Options for Underwater Mortgage Holders

underwater mortgage optionsQ: I need guidance on what to do with my underwater mortgage. My wife, my preschooler, my infant and I are living in a house that we owe $90,000 on that we bought eight years ago for about $100,000. Comps in our neighborhood put the current value of our house at about $50,000.

Three foreclosures recently re-sold for about $40,000 to $50,000 in my neighborhood in the last year. Those houses were very much like mine in size, age, condition, and lot dimensions. We have an adjustable rate mortgage with a current interest rate of 3.7 percent. The “margin” on our loan is 3.5 percent, which is fantastic and the loan is tied to the one-year Treasury Note.

This is not our forever house. We live about 45 minutes from where we want to establish long-term roots (different county, resources, and opportunities for the kids). We bought this house as our first home and planned on living here 5 to 7 years.

We can afford the house without a problem. There is no issue there. What concerns me is being tied to the house until such a time that we can sell it and at least break even. At a yearly appreciation of 3 percent, that would take 25 years. I don’t know how this is going to shake out, but I am certain of where I am currently. I can buy houses in my area, right now, just like mine, for half of what I currently owe.

I can’t see paying for a house that is worth half of what I owe and will take so long to recoup to get back to where I started eight years ago. What questions should I be asking myself to help me make a decision about what to do? What are my most responsible options?

A: You’re already asking the right questions. Now you have to consider the consequences of the answers.

You’re right: it may be years before the value of your home recovers to where it was when you bought it. Fortunately, you have the ability and the means to pay your debts and keep your home. You even have other options available to you.

When property values were increasing rapidly, people never questioned selling their current home and buying another one for quite a bit more money. It was not uncommon to see a person sell a home for $200,000 and buy a new one for $400,000.

The current market may have similarities but with different emotions. That home that was worth $200,000 may be worth $100,000 and the $400,000 house may be worth $200,000. If you purchased the home for $200,000, you may feel terrible that the home is now worth half of what it was worth, but if you are planning to trade up to another home that may be your long term home, this may be the time to take the loss but see it as a gain.

While losing $50,000 on the sale of your current home will feel terrible, you might be able to afford your next home at today’s historically low interest rates and purchase a home that is now within your budget that can meet your needs as your family grows up.

You’ve done the math correctly. But it doesn’t seem that you will want or be in a position to remain in this home for more than a couple of years. If you otherwise would be thinking of buying in this market and moving to a home that suits your needs, it may be time to bite the bullet, get what you can from your current home and move on.

However, if you make that leap, you’ll owe money when you sell your current home. For some home sellers with savings, they can use those savings to pay off the bank and use what’s left for a down payment on the new home.

Your current adjustable rate is great. With the one-year treasury rate at about two-tenths of a percent and your “margin” of about 3.5 percent, those two numbers combined result in your new interest rate. You will probably see that low interest rate for at least another year or two.

But eventually, interest rates will rise and so will your home mortgage interest rate. If you planned to stay in your current home for 20 years or so, this would be the time for you to refinance. But your home is underwater. You owe more on your loan that what your home is worth. It will be difficult for you to refinance now unless you get lucky and somehow qualify for the new Home Affordable Refinance Program (HARP). But don’t count on it.

Everything comes down to whether you have extra cash that would enable you to move on. If you sell the property in a short sale (where the lender accepts less than what you owe), you won’t be able to buy a home for 3 to 5 years. And, you may be required to agree to pay back the missing money to the lender (known as the deficiency) over the years. Plus, if you don’t pay the loan in full, you should be aware that the short sale will hurt your credit score and credit history.

A final option is to purchase a new property and rent your existing home. If you can do that, you may be able to take advantage of lower prices in your neighborhood of choice and hold out while the foreclosure market in your existing home settles.


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One Response to Options for Underwater Mortgage Holders

  1. Brian says:

    The banks will not come after you on a short sale or foreclosure for that matter. Yes it will hurt your credit but it’s a losing investment. The only reason why people have a hard time making this decisions is because they let emotions get involved and the guilt of not ‘doing the responsible thing’. The right answer is do what’s best for you and your family.

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