Thursday, April 7, 2011

Underwater - Help!

Of all the changes you might make to live more cheaply, the most fundamental is finding a cheaper place to live. Sadly, it's an option that's largely closed off to people who are underwater on their mortgages. Unless they have cash to cover the difference between what their house will sell for and what they owe, they're pretty much stuck. Here are six options for people in that situation.

You will definitely want to get legal advice well in advance of actually doing any of these.  A consultation with a lawyer could save you tens of thousands of dollars.

Here they are!

1) Stay
If your house still serves as shelter and you can still afford it, there's no particular reason that you can't just go on living in it, pretty much without regard to its value versus what you owe on the mortgage.
This may be the most expensive option: You can't take advantage of the cost savings of moving to a cheaper place, plus you're putting significant amounts of capital into an investment that gives back a low return. Still, as long as you can make the payments, this is probably the default option, and it's not necessarily a bad one. Eventually--no matter what happens to the real estate market--you'll be above water on the mortgage, but plan on staying put for awhile. (In fact, eventually you'll pay off the mortgage and own the house free and clear.)

2) Rent it out.

If you can rent the house for enough to cover the expenses of ownership, then you can move into a cheaper place and live there. In fact, even if the rent doesn't quite cover the costs, you can still come out ahead, if you can find a place to live that's enough cheaper (but you will become a landlord and will want reliable tenants).

Or, you could rent out a room. That could make staying in the house as economical as moving someplace cheaper. In fact, there's no need to stop at renting out just one room--if you have a big house, you could potentially rent out two or three. At the far extreme, you could move into the basement and then rent out the whole rest of the house to another family. Not what you had in mind when you bought it, but perhaps better than losing the place to foreclosure. Although this may not feel convenient or practical for many to have tenants in your space.

3) Short sale.

This is where you get the bank's permission to sell the house for less than the balance due on the mortgage. Sometimes the bank will settle for the sale price and wipe out the debt. Other times they still expect you to pay part or even all of the difference--the balance due is just converted into an unsecured loan. Even in the latter case, you at least owe a lot less money. (Of course, you also have no place to live.)
This is one case where you really have to check with a lawyer. If the bank forgives any of the loan, the IRS may treat that amount as taxable income. There are a few government programs out there that can help homeowners in making sure they are not liable for the deficiency, but you must qualify.

4) Renegotiate the mortgage.

This covers a lot of ground. If your lender agrees, pretty much all the terms of your mortgage are negotiable--the interest rate, the number of payments, even the balance due.

The federal government is pushing several different plans to adjust the terms on mortgages to make them affordable. One that I've read about involves moving the rate down to market rates and then adjusting the balance down to no more than 85% of the house's current value. That might make the house affordable to keep. It might just make it affordable to sell.
If there was a temporary problem in making payments (due to something like illness or unemployment) that has now been solved, it may be possible to roll all the missed payments into the balance and start fresh.

5) Walk away.

In some places, mortgages are often made on a non-recourse basis--that is, the bank can take your house, but can't come after you for any balance due on your mortgage. (Check with a lawyer! This is not true everywhere--and even places where it is often true it isn't always true.)
Often better than literally just walking away is to negotiate what's called a deed-in-lieu, where the bank agrees to take the deed and forgive the balance owed on the mortgage.
The way to do this is to:
  1. Offer the bank a deed-in-lieu
  2. Stop making payments
  3. Continue to live in the house
This gives you a certain amount of leverage, because taking your offer saves the bank the trouble of foreclosing (and the risk that you'll trash the house the day before they foreclose).  That's going to be important: You're going to need it to find another place to live, and your access to credit is going to be limited for quite some time if you try this option.

6) Bankruptcy.

Especially if a lot of your assets are in retirement plans (which you generally get to keep), bankruptcy is one option for households with an untenable cost structure.
Yet again, check with a lawyer.

Those are the options that I can think of, for people who are underwater on their mortgage, but who would like to consider the option of cutting their expenses. Maybe one or another will turn out to be the right move for you.
There is no single correct answer for what action you should take when your home’s value exceeds the amount of money you’re paying back on a large home loan. Be sure to take your time and thoroughly research all your options with professionals before making a definite decision to pursue one action over another. Lots to consider!