Photo: karl frankowski on Flickr
And even more people are asking questions and wondering if they can buy a new house and bail on their old one.
Buy and Bail: Example of How it Works
Joe Homeowner has seen home values in his area decrease by 50% in the last few years and as a result, he currently owes $400,000 on his home that is worth $200,000. Joe finds a home that is 5 miles away from his current home, is 1,500 square feet larger and with nicer upgrades than his current home selling for $300,000.
Joe is the CEO of a small business, makes a good living and can qualify for both mortgage payments. He wants to know if it is possible to buy the new home, move into it and then do a short sale on his existing home or just let it go to foreclosure.
This is a common scenario of what has come to be known as the buy and bail: buy a new home and bail on the old one.
Because the buy and bail scenario has become more common, many lenders have put guidelines in place to try and prevent it from happening.
Although the guidelines may vary by lender, just a few of the questions that Joe Homeowner may expect to be asked by the lender could include:
- Do you have equity in your existing house, or do you owe more than it is worth?
- Is the new house closer to your work?
- Is the new school district better than the old one?
- Are there sex offenders that have moved into your old neighbourhood?
- Has your family size increased?
- Is the new home one level vs. two levels for your old house?
Simply put: if Joe Homeowner applies for a mortgage for the new house, he can reasonably expect to be asked questions designed to prevent him from buying and bailing. If the new lender suspects that it is a buy and bail scenario, they most likely will not give him a loan for the new home — even though he may be able to qualify for it.
Bail and Buy: An Alternative to Buy and Bail?
What if Joe Homeowner applies for a loan and is denied because the lender suspected that he was trying to buy a new home and bail on his old home. Is he out of options?
It is possible for Joe to bail on his current home and buy a new one, although probably not the superior house that Joe has his eye on.
However it is possible to buy a home one day after short selling his current house if:
- Joe has made all of his mortgage payments in the previous 12 months prior to his short sale
- Joe has been current on all of his other payments in the previous 12 months prior to his short sale
- Joe is not buying a home that is superior to the home he short-sold in the same area.
What FHA is concerned about is “taking advantage of declining market conditions” and it is what they are trying to prevent.
With both the buy and bail and the bail and buy scenarios, there is a significant grey area that many people seem to have opinions on. Is it right to buy and bail? Is it wrong to buy and bail? I have heard arguments both ways.
The real question is this:
How many people who have bought a house in the last 12 months have short sold a house in the 12 months after they bought a house?
I suspect it may be more than you think.
Justin McHood works for Academy Mortgage and is based in Chandler, AZ. He is a contributor to Zillow Blog and has conversations about mortgages whenever he can. Learn more about Justin at http://www.mortgagecommentator.com.