This is a re-print of one of my articles, which was originally published on Money Under 30:
Mortgage Underwater? Here Are Your Options
March 18, 2011 By Sarah Davis
So, was 2005 the year that you dove in and bought your first house? How much do you wish you had had a crystal ball back then?
Don’t be too hard on yourself: NOBODY had the ability to see the future and nobody knew just how bad the housing industry would get. Homeowners from all walks of life have been affected by this—multi-millionaires and people who barely got into homes costing less than $100,000.
If your house is worth less money than you owe right now (a.k.a. underwater or upside down), it may seem like you’re throwing good money after bad and that you don’t have a lot of options. But you do have some, which I’ll lay out here. Research the options that appeal to you, and think carefully about what’s right for you.
Finally, keep in mind that when you’re underwater on your mortgage, your options vary greatly depending on whether or not your lender has filed a notice of default (NOD) on your house—the legal prerequisite for foreclosure.
Please keep in mind that I am NOT an attorney, and if you receive a NOD or are considering some of these options, you should ABSOLUTELY consult one, and possibly a professional accountant, too. Even if you think you can’t afford it and even if you think you can do it yourself. Banks prey on the vast majority of homeowners who don’t lawyer up because they can. Sometimes, just having an attorney at your side is all it take to get them to play fair.
That said, here are some options if you’re underwater on your mortgage:
WAIT IT OUT
This is a favorite option of ostriches. That’s right—stick your head in the sand and avoid the issue. This option works IF:
•You’re not behind on the mortgage payments (and therefore have not had an NOD filed),
•you have enough money to keep paying them, and
•you WANT to stay in your house for a long time.
But who knows when your home’s value is going to come back up? Property values in some areas are starting to rebound but experts say it could be years before the housing market sees a full recovery. The truth is, nobody knows, so if you’re waiting for your home’s value to increase so you can sell or refinance, you could be waiting a long, long time.
Sorry to break it to you but it’s not going to happen. In this economy, lenders simply will not refinance if there isn’t a sufficient amount of equity in the house.
RENT IT OUT
Renting the house out is a viable option in some situations. There are two important questions to ask yourself when considering renting your property out.
1) Would the current market rent cover my mortgage payment and then some?
Check Rentometer.com to find out what the current market rent is for a house of your same size in your area. Craigslist is another great place to compare rents. Keep in mind you’ll need the rent to cover your mortgage payment plus property taxes and interest, and an allotment for repairs and maintenance. That’s assuming you’re not getting any cash flow.
If you want to make a little money in the process make sure that what you can rent it out for is at least a few hundred dollars above your mortgage payment. If you have an adjustable rate loan, you’ll need to take some extra time to review your paperwork to see when the loan can adjust and how much it can adjust.
2) Am I willing and equipped to handle being a landlord?
If you’ve never been a landlord before, I’d suggest reading a book on landlord-tenant laws in your state and reviewing Rentlaw.com. It’s also a good idea to talk to a few landlords, if you know any, about the ups and downs they experience. You may be able to make a little extra money this way, but unless you pay money to hire a property management company, guess who’s going to get called at 3:00 am when a toilet gets clogged? As a landlord, you’ll be responsible for marketing, screening tenant applications, choosing a tenant, collecting payments, making sure the property is continually safe, making (certain) repairs and if necessary – evicting, at your own expense.
TRY A LOAN MODIFICATION
“Try” being the key word here. People who have missed mortgage payments and are facing foreclosure seem to favor loan modifications, most likely due to the promise that they’ll be able to stay in their homes.
According to Aleksandra Todorova of Smart Money, “It should come as little surprise that with few lenders reducing principal—and most tacking on fees to the loan balance—nearly half of loan modifications (45%) actually resulted in increasing a borrower’s monthly payment.”
Loan modifications may reduce monthly payments for a period of time, but they will never address the underlying problem: negative equity. The other thing to note about loan modifications is the qualifications. If you’re unemployed, you can bet that you probably won’t qualify for a loan mod.
Still want to try a loan modification? BEWARE SCAMS! If you want a loan mod, contact your lender directly, get a trusted attorney, or go through a Department of Housing and Urban Development-approved counseling agency.
FORECLOSURE (OR WALKING AWAY)
Let’s face it, nobody wants to say the “F word”. And, in most cases, you should try to avoid foreclosure. The recent housing crisis has changed that for some people, however, with a growing number of homeowners simply walking away from their homes.
If you’re considering walking away, remember that a foreclosure record can damage your credit for up to seven years, according to the National Association of Realtors. I’ve heard some people say “I don’t care if my credit gets damaged because I don’t want to buy another house for a while.” What you must realize, however, is that your credit also affects your ability to rent an apartment and even, in some cases, get a job. (That said, given the recent housing crises, foreclosures may not carry the same stigma they once did, and provided you have income, you may find landlords and employers willing to listen to your story.)
Though best avoided, sometimes it may make sense to let the bank foreclosure and move on rather than spending money and time fighting to save a home that’s just not worth it. Most people have an emotional attachment to your home, but if you can come to the realization that you can make a happy home someday somewhere else—and somewhere you can AFFORD—foreclosure may not be such a bad thing.
DEED IN LIEU
If you’re far behind on your mortgage payments and know you won’t be able to make up the deficiency, you may consider a deed in lieu of foreclosure. With a deed in lieu, you voluntarily give the deed back to the bank.
A deed in lieu will also negatively impact your credit, and you’ll forfeit any equity in your home (which isn’t an issue, of course, if you’re underwater). Your bank may give you up to $3,000 cash to help rent an apartment. Note, however, that you can only get a deed in lieu if you have only ONE loan on your home (so if you have multiple mortgages or home equity line or loan, you can’t qualify).
DO A SHORT SALE
In a short sale, the lender accepts a purchase price of less than what is owed on the property. The short sale process involves listing the property for sale with a real estate agent, finding a buyer and having the agent submit the buyer’s offer along with a “hardship package” to the lender(s).
The process still damages your credit, but typically not as badly as a foreclosure. With a short sale on your record, it’s clear that you were actively participating in trying to solve the problem, rather than walking away. The National Association of Realtors states that with a short sale, you may be able to buy a home again in as little as 24 months but with a foreclosure on your record the wait could be as long as seven years.
Short sales are great when they work, but you first must find a buyer and get your lender to agree to sell the home for less than you owe. Finally, you may be required to pay federal income tax on the difference between what you owed on the home and what it was sold for…an amount that could total tens of thousands of dollars…so it’s wise to check in with a lawyer or CPA if considering a short sale.
A NOTE ON BANKRUPTCY AND UNDERWATER MORTGAGES
Being underwater on your mortgage by itself isn’t a reason to file bankruptcy. In fact, although bankruptcy law has provisions to help you stay in your home, consumer bankruptcy is really designed to help you deal with unsecured debts like credit cards and medical bills, not mortgages. In all cases, bankruptcy should be a last resort and you should always consult a qualified bankruptcy attorney before taking action.
Are you underwater on your mortgage? How are you handling it? Please share your story…