“Experience is simply the name we give our mistakes.” – Oscar Wilde
Via the recent CARE Act, many homeowners that have a mortgage now qualify to halt 12 payments on their monthly mortgage through a forbearance request to their lender. Now, nearly 4% of all mortgages are in forbearance and the Mortgage Banker Association reports a 1,270% increase in forbearance requests the week of March 2 and March 16. Followed by a 1,896% increase between March 16 and March 30. While on the surface forbearance is intended to offer temporary relief, for those lacking long term planning this could have unintended results. Those seeking forbearance often fail to realize that forbearance does not mean the payments are forgiven. Instead, these payments are put off and are due in full at a future date.
For some individuals, the forbearance provided by the CARE Act can be a helpful option. In particular, for those that lost a job but still work in an industry not affected by COVID-19 and have flexibility in their budget this could be an opportunity to reset their finances. This can give these individuals a couple of months that they need to find a new job and figure out how to get caught up on their payments.
If you are considering forbearance, it may be helpful to set up a sinking fund where future monthly payments are set aside in a separate savings account. From a behavioral standpoint, this can be tough to do, so unless one has a track record of this behavior, they should be cautious with this approach. While some may be tempted to invest their monthly deferred payment, investing often comes with risk to the loss of the principal. If an investor experiences a loss of principal during those twelve months of forbearance, it can leave then in a dire situation unless they have other assets in place to provide additional layers of protection.
For many homeowners, they will face a difficult uphill climb if they experience an unexpected job loss. According to the Bureau of Labor Statistics, the average couple spends 32% of their gross income while single individuals spend 36% of their gross income on housing. While every person’s situation is different, a general rule of thumb that many financial planners and advisors suggest is spending no more than 25% of one’s gross income on housing. This is often due to the fact that one’s gross income does not account for the reductions of federal taxes, state taxes, Social Security, Medicare, insurance premiums, and current retirement savings that are taken from one’s paycheck. In fact, it is not uncommon for many individuals’ net take-home pay to be 30-40% less than their gross income.
For example, Natalie makes $75,000 a year in gross income. After taxes, insurance, etc, she takes home 70% of her gross income which is $52,500. Her lender approved her for 36% of her gross income ($75,000) as a mortgage payment which is $27,000 a year. Now Natalie has $52,500 – $27,000 = $25,500 for all other lifestyle expenses (utilities, food, gym, subscriptions, health, etc.) and any future savings potential. Depending on where a person lives, after housing costs even a seemingly great salary can result in a tight budget in many areas of the country.
The average mortgage payment in the USA is $1,100 according to the American Housing Survey from the U.S. Census Bureau. With some areas in the country being much higher. Based on the average payment, if a borrower went twelve months without payment, they could be looking at a total of $13,200 due at the end of the year. If one cannot afford this, the mortgage lender will start to file foreclosure paperwork. Loans backed by Fannie Mae and Freddie Mac provide a 60-day timeline before the foreclosure process begins, allowing some time to try to work out another payment deal to get caught up. While they do provide some leniency, counting on their flexibility is risky.
While some homeowners may continue to make mortgage payments, not everyone finds themselves able to continue payments. For those that already felt that their mortgage payments were too high and money was tough to save, experiencing a job loss can result in being pushed over the edge and placed in a very tough position. These individuals need to analyze options on increasing their income and/or reducing lifestyle expenses, along with reviewing the current equity position in their home. Also, currently, there are programs for those unemployed offered at both the state and federal level. Click here to get a breakdown of the benefits provided by the CARE Act to help those with unemployment.
Outside of government programs, another oft-overlooked strategy is working directly with the lender to sell or starting the process of selling a home during this loan forbearance period. This period allows some reprieve while also giving an opportunity to downsize which is not giving up so much as it is a great strategic retreat. The battle may have been lost, but this retreat allows individuals to come back faster by focusing on building up one’s financial foundation versus fighting a losing war to get out of this losing situation.
Every situation is different and these options and choices can be difficult to make. However, even if a person is blindsided by an unexpected event, be it a job loss, or a major expense, it is often in the best long term interest to reset and learn from these valuable lessons. It’s also important to know that whether it be a bullish economy or more somber bearish times, you do not have to make crucial financial decisions alone. My Financial Coach is always here to provide guidance at crucial moments on your financial journey. If we can be of any assistance during this time, please do not hesitate to contact us.
James Hargrave, MBA, CFPⓇ, CLUⓇ
Director of Financial Planning