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By now, you should have heard that the real estate market is picking back up. Low interest rates and low inventory are spiking the average home price here in Washington State. Homeowners are now deciding on their options of either letting go of their underwater homes via short sale or foreclosure, continuing to live in it, or even rent it out and becoming a landlord. Which option would be best for you?

According to Corelogic, home prices nationwide increased on a year-over-year basis by 8.3 percent in December 2012 compared to December 2011. The spike is largely attributed to investors buying out most of the inventory thus increasing demand. This appreciation rate will most likely be unsustainable but of course, only time can tell. Zillow Home Value Forecasts (ZHVF), expects home values to increase 3.3% (Dec 2012 to Dec 2013).
Ah good news, home prices are rising again! So shouldn’t we keep our home that is underwater until we break even so we can avoid a short sale and a ding on our credit?
Let’s explore this option.

We will use the example of Mr. and Mrs. Smith who are barely making their payments and have a home that is worth $230,000 but owe $300,000 to their lender. The Smith’s think to themselves, if they live in their home in hopes to sell it once they come out from underwater, they don’t have to sell short. Assuming we will get a 5% appreciation rate (being optimistic), it will take them about 4 years just to break even. The Smith’s realize that it isn’t worth throwing away about $57,000 over the years in a home that has negative equity.

So they discuss their option of making their home into a rental property for the next 4 years to avoid the ding on their credit. Most likely, they will have a negative cashflow situation for all four years if you include PITI (principle, interest, tax, insurance) along with maintenance and repairs. Most importantly, the Smith's do not realize how difficult it is to be a landlord. Dealing with tenants (finding and maintaining), lease contracts, property maintenance/repairs, among others difficulties many times suck the life out of landlords. Many homeowners who opted to rent their homes because it was underwater are concluding to short sell years or even months later. Just ask friends or family about their experiences as landlords.

Mr. and Mrs. Smith’s situation is very typical and if they took the route of holding until breaking even, they will most likely be left with an even bigger headache.

What if Mr. and Mrs. Smith chose to short sell now?

A short sale is when you sell your home for less than what is currently owed on the property. The Smith’s decide to find a short sale expert and talk to their lender to see if they qualify for a short sale. IF they short sell now, they will finish in about 120 days which means if they started now, they will be done and out of their negative equity situation by summer time.

How would the financial rebound look like for the Smith’s? If they were not delinquent on their payments but was able to show inevitable delinquency, the ding on their credit score would be significantly less. If they were delinquent prior to closing the short sale, you will be facing about a 80-160 point ding in your FICO score.

Now how soon will they will be able to rebound on their credit depends on different factors. If the Smith’s end up using Lexington law to expedite rebuilding their credit score, they can easily repurchase another home within 2 years (possibly sooner) using the money that they saved from the mortgage payments that would’ve wound up in their underwater home. Once they are in a home, again, assuming that there is a 5% appreciation rate, they will start BUILDING equity.

So what is the best choice for Mr. and Mrs. Smith?

What do you think?

Peter