growing family, and are not all that pleased with the options we have available:
- We can sell our house, but we would have to come up with between $30,000 and $40,000 to cover the difference between what we owe and what the house is worth. This would wipe out our savings, and we would be just about starting over financially. We would have to find a place to rent as well while we save money towards the down payment on a new house.
- We can buy a single family house now, and keep our two family, renting both units. The trouble with this option is that it would also wipe out our savings, putting us in a precarious situation if any emergencies come up. Another problem with this plan is that the market rents for our two units is less than the combined mortgage, insurance, and utility rates we would have to pay out each month. This is what makes the property an Alligator. Each month we will have to feed it hundreds of dollars to keep it afloat. This could actually be seen as a really great investment, a forced savings plan of sorts, since we will eventually get this money back when we sell the house.
- The default option here is to keep doing what we’re doing. That’s fine for now, but we live in a 2 bedroom apartment, and depending on the gender of our next child, may only work out for a short period of time. The real downside to this plan is that we may miss out on some great real estate deals as the market bottoms out. Under this plan, we can save for a new house over the next several years. However, there is still the issue of the 2nd option above. With any luck, rents will rise over the next several years to offset the continuous payments we will have to make into the house, but we can’t bank on that.
We made two major mistakes along the way with the purchase of this house. We bought an over-valued asset at the height of a market bubble. We failed to adequately assess the income versus expenses for a rental property. In our defense, we bought the house for the reason stated in Part I: to be able to afford to live in the area we wanted, close to other family and in a decent neighborhood. But in retrospect it was an investment that will not provide the returns that we could have achieved using other investment vehicles.
What would you do? Do you see options that I haven’t seen? Are you feeding an alligator? Let me know what you think in the Comments section below, or click here if you’re reading via an RSS reader or by email.