What Would I Do If my Home Was Underwater?

There are still millions of homeowners with underwater mortgages due to the housing bubble, I am thankfully not in this situation but I recently heard from a friend that is and I got to thinking about what would it mean for me and what could I do about it if my home was underwater?

What are the implications of being underwater:

#1 My housing costs would be higher because of when I bought the house.  If I had bought more home than I could afford I would be in danger of losing the home.  The extra cost would make it harder to achieve other financial goals like retirement savings or college savings.   

#2 Moving would be difficult because I would have to bring a lot of cash to closing, get the mortgage company accept a short sale, or rent out the property instead of selling.

#3 I couldn’t do a regular refinance because no lender will touch an underwater home.  If I had a variable rate mortgage I would be facing the risk that a significant rate increase could make the mortgage payments unaffordable eventually leading to foreclosure.  I would also lose the opportunity to lower costs by refinancing.    Today yahoo lists 3.87% 30 year fixed and 3.11% 15 year fixed- that really is insanely low.   In fact rates have fallen enough that it might be worthwhile to do another refinance.

The big question is to keep the house or not?  The critical factor is how affordable is the mortgage payment?    If I couldn’t make the payments without drawing from savings or incurring credit card debt then I couldn’t really afford that house and it would be lost without a major change like a new higher paying job.  If I could make the payments but had nothing else left I might sell the house too.  While I would hate to be forced to sell my house, I think it would be worse to keep the house by sacrificing retirement savings.  I wouldn’t want to live in a nice house but have so little cash left over that I couldn’t enjoy life while I was living there.   If I could afford to keep the house keep my financial goals and have a reasonable life I would keep the house and accept the fact I didn’t get the best price on it.   It’s almost impossible to time buying a house perfectly so virtually everyone overpaid to some extent that isn’t a good reason to sell.  

If I were going to keep the home I would make efforts to stabilize and lower costs.   I would review all of the government programs to help underwater home owners- but I won’t expect to get the best rates either.  This article on HARP states banks are not giving great rates.  It might be worth the peace of mind to get out of a variable rate mortgage, especially if there is not cap on the variable rate as I doubt today’s low rates will be here forever.

I would simultaneously try to build up a large emergency fund but I wouldn’t make any extra payments toward the mortgage until I accumulated enough bring the mortgage above water.   If I did have to resort to a short sale all the extra repayments would be lost.   Having some extra liquidity could be the difference between keeping the home or losing it in the future. 

If I was going to try to get rid of my home I would look into doing a short sale and I would work to get the best sale price I could. 

A short sale would hurt my credit but a foreclosure would pretty much ruin my credit score for seven years.  That would be it very hard to get another mortgage in that time frame without paying a much higher rate.    In some states lenders could get a legal judgement against me for the difference between the sale price and the mortgage balance.   Normally the IRS treats forgiven debt as taxable income, causing a huge tax bill but the government changed the rules for 2007-2012  I would research the legal and tax implications for my state to find out all of the details before I did anything else.   I would also have a place to move to before I did the sale as a bad credit score will make it harder to get another rental or mortgage.   It should go without saying that I would need to move to a lower cost home/apartment, something that I really could afford.                     

2 Responses to “What Would I Do If my Home Was Underwater?”

  1. Luis says:

    Very well said. It brings a thought to mind. Which one is worse, a short sale or a foreclosure?

    If one’s finances are so bad that they can’t imagine bouncing back within 7 years in any form, then what is the use of going for a short sale? If the resultant of a short sale is a hefty IRS tax bill, why take the short sale?

    On the other hand, could one be approved for an apartment with a wrecked credit score after foreclosure? I bet a lot of folks take advantage of naive landlords to score a place to live after foreclosure.

  2. Rick Francis says:

    @Luis
    Both would be pretty bad- but foreclosure should be worse. It is a bit hard to tell because the credit scoring is proprietary.
    You could (theoretically) do a short sale even if you have never missed a payment, although I suspect banks would be hesitant to accept a short sale unless you had missed several payments and they hought they would have to foreclose.
    You don’t get the hefty Tax bill under current rules- but that exemption won’t last forever- it would really suck to struggle paying the mortgage for a few years then be forced into a short sale or foreclosure and get a big tax bill for it as well.
    Some landlords may not check credit or background, but I wouldn’t count on that.

    -Rick

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