Hard Lessons in Home Economics - Page 3 of 3

Hard Lessons in Home Economics

A second measure to improve not just short-term, but long-term cash flow is to refinance the mortgage on the family’s primary residence. Without specific information on the credit situation of the Carré family, I am assuming this is still possible, especially given Sherley’s employment in a high-paying job. With respect to their primary residence, the Carrés are suffering from a situation similar to some 20% of all American homeowners–negative equity. The Carrés are hurt to a much greater degree, however.

At current market prices, their primary residence has a loan-to-value ratio of 149%.  Lenders prefer this ratio not to exceed 95%, and the lower the better. Still, there’s hope. Part of the Obama administration’s Housing Affordability and Stability Plan is directly aimed at homeowners like the Carrés who are not currently in default but are likely to default on their mortgages due to their high level of negative equity.

There are many ways the Carrés could have their mortgage modified. The simplest method would be an interest rate reduction. Assume that they were able to achieve a modification that reduced their interest rate by 2% annually. This would save them approximately $400 per month, or $4,800 a year. If they were able to negotiate a modification that extends their mortgage’s term from 30 to 40 years, in addition to a reduction of their interest rate by 2%, this would save them approximately $600 per month, or $7,200 a year. Finally, if they were able to have their mortgage amount reduced to 105% of current value (difficult, but not impossible), maintain the term at 30 years, and receive a 2% interest rate reduction, they could save approximately $900 per month, or $10,800 per year. Let’s assume they achieved the middle option, extending the term with a rate reduction, and temporarily removed their youngest child from daycare until Edenswear found permanent employment, on a pretax basis, they could effectively replace 85%, or $20,800, of Edenswear’s lost after-tax salary.

n My final piece of advice will likely be the hardest to accept. The land that the Carrés bought to retire their parents on in Texas–sell it. Don’t get me wrong, loyalty to one’s parents is a laudable value. However, economic responsibility is also a laudable goal. By the Carrés’ own admission, they did not purchase the property with an eye to making it an income-producing piece of land. They currently receive no cash flow from it, and are unlikely in the near future to be able to build a home on it to house their parents. While it’s true that they are currently underwater on the property by approximately $46,000, they may be able to recoup some of this loss through capital gains reductions on their taxes. This could reduce their taxes by as much as $750 in the year of the loss (capital losses are limited to $3,000 against ordinary income), not to mention the approximately $11,000 in increased liquidity that they would receive from the proceeds of the sale.

Additionally, they could carry forward the remaining losses to future years for further tax savings. Collectively, all of these recommended cash flow improvements in the first year would increase their cash flow to $32,550 (or 133% of Edenswear’s after-tax salary).  Note that this solution does not have to leave the Carrés’ parents out in the cold. Instead of moving them to Texas, give them the rental property in Florida.

If they just replace the current amount of rent received, $1,000, then there is no loss. If they receive the property free and clear, then the foregone monthly rent will be a minor portion of the salary Edenswear receives from a new job.

This story originally appeared in the May 2009 issue of Black Enterprise magazine.