Getting equity out of a paid off house?

[RosieTR]

Anyone know what options are out there for getting equity out of a paid-off house? We are in a weird situation in which we have one paid off house and another pretty far underwater. We live, now, in the paid-off one and had the other rented out. Well, found out today that the renters were actually using it as a drug house! Thank goodness not a meth house with the associated toxins, but now we have to get the doors that the cops kicked in fixed. BTW, this was managed and screened via a property mgmt company. I had thought about seeing if we could take equity out of one house to afford to sell the other, if we even can, but since it's paid off I'm not sure how that works. We don't have enough cash to cover the difference (~ 1 yrs pre-tax salary for both of us) and don't yet think it's a good idea to look into any retirement type funds. It would be hugely disappointing not to have a paid-for house, but I'm starting to seriously consider whether it's worth renting out for the years/decades it would take to get to a point where we could afford to sell with cash on hand. I think the difference in monthly cost would be less variable, maybe a bit higher over the long term but not something we couldn't afford at this point.

[SteveinMN]

Well, there are home-equity loans and reverse mortgages. I don't think you want a reverse mortgage since you want to hold on to the paid-off house anyway and RMs don't "pay" all that well. So that leaves home equity.

One other thought, though, one you would need to discuss with a real-estate person or maybe your management company: rent-to-own -- finding renters who may want to/have to rent due to credit issues (like their own short sale/foreclosure) who would want to use some of their rent toward the purchase of the house at some future point. That should get you a better class of tenant since damage done will be damage they have to live with. Like I said, I'm not completely up on the specifics, but it might be an alternative to trying to sell the house now.

[jennipurrr]

The two products you most likely want to consider are Home Equity Loans (HEL) and Home Equity Lines of Credit (HELOC). On either of these products the bank will usually let you take out only a certain percentage of the home's value (70% - 80%) to ensure that if they had to foreclose they would still have an asset worth more than the loan. Getting either of these products is usually much less involved than a typical mortgage, but still requires some of the same documentation, process.

Home Equity Loans have a fixed term and payments, much like a mortgage. The interest rate is typically fixed.

HELOC's are more like a bank account you can draw from on your equity. You can have one sit out unused and it does not cost anything. When you use it (write checks against it, withdraw money off it, etc) then your payments will be calculated off a formula and variable interest rate.

Right now rates on either are low. Here is a sample from PenFed, which is a credit union that consistently offers good rates for these products.

https://www.penfed.org/home-equity-loan/

https://www.penfed.org/Equity-Line-of-Credit/

[Spartana]

Rosie - Are you willing to put your paid off home at risk by taking out a large HEL or HELOC on it. Maybe you would be better off doing a short sale or something like that and just letting the 2nd house go. While I'm a strong advocate for paying off any loans/mortgages a person has even if under water, this housing recession seems to make that impossible for most people - and I don't think it'll get better anytime soon (i.e. property values won't rise by much). So maybe you can work with the bank to short sale the house. I persoanlly would never put my paid for home at risk by taking out a loan on it. What if you lose your jobs? What if a medical issue arises? Or some sort of disaster like a fire? Or the hoysing market falls further? then you could be the owner of not one, but 2 underwater houses - or worse - be homeless because you can't make the payment on the HEL.

[jp1]

I agree with Spartana. I'd think loooong and haaard before taking out a loan on a paid off house to use on an underwater house. How I would deal with your situation would probably be influenced by whether I lived in a recourse state or not.

[RosieTR]

Thanks for the replies! Our situation is more complicated because even though it is a non-recourse state, we didn't fully realize the implications and instead went with a VA loan. Translation: my understanding is that even if we did a short sale or foreclosure, the VA would then go after us for the (considerable) difference. The end result of all that would be trashed credit, possible tax implications (for a short sale, not sure about foreclosure) and still having to pay the difference. I would dearly love to have a rent-to-own tenant and would definitely accept a lower rent in exchange but I'm not sure whether that will possibly occur. The market is totally skewed: rent is 4-5 *times* what a mortgage payment would be for purchasing a comparable home! But we'd still have to come up with the difference for a rent to own, so would still face the prospect of pulling equity (probably about 40%) from one house to the other. I suppose in our current situation if we faced total financial catastrophe we'd still have the house we own provided we could pay the property taxes, and the VA wouldn't have much to go after. Of course, trying to be generally responsible adults we planned for various contingencies when we bought the second house so we'd have to sink pretty quickly and far to not be able to afford it at all, esp if it were rented out. It's frustrating because we had even thought about what if the home value falls but hadn't really accounted for this degree of fall. According to Zillow, it's worth a touch over a third of what we bought it at, and this after it had fallen considerably from the highest peak. I don't know. At this point it may be well worth speaking to a professional of some sort, but I'm not sure if it should be a mortgage lawyer, certified financial planner, or bank loan officer (or maybe all 3!). But thanks for the advice, I can start looking into some of it.

[SteveinMN]

Rosie, if it gets to either a short sale or a foreclosure, your credit is trashed either way. The only difference is for how long (approx. 3 years for a short; 5-7 for a foreclosure).

I'm not sure I'm understanding the rent situation correctly. Around here, rent has long been higher than the PITI cost of buying a home. Even with the current demand here, rent does not often outrun three times the PITI cost of buying. Are you saying that current market rent rates will still not cover your mortgage costs? I certainly can understand that, as we explored renting out my wife's house after months of it sitting on the market, and we found it was unlikely we could charge a market-rate rent and cover the expenses (we eventually ended up going short on the house after it sat on the market a year after that).

We ended up speaking first with the lender (who generally will not speak to you until you're missing payments, so we escrowed the mortgage payment until they would talk with us and then we spoke with a different person every time we called; what a fiasco....) and then with a lawyer whose specialty was property law and then with a tax accountant. Between the two latter people, we understood what our options were in Minnesota and what the benefits and consequences were. If you have not had a real-estate appraisal or market comps done for the rental property, you might want to see if you can get that done. Zillow is a fun tool to play with, but real estate is intensely local and a national aggregator like Zillow cannot do a very accurate job of it. And you really should know the estimated value of the property if you're going to negotiate an end value with any lender.

[RosieTR]

I appreciate your perspective, Steve. As far as the costs go: what we can get in rent is maybe $100 or so short of our mortgage payment on the house, not counting any maintenance costs. Yes, this means we lose money no matter what. However, if the house were for sale, what the ultimate buyers would pay for PITI now is probably 1/4 of what the same people would pay to rent the same place now. We are losing money on the whole deal because we bought nearly 4 years ago and the market has dropped nearly 2/3 since then. Obviously economics laws would dictate that just because we must pay a certain mortgage does not mean market value supports this, so we have little choice but to do one of three things: 1) rent out the house and lose the money a little at a time, 2) sell the house and come up with the difference, or 3) let the bank eat some or all of the loss and receive whatever other consequences result from that. Because our cash flow was OK with option 1 it looked like the best of the bad options, but after this most current landlord experience I'm rethinking option 2. However, we don't have that kind of cash unless we do financial rejiggering, and IMO the better (of bad) options is to pull equity from our other house. I had vaguely looked into option 3 to see what the consequences would be and found that it was likely to be even worse than 2 even from a purely financial standpoint. In some ways I think we're in a bad position partly because we were trying to be responsible: we could, at this point, just pay the mortgage and leave it empty. Is this a financial drain? Of course. Is it less risk than renting it out, when the possibilities of having a much greater loss than the rental income are there? Maybe. Thankfully the renters weren't cooking meth but if they had been it would be a total loss. But people can be destructive in other ways, as my frequent viewing of shows like "Hoarders" has shown me. This is why I wonder if it would be, in fact, a smaller risk to obtain the cash to sell even if it puts our current house at risk, because at least I know what the deal is. The risks of losing our current house seem easier to predict and insure against as well: life insurance, long term disability insurance, homeowners insurance, and various maintenance items and habits that decrease the risk of financial loss. Maybe there's something I'm missing, however, in terms of what our risks are. Hence perhaps an attorney would be worth talking to. It sounds like it was necessary for you, Steve, and you had a likewise major issue to understand. Anyway, thanks for the advice.

[SteveinMN]

Rosie, you're welcome. About the only further comment I would make at this time is that I believe most tenants just want to get on with their lives. The percentage who cook meth or hoard or hold wild destructive parties is small. I understand the bad renters you had were "vetted" by a management company. My guess is that, if you threatened them with taking away the business or finding a higher-quality tenant, they might push for a higher-quality tenant. And there should be more and more of them out there as people need to move and cannot take on the purchase of a house or the securing of a mortgage. Then there are the folks who went through shorts or foreclosures -- they won't be buying houses anytime soon. Good luck, whatever your decision.