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Help! I’m Upside Down on My Mortgage! What Can I Do?


By Jason Van Steenwyk

The problem of negative equity – owing more on your home than your home is worth, has become a severe economic challenge. Many homeowners find themselves out of work, and if they live in an area with limited job prospects, they find themselves unable to move. This makes unemployment more severe, and more difficult to escape. It also affects the liquidity of the housing market – workers with negative home equity cannot simply migrate to where the jobs are. It would cost them a prohibitive amount of money at closing, just to sell their homes.

If this is you, don’t expect miracles. Most of your options are unpleasant. But you do have options – and it’s important to make an informed decision on what course to take.

Option 1: Stay put.

This is the simplest solution, of course. But that presupposes you being able to earn a living where you are, and the house being suitable for your family. That can be tough if you just got laid off as an auto worker in Detroit, and all the auto jobs are in Tennessee. It’s also tough on military families, who typically have to move every three years, whether they are upside down or not.

Option 2: Move and rent out the old house; this can be a terrific option for some of you. Here are the advantages:

  • You can still take advantage of a tax deductible mortgage on the property. If you bought the house relatively recently, you probably bought it in a comparatively low interest rate environment.
  • The house as an asset will, presumably, increase in value over time. As the owner, you will get 100 percent of the increase in value of the home, even though you only put in part of the money – a concept known as leverage.
  • Once your old home becomes an investment property, rather than your primary residence, you can start taking the depreciation deduction every year. This is a significant tax advantage, and it makes it much easier for you to make your property cash flow positive.
  • Other people will be paying you mortgage for you.
  • Rental income is taxable as ordinary income.
  • Money you don’t receive from selling your new home is money you won’t have available to put down on your new home.
  • Renters occasionally run into trouble. They may be late on a payment. They bounce checks. They move – leaving you scrambling for a tenant. Depending on the laws in your state, a tenant can potentially fight an eviction for weeks or months – leaving you unable to find a new tenant. Ask yourself if you can handle several months in a row of the house going empty or inhabited by a problem tenant.There are a few disadvantages to this rental option…

    Option 3: Sell the House and Write a Check

    If you’re upside down, that means you’ll have to come up with cash at the closing to pay off the old lender. It’s going to hurt to write a check that big, for most of us. There are several advantages to doing so. First, you’d pay the money sooner or later, anyway, whether you stayed on or rented

    the house. Second, it’s simple. If you don’t want to be a landlord – and being an absentee landlord is extra tough – then this may be the way to go. Before you roll over and write the check, though, you might want to investigate some other options.

    Option 4: Walk Away

    This is usually the worst of all possible options. But many homeowners, caught in an impossible situation, are simply moving out, and mailing their keys to the lender. The lender, of course, will quickly foreclose on the property.

    This measure is called “strategic default.” However, this is problematic because it will immediately trash your credit. You will probably be unable to secure another mortgage for years. And it presents a tragedy of the commons problem: If banks have to build assumptions that a significant number of people will simply walk away from future mortgages if home prices fall, interest rates will have to rise in compensation. This will make it much more difficult for future borrowers to get mortgages, reduce the demand for housing, and create a vicious cycle.

    Sometimes, though, it is the only way.

    Option 5: Mortgage Assistance

    You can seek a restructure of your mortgage – usually via a reduction in monthly payments, but this doesn’t solve the issue of you being upside down on the loan. In fact, it may even prolong the problem, since the lower your payments, the slower your equity in the home will build, all else being equal. You may be able to accomplish a payment reduction by refinancing the loan to a lower interest rate, but you still have the same negative equity problem.

    Under current law, there’s no obligation on the part of the banks to lower your principal outstanding to help you out of the jam unless they actually foreclose on a non-recourse loan. This will accomplish the same thing as a principal cram-down… except you’ll have to lose your home in the process. The bottom line – mortgage assistance programs are more suited to help those with cash flow issues, or whose income has been reduced due to the recession, and who can’t downsize in home, as they could in past years, because of their negative equity.

    Option 6: For Military

    In some limited circumstances, members of the military may qualify for a special assistance plan called the Homeowner Assistance Program. This program was originally designed to help military homeowners who had negative equity in their homes, and who were facing an involuntary transfer. Remaining in the home is not an option for these people.

    Recently, the eligibility for the program was expanded to include widows of deceased service members who died in the line of duty after September 11, 2001, or service members who had medical conditions forcing them to move.

    Option 7: VA Loans

    If you have a VA loan, and you have negative equity, the VA may be willing to work with you to facilitate a short sale, under certain circumstances. You must have no other significant debt or liens encumbering the home, and it would have to cost less to effect a short sale, in the VA’s estimation, than it would to foreclose on the property. This can help VA mortgage holders to partially resolve a negative equity situation.

    Category: Credit

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