Mom hopes to remain in house

Q:I am recently divorced, and our settlement was amicable. I was allowed to keep

our house in Alexandria after refinancing to take cash out and buy out my husband. My mortgage balance went from $160,000 to $350,000. Because my income isn’t that high, I needed to take out a “no documentation” loan.

It has been a little over a year, and I’m running out of money. The house is worth at least $700,000. Should I refinance the house and take more cash out? Please don’t tell me to move because my daughter is well adjusted in school and in the neighborhood, so I need to remain here for the next two years, when she graduates from high school. Besides, there’s nothing close by that I could afford anyway. My credit is excellent.

A: Your situation is an unfortunate, but not too uncommon, dilemma. Being forced to relocate as a result of a divorce compounds an already stressful situation. Let me be brutally honest about your situation, and let’s outline your options.

First, recognize that you are currently paying for a house that you cannot intrinsically afford. Such a situation is one of the first mistakes in personal financial management.

Second, you must realize that there is something very true in the saying, “You can’t have your cake and eat it, too.” You indicate that you live in Alexandria. Property values are not cheap in Alexandria. There are less expensive communities outside the Beltway, and you could sell the Alexandria house and take the equity to purchase a similar-sized home in a different area, with a more manageable mortgage.

Of course, this alternative isn’t appealing because your daughter would be uprooted, not to mention that there would be an undoubtedly longer, more congested commute.

Unfortunately, these are the parameters with which you must work. Either uproot your daughter and move to a less expensive and less desirable community, or increase your mortgage balance so you can use your equity, which is probably a significant part of your nest egg for retirement, to pay the mortgage.

This is a choice that you must make. As a mortgage and financial adviser, I cannot enthusiastically recommend that you eat up your equity to pay for a home that your income cannot support. But you have some very compelling reasons that are not of a financial nature that would justify making a decision that is not, perhaps, the best financial decision.

Having said that, let me assume that you won’t be convinced to sell and move out. I have some suggestions that might ease the financial harm caused by financing an asset that isn’t intrinsically affordable.

First, understand that unless your income increases, paying the mortgage must come from the equity in your house. The longer you hold the house, the higher the balance of the mortgage. Since your daughter is graduating from high school in two years, give yourself two more years in the home. This deadline will ensure that you don’t eat up all of your nest egg.

After running the numbers, it doesn’t look too bad. The interest cost to service the mortgage for the next two years will fall in the range of $50,000. This means that if you took out a $400,000 mortgage, which would provide $50,000 in cash, it would take about two years before the money was used up, assuming you don’t supplement the payment with your income. In that case, the $50,000 would last longer.

While property values are no longer escalating at unsustainable levels, your property would have to appreciate by only about 3.5 percent annually over the next two years for it to be worth $50,000 more than it’s worth today. While this is not something that shouldbe assumed, a 3.5 percent appreciation rate is certainly not out of the realm of possibility.

Now, let’s talk about a couple of ways you can help improve the imbalance between your cash inflows and outlays. One way to reduce the monthly payment is to take out a loan that offers an interest-only payment.

This will reduce the monthly payment by about 18 percent compared to a loan that’s amortized over 30 years. Avoid a loan that carries negative amortization. While the payment will be even lower, the debt in the house will grow with every mortgage payment made. Furthermore, the rates on these programs usually adjust monthly and are currently hovering in the mid-7 percent range, far higher than what you can get with a fixed-rate product.

To increase cash flow in, consider renting out a bedroom to a student or young professional. When I first started my business, my wife and I rented the spare bedroom to European students here to study English. We did this for more than a year, and for $700 per month, all we needed to do was provide room and board.

As I said, I cannot enthusiastically recommend that you continue to hold a mortgage that you can’t afford, but I understand that there are other reasons that are important enough to continue to do so. Make sure you have a deadline, and with a little outside-the-box thinking, your nest egg shouldn’t be significantly reduced.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).