Wednesday, March 14, 2012

Upside Down Options - Not Many!

Once you are upside-down on a loan, what do you do?

In my posting, My Neighbor's Upside-Down Boat, I noted how easy it is to get into financial trouble with loans and how difficult it is to get out.

And I probably misused the term "upside down" or "underwater" (the latter a far better metaphor for a boat!) as most of the media does.   It is the loan that is upside-down, not the boat, car, or house.  The loan balance is not supported by the equity in the underlying security.

And this is key to understanding the situation.  You borrowed the money and now you owe it back.   The boat did not borrow, nor did your house or car.  Inanimate objects cannot borrow - nor can they pay back.

Boats, Houses, Cars - these are just collateral on the loan, and right there is the key to the way we think about debt.   We think of a "car loan" as a loan the car has, not us.   Or a Mortgage as being "on our house" and not us.  "My house is mortgaged" we say, when in fact, it is us who are mortgaged - the house is just collateral.  It is encumbered by a mortgage, but the mortgage is our responsibility and liability - not the house's.

A trivial distinction?   Perhaps.   But I think it illustrates how people get into trouble with debt - assuming that the House/Boat/Car will pay off the loan down the road, and then getting upset when these collateral items refuse to get out their checkbooks.

Debt is personal, not attached to physical items.  Yes, they will "repossess" your House/Car/Boat if you stop making payments on the item.   But that doesn't end the deal - as you are personally responsible for the debt.  So, when they sell the House/Car/Boat, and come up short on the loan balance, they may still come after you for the difference.

And that difference may appear as an uncollected judgement on your credit record - in addition to the late loan payments, default and repossession/foreclosure.

It is, a messy business.  But not the end of the world, of course.  People survive bankruptcy - every day.

But avoiding it in the first place, is a better idea.

In response to that earlier posting, a reader writes:
You perfectly described my story in your blog of 2010. I'm at least $50k upside down on mine, trying to figure out how to "short sale" the boat. Has anyone come to you with any creative ideas? It's caused my marriage all kinds of issues as well. 

Thanks for writing!
That message illustrates the problems in financing things like toys.  Boats are particularly problematic, as people lose interest in them.   As one fellow told me, in Fort Lauderdale, after he and his wife visited every beach and every waterfront restaurant by boat, twice, they sort of lost interest.  "Been there, done that" takes over.   And his wife wasn't interested in going offshore even in their 42-foot boat.  They could have gotten by with a much smaller boat, but that doesn't impress the dock-hands at the marina, does it?
So the boat sits and rots at its slip in Fort Lauderdale.   Or, like another fellow I know here on the island, it sits and rots in a dry slip in storage, costing $3000 a year just to sit.  "Why keep it?" I ask him.  "Well, you still have Pride of Ownership!" he replies.

Huh?  Am I missing something?   Owning stuff you never use or even see, is its own reward?

A former dental hygienist of mine told me she and her husband bought a runabout at a boat show (bad, bad idea) used it once and decided they didn't like boating.  They didn't know squat about boats, so they didn't bother winterizing it. The first year, it filled up with snow and water and the water in the engine cracked the block.   Five years later, the boat is trashed, still sitting in their driveway and they are still making payments on it.   People actually do things like this and it amazes me every time.   Go visit a boat/RV storage lot sometime - it is an education as to the stupidity of Americans.

The point of my original posting was not to illustrate ways to get out of a situation like that - there really are NONE that are attractive.   Rather, my point was to illustrate how dangerous such purchases are, and how they can bankrupt people, slowly, over time - or just squander their life's savings.

The guy down the street with the boat, toy tractor, cars, trucks, and other vehicles in his yard is not "rich" but likely heavily in debt.  And since most of the stuff is either worn out or allowed to go to waste rather quickly, he rarely uses any of it.  A boat in a yard ceases to be a boat in short order.

So how do you get out of this mess?  Likely you don't.  As far as I can tell, there are few options, none of them good, few of them realistic or possible:
1.  Stop making payments on the boat, they ruin your credit rating, repossess the boat, ruin your credit rating some more, then sell the boat, send you a bill for the difference, and then sue you and get a judgement when you don't pay, perhaps attach a lien to your other properties, and ruin your credit rating a little more.  Obviously this is not an optimal outcome.

2.  Find a buyer for the boat at the best price you can get - you may have to spend many weekends polishing it up and making it in best shape.   Come up with the difference in cash by selling stock or cashing in investments (note the 10% penalty for cashing in an IRA, and $50,000 would be taxable and also put you into a higher tax bracket.  Ouch!).  This gets the boat out of your yard, preserves your credit rating, but dings your retirement plan and leaves you with a huge tax bill.   Wow, these options really suck!

3.  Find a buyer for the boat at the best price you can get - you may have to spend many weekends polishing it up and making it in best shape.   Come up with the difference in cash by getting a home equity loan or doing a cash-out refinancing.  This gets the boat out of your yard, preserves your credit rating, but increases the balance on your mortgage.  Also, getting such a loan is difficult, particularly if you are cash-strapped or have been late on payments on your house, boat, cars, etc.

4.  Refinance your house, take out enough money to pay off the boat loan.  You can then keep the boat and use it (but like most people, you probably have lost interest by now) or sell it and use the money to pay down your mortgage.  This is problematic in that if the boat is $50,000 underwater, then the balance on the loan must be in the hundreds of thousands - and not many people have that kind of equity in their home.   And again, banks are not so willing to lend, etc., particularly if the borrower has bad credit.

5.  Bankruptcy.  If you have a lot of other debts, and not a lot of money, you may actually be insolvent.  TALK TO AN ATTORNEY (not some help-u-bankrupt joint).   It is a STATE LAW question, and in some States, there are very generous terms.   For example, generally your retirement plans and 401(k) are protected (which is a good reason to invest in these plans!).  In "homestead" States like Florida, your house is protected (which is why O.J. lives there, or did, until he went to jail).   Bankruptcy may wipe out some debts.  Other debts, you may be forced to work a payout scheme, over time (e.g., five years) with interest and part of the debt wiped out.  Again, talk to an Attorney for more details.   Yes, this screws up your credit rating - for a while - but gives you a chance to start over.

6.  Insurance Fraud:  You sink or set fire to your boat, and then collect the proceeds.   Problem is, the insurance may only pay up to the book value of the boat, which is still less than the loan.  So you don't solve the problem.   And guess what?  The insurance companies are on to this and there is a very good likelihood you may go to jail, not collect, and end up losing your job, declaring bankruptcy, and finding a new special friend in jail.   I do not recommend this approach.
7.  Short Sale.  While banks are willing to go along with "short sales" on houses, I have never heard of one with a boat.   With a house, it can take months, if not years, to foreclose, and as a result, the bank can spend tens of thousands of dollars on foreclosure processes and then not get as much for selling the house.  A short sale can be a win-win for both parties, as the bank takes a hit, writing down some of the debt, while the homeowner walks away from his down payment.  However, these should be negotiated carefully - some times the agreements allow banks to come after you for the debt, and/or it might appear on your credit rating.   I have never heard of a bank doing this with a boat, but I suppose it can't hurt to ask.

UPDATE:  Tithing Guru Dave Ramsey suggests getting a personal loan from your credit union.   This may be possible if you have excellent credit, but in most instances, these upside-down people have missed a payment or two (which is why they want out of the deal) and an unsecured loan is not in the cards.   But it is worth a shot.   I would suggest also not tithing to a church as Ramsey suggests, as God doesn't need your money and he told me, personally, that he would rather you pay off your boat loan than buy the minister a new Gulfstream jet.

Those are the only options I know - there is no "secret" or "Creative" response that makes debt magically disappear, other than to win the lottery.   I wish there was, but there ain't.  YOU owe the money, not the boat.

And again, this illustrates why it is so important NOT to get into this trap - or any other trap.   It is a deadly trap and the only way out - in many cases - is to gnaw your leg off.

We have had three boats - but we paid cash for all of them.  Why?  Because I knew boats depreciated like mad, and I didn't want to be "upside down" on a boat, and also have to make payments and pay expensive insurance premiums on them.  As a result, while I have lost money on boats (you ALWAYS do!) I was never in a situation where I had to keep something I no longer wanted, simply because I owed money on it.

Traps like this are deadly - and they are baited with enticing cheese - frequent flyer miles, cash rebates, have-it-all-now with no down payment!   But the downside is being painted into a corner, with no way out, other than some odious choices to make that basically destroy you financially.

And yet, like clockwork, I get messages from people saying, "Well, if you play the game right, you can make lots of money on these coupon deals!"  No you can't, really, all you make is small amounts in the margins - while risking an awful lot.

Boats are the same deal - often sold to the unwary at boat shows, with nothing-down loans amortized over a decade - or two.  Even in a good economy, people end up "upside down" in these deals for the first three to seven years.

That is a long prison sentence!

So I don't have any good advice for the lady who wrote to me.  But if you haven't done silly stuff like this, read her message and LEARN FROM IT.    If you are going to go through life having to put your hand on the hot stove in order to learn, you are in for a world of woe!

* * *

We can rent a very nice houseboat on the St. John's river for about $1500 a week, which for four people, is pretty reasonable.   If you want to go boating, there are ways to go that are pretty inexpensive.  Owning a boat is a very pricey proposition, and unless you live on a lake and use it a lot, it ain't worthwhile.

$1500 may sound like a lot of money, but each trip in our 28-footer cost me at least $600 in terms of fuel, insurance, and storage, alone.   Throw in depreciation, and likely even a simple day-trip was costing us $1500 or more.

Boats are fun, but unless used every day, not cost-effective.   The guy renting houseboats makes use of them nearly every day - he makes money.   The guy owning a houseboat and using it every other weekend, likely spends more than he would, renting

UPDATE NOVEMBER 2014:  This posting got me to thinking, "The lack of options for people upside-down on a boat or RV, is one reason the banks are so willing to lend!"

Think about it.   You own a boat worth $50,000 and owe $70,000 on it.   You have a house, a car, some money in the bank, and the like.   You are not about to go ruining your credit rating over an upside-down boat, right?   So you pay and pay and pay, and when the loan is finally paid off, years from now, you can cut up the rotted boat with a chainsaw and have it hauled away in a dumpster (Yes, I have seen this happen).

They really have you.   Even if you declare bankruptcy, thanks to new Bankruptcy laws (thanks GOP!!!) the debt may not be fully discharged.   They take the boat and sell it, and you have to pay at least part of the difference.   What with all the interest you paid over the years, the bank still comes out ahead

Perhaps if the banks were more at risk from bad loans they wouldn't write 10-year boat and RV loans with "no money down".    Maybe if we held their feet to the fire, they would only write good loans.

And now you understand what the term "predatory lending" means.   More on this in another posting.

If you are upside-down on a boat, car, RV, house, or whatever, you have my condolences.   But frankly, there are few options other than paying up, or declaring bankruptcy.   Sorry!