Looking down the road is always a good idea, whether you are driving, buying a house, getting married, or engaging in war. Sooner or later, something will happen. How you deal with it depends on whether you anticipate the situation and think through the consequences of your options.

Let’s talk about buying and owning a house. Owning your own home is the great American dream and the purchase of a house represents the biggest financial decision most people will ever make. Usually, it’s an emotional decision too - this house feels welcoming and fulfills our dreams, that one doesn’t.

The dream has turned into a nightmare for home buyers who, a few years ago, allowed their desires to overshadow financial reality. Too many people accepted loans that would adjust upward to much higher interest rates without taking a good look down the road at market changes and their personal income expectations. Their rose-colored view was encouraged by unscrupulous lenders and, yes, Realtors. Both should have made certain their clients understood the nature of the contract and the cyclical nature of real estate.

Fast-forward to today.  Many of those home buyers, along with home owners who refinanced to cash-out their equity during the “up” market are now in trouble. Their income didn’t grow enough to cover the interest-rate boost and the value of their property has dropped. The double-whammy has forced those living on the edge into foreclosure. The certainty that the market will turn and home values will again rise isn’t going to save them in the present.*

Today, such over-extended homeowners have some options: Lenders are increasingly willing to renegotiate loans with borrowers who are able to stay current on their payments. Homeowners may be able to use retirement savings to reduce their debt to a manageable level. Or, the homeowner may negotiate a short-sale with the lender’s permission.

In a short-sale situation, the expected proceeds from the sale of a property and necessary  closing costs are lower than the amount owed. In order to complete the sale, the lender must agree to accept less than full payment. In many cases, there are two loans outstanding on the property, the primary mortgage and a secondary obligation, often a home equity loan secured by the property.

Why would a lender accept less than what is owed? If the borrower cannot make the payments, the lender’s recourse is to fine a notice of default and, ultimately, foreclose on the property - in other words, the lender ends up owning the property. Now, in addition to owning a property that is earning no interest, there is upkeep, maintenance, the expense of selling the property, and a hit on the lender’s own credit standing. That’s why lenders are willing to accept short sales.

In lending institutions, the decision of how much to accept in a short sale is made by a committee charged with minimizing the loss. The listing agent must disclose to prospective buyers that a short-sale situation exists. The lender decides whether to permit the short sale. (The lender can choose to demand full payment or foreclose on the loan.) When you submit an offer on a short-sale listing, it can take a month or more to get a response from the committee and then the counter-offer may be for more money than the listed price set by the seller.

If there’s no short sale, the foreclosure process ends with the property offered for sale on the steps of the county courthouse, and if no one else buys it, the lender takes possession. The property then can be put back on the market as a “repo” and often at a below-market price.

“Repos” can be good investments, but buyers should look at bank-owned property very closely. Because the lender has never occupied the house, it is not required to provide the usual disclosures. In addition, the previous occupants - that foreclosed owner - may have mistreated the house before moving. It is definitely a “buyer beware” transaction. Potential buyers are strongly urged to have the house thoroughly inspected before completing the purchase. That said, a buyer with eyes wide open can pick up a house at a substantial discount. Lenders who were coy during the short-sale listing are now eager to strike a deal.

If you are planning to buy a house in the next year, I would like to talk with you. Please visit my website, http://www.ilajosephs.com/ or call me at (909) 261-3541. I am dedicated to the success of my clients and use a team of like-minded professionals to ensure you are well-represented in every aspect of your real estate purchase. Home buyers who have not owned real estate in the past three years, teachers, firefighters and police officers may be eligible for government or private programs offering down payment assistance or lower interest rates.

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* Why is it a “certainty” that market conditions will change and home values will rise in the future? That’s what history shows us and the state currently faces a housing crisis because our California population is increasing faster than new housing is being built. Here is a link to the state report, which was updated Nov. 30:  http://www.hcd.ca.gov/hpd/hc113007.pdf

Southern California real estate cycles in the past century resemble a lop-sided grin, starting with the last market “peak” and easing down to a valley where the grin levels off and starts going up again to another “peak” that’s higher than the first.

The second peak is higher than the first because as our population continues to increase, available land does not. Higher demand makes land more valuable. People expect and need shelter, and they either rent or buy homes. A low housing affordability index is bad news for home buyers, good news for investors and apartment owners, who can raise rents. As the cycle changes, more renters are able to buy homes, which then increases the demand and the price of the homes.