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Part 2
Many years ago my father shared with me his theory on economics. That rather simplistic theory, expressed a mathematical formula, is [IC – OG = OC]. The problem with mathematical formulas is they tend to turn off the minds of people like me who are looking for simple answers for complex problems. Truth is, with little explanation, just about anyone can understand this formula. It stands for the proposition that “InCome minus OutGo equals OutCome.” The good thing about this theory of economics for me is that it is easy to remember and easy to understand. The bad thing about the theory for me is apparently my father’s taking credit for its creation is inaccurate. Seems a mathematical economist named Irving Fisher (1867-1947), and described as “one of America’s greatest mathematical economists and one of the clearest economics writers of all time,” is credited with its creation.3
In the previous article we discussed the plight of John and Suzie Smith. They, like many others who gained the label “first time homebuyers” over the past few years, are facing what they would likely describe as the nightmare associated with homeownership. It is hard to credit the Smiths with fault for their situation. The “Real Estate Industrial Complex” [REIC]4 was at the time loudly touting real estate as an investment that only goes up in value and the then Federal Reserve chairman Alan Greenspan was singing the praises of adjustable rate mortages [ARM]5.
The situation the Smiths face is surprisingly similar to the story told by Jim Wasserman in his recent Sacramento Bee article titled Foreclosures Stacking Up6. In it, he describes the situation facing Tracy Trammell who sold the boat, the extra vehicles and tried everything to find a way to refinance, or do what she could not to lose the house. As the author noted, Tracy was “in a bind all too common in Sacramento: a home losing value and an adjustable-rate mortgage with payments that jumped $1,000 a month in June.”
According to the article, “thirty days ago, Trammell, a widow and working mother with two daughters, skipped her first payment to Countrywide Financial Corp., a company deep in its own crisis amid a pileup of hardship cases. This month, Trammell will miss a second payment on a refinance loan her late husband handled at the peak of the housing boom in 2005.” The result to date is neither Trammel nor Countrywide has yet been able to work out a deal to spare her small house from foreclosure. There are no loan modifications. No refinance options. No waiving of a pre-payment penalty that stings a borrower for thousands of dollars to get out of trouble. In response to Trammell’s request of Countrywide for a solution, she said they recommended that she get a roommate.
A potentially fatal mistake Trammell may have made was utilizing the proceeds from the sale of the boat and extra vehicle to make the mortgage payment. Her interests may have been better served holding that money in reserve to help fund some sort of “workout arrangement” with Countrywide and immediately approached her lender when it became clear that she wouldn’t be able to make the payments. By having seed money to sweeten any proposal, she might have been able to convince Countrywide to defer a portion of the delinquent payments by adding it to the loan’s unpaid principle balance. Alternatively it could have served as a source of money to fund the costs associated with renting a home in the event she was unable to negotiate a workout arrangement with Countrywide and ended up losing the home through foreclosure.
For John and Suzie Smith to avoid potential mistakes, it is absolutely critical that they make an honest assessment of their situation. One approach may be to first develop an action plan that has them losing the property through foreclosure. If that becomes the case they will need to have the financial resources to obtain replacement housing. That means doing research about the rental market to ascertain what an expected monthly rental cost will be along with typical landlord requirements in terms of move-in costs (security deposit, first month’s rent, etc.). An obvious source for funding this results from the non-payment of their home’s mortgage during the foreclosure period. The practical truth is, if the property is over encumbered (more debt than its is worth), and the lender is unwilling to negotiate a workout, the best thing to do may be to occupy the premises as long as possible and save money so you can afford to move.
In future articles we will discuss what other information you will need to map out your strategy. Recognize that when armed with enough information you will be in a much better position to follow a course of action that benefits you the most.
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