Welcome back folks. Here, in these posts, we talk about owning and operating your rental property. Most of my posts are technical in nature, discussing specifics about buying, fixing up and renting your property. Now and then, I diverge and discuss broader topics about the housing market. If you are new to this blog, I’d suggest you read Getting Started and Getting a Mentor first. Again, we talk about operating in Dallas, Fort Worth, Denton areas or the DFW metroplex.
I read this article today about Bank of America’s ‘Be a renter in your own home‘ program for those who are in default. The basic idea here is that if you are going to foreclose on your house, you’ll let the bank sell your house to an investor who will let you stay in your house and you pay him rent instead. I guess, one take on it would be that we should give some credit to the innovative brains in Fannie, Freddie, FHA and some of these giant banks as they come up with these ideas one after another. But, that’s not my take! I am not going to be merciful. Let’s take a closer look:
1. So, someone who did not pay their mortgage for presumably several months will now start paying rent?
That must be the thought process behind this idea – would it not? So, what’s a rent amount? As an investor what do I expect it to cover? I would expect rent to cover my mortgage on that house (principal and interest), property taxes, operational expenses and a little bit of left over cash flow for me. So, someone who could not pay just the mortgage piece will now pay for all of this? Okay, may be they want investors who don’t know what they are doing. But, if you are reading this, you are not one of those.
Let’s try to rationalize their thought. This math could work if this home owner got into this house at such a high interest rate and paid such a high price that their mortgage is actually higher than what they would pay as rent (calculated as above). So, the thought is that you as an investor would buy it for a lower price (why?), your rate would be a lot better (why?) and your expenses would be lower (why?), so you can rent it out for less than what they paid as mortgage.
Let’s look at the three why-s above. Why would you buy for a lower price? “The market’s crashed”, really? Then are you buying at a lower price? Lower than what? Lower than what some dreamers paid for it? What random threshold is that? The real question should be – can you buy it for much lower than what the current market value is? If not, then you are not getting a good deal. You are not an investor. You are a dreamer as well. Did I mention I was not going to be merciful? So why would you do that? So that negates the first why.
Let’s look at the second one: Your rate would be a lot better. Why? You as an investor have better credit, really? What does that mean? You have been careful about living below your means and you are very careful in almost everything you do. So suddenly you are going to be tempted to buy a house and keep a person in there who currently is not paying!
Let’s look at the third why. Why would your expenses be lower? We have already established that this investor who’s buying this house under these conditions is not going to buy smart and not going to have a lower rate. So his mortgage is going to be lower? How about operational expenses? There are two facts about this current home owner: They have financial trouble and they don’t mind not paying. So how well do you think this house would have been maintained? If they are not paying and are willing to freebie it till they are allowed to live there, do they really feel like this is their “home”? Are they emotionally attached to this house? If not, do you really believe they are watering the foundation and changing the filters every month? Why would your expenses be low?
The mathematics for this deal simply does not seem to work. The most important part of the equation in running a successful rental business is your tenant. Someone who’s not paying Peter is not going to pay Paul.
2. Why does the bank care who you rent to?
So in this proposal, the bank is telling the current owner that their property will be sold. So, first of all for a lot of these home owners, they had no skin in the game. They have no equity, they have no built in appreciation in the property. So, when their property is sold and they still retain possession by way of a lease, what are they losing? Nothing. Remember “Moral Hazard”?
At least from the article it seems like the bank is doing a short-sale, not a foreclosure. May be this whole thing is a way to sidestep the DAs suing them in so many states for not following the foreclosure process. So you make this a short-sale which is a contract between two parties that does not involve the legal system and create another investor sale and a lease contract on top of that. What a mess. First of all a short sale itself is a very complicated and lengthy process. Talk to agents who deal with it. On top of that you have a lease contract and the bank is mediating? This is a joke.
3. So what happens when they don’t pay the rent?
Note I say when, not if. Who does the eviction? What’s the bank’s culpability. They found you this tenant. I am sure, the contracts will be drafted such that the bank’s not responsible. The investor is responsible for the actions of this tenant that they did not find. They decided to get into this deal though, so perhaps that’s what they deserve. Moral Hazard again. So what did the bank gain? I can see that they cut their maintenance and court costs. They don’t have to throw any one out. May be they scored some soft points that way, that they very much need after their $5 debit card fee idea? Did I give credit to these innovators before?
Bottom-line, if the bank is trying to offset their liability and take as small a hit as possible for colossally stupid decisions they made in the past – or bought companies that made colossally stupid decisions – then that’s their right or even duty as a function. On the other hand, my job as a mentor is to tell you, a potential investor and protegee, is to how to do the math and what’s important in being successful in a rental business and not fall for trappy ideas.