Help a Reader: What to Do with a Mortgage That's More than the Home's Value

Here's a situation a reader described as a comment on my post titled When You Owe More on Your House than It's Worth:

Okay so we bought our house with 20% down and a 30 year fixed that we can afford.

Unfortunately we bought in 2004 in Vegas when the investors, subprime, etc drove prices up 54% and drove home availability down to just a 100 homes or so and home builders created waiting lists jacking up the prices 10K per day (only to drop the same home price 100K the next year for new buyers).

So now LV has dropped so much that our 20% down has disappeared and banks and investors are selling homes for so little that it is depressing prices more. As a result we owe more than we could sell the house for. Makes it depressing to keep paying the mortgage.

What do you do when you owe more than the house is worth but can pay the mortgage? Homeowners in trouble are able to get their mortgage adjusted so they can avoid foreclosure and get their mortgage repriced. Right nice punishment for those of us that can pay our mortgage but need to move.

No wonder people who can afford their mortgages are starting to walk away.

This is a tough situation. He's played by the rules, been faithful, and is now left paying on an asset that's worth less than what he owes on it. And, to make matters worse, he needs to move (or at least I think that's what he's saying.) So he has to sell at a loss.

I'm not sure what I would do and there are a lot of unanswered questions (the main one being why does he have to move?) But I would likely try to sell as quickly as possible at the going market price and pay off the additional mortgage remaining over time. If I had to rent (or do whatever) to keep my costs low in the meantime, I'd do it. I would not take bankruptcy/foreclosure/abandon the property. I would feel like I had given my word to pay it back and that's what I'd need to do -- even if I took a beating on it.

And not to rub salt in a wound -- I'm not even addressing these comments to this reader, they're for us all -- this is why we want to:

1) establish as much room between what we make and what we spend as possible

2) buy a house we can afford with a good downpayment (prices must have REALLY dropped if he did these two things and is still underwater) and

3) make sure that our homes aren't such a large part of our net worth that if things go south with them that our whole financial house collapses. 

That's my two cents. What would you suggest he do?

Comments

When I read that, it didn't sound to me like he needed to move, just that he is kind of depressed at the situation and upset that people who didn't to the responsible thing are getting bailed out or being even more irresponsible by walking away. So assuming that there is no need to move, I would just keep on paying into the mortgage. You bought it at what you thought was a fair price, so just focus on that, not what everything around you is doing. The market will pick up, and LV will still be a desirable location, and I'm guessing you'll get more than what you paid when you eventually sell if you wait long enough. If you do need to move, then it's a tougher situation. If it's something you can easily afford, I would try to keep the house (maybe by renting ) while you wait for the market to turn around. By being responsible, you will come out ahead of everyone else in the long run.

[tom]

I think the question of "why are you moving?" is the biggest one of all. He should just stay in the house if he can. Yes, prices will continue to fall, but if he bought the house for the long run, then there is nothing to worry about. He'll eventually make that money back and then some. It will take many years, but it'll eventually happen. Vegas will continue to expand and the real estate market will recover.

If he must move, then I agree with FMF... sell ASAP, and rent. I'm sure in the Vegas market (if he's still living there), he can find a house similar to his own at a very cheap rental price.

[No Debt Plan]

I didn't take from this that he needed to move... although I could be wrong.

Assuming he doesn't need to move, this emphasizes the fact that you buy a house to live in, not to invest in. You also buy a home that you are planning on living in 5-10 years, not just a few years.

He might try applying for mortgage help, but other than that he needs to sit tight and be thankful he can pay his mortgage.

[Kevin]

1) Why does he need to move? Is it really worth walking away from 20% of the home? We could be talking $40k or more here.

2) What about renting it out? The cash flow should work pretty well considering the 20% down.

[Jeff]

This is a tough situation not unlike the situation facing the majority of current home owners to some extent. I think the only responsible thing to do is to be patient and keep paying the mortgage like you agreed to do when you took out the loan. Defaulting would have a long lasting negative impact on your credit rating and would make getting a loan in the future problematic. Sooner or later, espacially in a long term growth area like Las Vegas, a housing bull maret will return. I don't know what their finacial situation is but it might even make sense for these people to buy an additional home at its current depressed value and use that as an investment vehicle. Of course this would require patience and a very positive (or excess) cash flow situation. Those of us who have lost substantial equity compared to a few year ago must also choose to either wait it out, or sell now if desired. Remember, buying low is always better than selling low.

[F. Morana]

This situation does not differ in any appreciable way from that of any investor who takes-out a loan, incurs a loss, and then is obliged to repay the loan, irrespective of losses or gains.

If you take-out a loan for any purpose, you have to repay it. Period.

This is not about "playing by the rules," nor even about real estate per se. This is about engaging in a speculative activity and then complaining & reneging when things don't go as you would wish.

[Jeremy]

I don't see a problem if they aren't forced to move. This is no different than getting an auto loan to buy a car. Nobody complains or seems concerned with the fact that they are borrowing money to buy something that is almost guaranteed to lose 10-20% of its value every year. People just have a perceived notion that when you buy a home, it has to go up in value.

As it has been mentioned above, you take on similar risks any time you borrow money for any reason. You pay what you feel is a fair price and agree to terms. For all you know, you could have been suckered into paying more than the market said it was worth when you bought the house, or maybe you bought it at a discount. Either way, you paid what you thought was fair, and there is no guarantee as to what will happen years down the road.

Just because people around you are selling for "depressing" values, it doesn't mean anything if you don't sell. And selling just because others around you are is the same as selling all of your stocks and buying bonds after the market falls for 3 months. You're buying high and selling low, and it is a sure way to lose money.

If they are forced to sell, then that sucks, and there isn't much you can do than to try and price your house appropriately to have it sell quickly while maximizing the sale price. But to bail out just because others around you are is foolish, especially if you have no problem paying the mortgage. You'll continue to pay down the balance on the mortgage, and when prices stabilize or even improve, you'll be rewarded when you sell.

[Jim]

As said by others, if you agree to take on an obligation (which is the loan), you have made the promise to pay. If you do not, in the end, you are asking someone else to take the beating instead. The person taking the hit could be a stockholder of the bank (which could be your friends and neighbors) or it could be that the bank passes on higher costs to other borrowers in order to offset the loss created by you.

[JoeTaxpayer]

The bank should not allow people to 'walk away' from mortgages that were properly written all around. He can pay the mortgage, he agreed to pay it, short of a bankruptcy filing, he shouldn't be permitted to walk away. Many people are in this position. Last thing the economy needs is another round of people who realize they can save money walking away. That will depress prices further and create the next group who then are in the same boat.
Joe

[Marco]

One has nothing to do with the other. His purchase of the home is now a sunk cost and like any other asset the price can change year to year. if he can continue to pay the mortgage just pay and ride out the storm. the drop in prices should not last forever and the homeowner will eventually be positive above the value he purchased it.

the homeowner signed a contract for a specific mortgage amount that he can still pay. there is no basis for the bank to lower the contract amount.

if the HO has to move thats a different story and he will have to work with the lender on a short sale.

[Marco]

One has nothing to do with the other. His purchase of the home is now a sunk cost and like any other asset the price can change year to year. if he can continue to pay the mortgage just pay and ride out the storm. the drop in prices should not last forever and the homeowner will eventually be positive above the value he purchased it.

the homeowner signed a contract for a specific mortgage amount that he can still pay. there is no basis for the bank to lower the contract amount.

if the HO has to move thats a different story and he will have to work with the lender on a short sale.

[Paul]

If not needing to move, ride it out. Home values are cyclical, so they will come back up eventually. It sounds like if they put down 20% then this wasn't speculative - they intended to hang in there for awhile. If the only motivation to move is the depression in home prices, then the analogy by JoeTaxpayer to the new car is a good one. One shouldn't buy a home as a primary residence for the purposes of it's impact on their net worth - they should buy a home because it is where they want to live and is convenient for all aspects of their lifestyle. In the long run, home ownership is the best option for wealth-building, hands-down (emphasis on the long-run).

This is a lesson to all readers about buying in a hot market. Just like stock investing, these folks got caught in the buy high, sell low mistake that comes from the herd mentality or from chasing gains.

Buy and hold for long-term gains.

[Judy]

He took out a loan, and he needs to honor his commitment. There is no integrity in blaming someone else, or circumstance when you choose to do the wrong thing. If he can continue to pay the mortgage each month, he should carry on and wait for the inevitable change in the real estate market. If he has to move, rent out the house. He has the benefit of the mortgage interest (and property tax?) deduction. If he rents it out and the monthly income does not cover all expenses, he will have a loss on his tax return which will lower the amount of income tax he will pay which he can use towards the monthly shortfall. ALl the while paying down the loan and being in that much better of a position once the market turns around in several years. If he chooses to sell and he has the money in the bank to make up the difference between what he owes and what he sells for, he should pay the lender the difference. If not, then take the 1099 from the lender (Relief of debt = income to the IRS) and pay the income taxes and move on. Quit whining. He has enjoyed the use of the home and the write off for tax purposes. If the party is over, go home.

[Judy]

He took out a loan, and he needs to honor his commitment. There is no integrity in blaming someone else, or circumstance when you choose to do the wrong thing. If he can continue to pay the mortgage each month, he should carry on and wait for the inevitable change in the real estate market. If he has to move, rent out the house. He has the benefit of the mortgage interest (and property tax?) deduction. If he rents it out and the monthly income does not cover all expenses, he will have a loss on his tax return which will lower the amount of income tax he will pay which he can use towards the monthly shortfall. ALl the while paying down the loan and being in that much better of a position once the market turns around in several years. If he chooses to sell and he has the money in the bank to make up the difference between what he owes and what he sells for, he should pay the lender the difference. If not, then take the 1099 from the lender (Relief of debt = income to the IRS) and pay the income taxes and move on. Quit whining. He has enjoyed the use of the home and the write off for tax purposes. If the party is over, go home.

[VS]

More discussion on such situations here:

http://cnnmoneytalkback.blogs.cnnmoney.cnn.com/2008/02/06/when-is-it-ok-to-walk-away/

[Meoip]

Many home builders mislead costumers, solid them sub par products, lied on mortgage applications, etc. If you are in that category you should and must file a complaint. If the deal was fair the day you bought it and you weren't mislead you have no right to complain.
My house is worth about 15% less today then when I purchased it in August. It's going to head back up by the time I get around to selling. I've committed finances to taking extra good care of it during these rough times so when I do sell it's been well taken care of the whole time not just fixed up for sale. My house already stands out on the street because of that. I did up my garden. I've painted and caulked. I'm one of the few houses on the street who painted the interior.

[JR]

Yea, I don't see where the homeowner "has" to sell. No more than one HAS to buy!
In any case, I have little sympathy for any who have bought in the wildly speculative last few years. How could one NOT think the bubble would burst? If folks hadn't rushed to the table, the prices wouldn't have inflated so badly.
Our homes are not an investment venture. They're our HOME. If you don't plan to live in a location for more than a few years, why buy? It's a gamble. Always has been, always will be. It's not an investment vehicle to be quickly cashed in. Good grief! Even in the stock market they say invest for the long term! Those selling quickly may either profit or lose big time.
So, if you're "upside down" either you gambled and lost, or you'll just wait it out, live in your home, or use the strategies others have mentioned.

[Tom]

I'm getting a little tired of the "He took out a loan, and he needs to honor his commitment" mentality. The fact is he took out a loan and made an agreement with the bank to EITHER pay back the loan (with interest) or forfeit his house to the bank. He is free to do either one! He does not need to "honor his commitment" blah blah blah. Well, maybe I should say he does have to honor his commitment to give the house back to the bank if he's not going to pay for it.

Face it, the homeowner took a risk when he borrowed the money, but he thought the benefit of living in his own home 20 years before he could save up the full amount to do so worth that risk. Now he deals with the consequences of his decision. The bank also took a risk when they loaned him the money. But they thought 20% down plus what the house would be worth if they repossess to be worth that risk. Now THEY deal with the consequences of their decision.

Why are people trying to turn this into a moral/integrity issue? Perhaps if the homeowner was trashing the place right before turning the keys over to the bank, then perhaps we could talk about integrity, but otherwise lay off people!

[Dan]

Buy one of those less expensive homes, walk away from your current one. You just lowered you mortgage and its payments. The banks are destroying us. Dumping homes on the market for 1/2 of what they were worth a few months ago. Then they cry that more people are not paying, duh. You can clean up your credit faster for non payment than you can for bankruptcy, still buy a car, get credit cards etc. granted for a bit higher interest rates, but you need to manage your money anyway, just different guidelines.

[Wanzman]

When your stock investments go down, you don't just give them back to the broker....You ride it, or sell and pay off any uncovered margin loans.

You shouldn't be able to do that with your house.

If you look at your mortage very carefully, there is a spot where it says "I PROMISE TO PAY..."

[Sarah]

Well, no, Tom is right: you promise to pay, at the cost of certain consequences if you do not. That is, if you don't pay, you can lose your collateral (down payment + house) (and, incidentally, your credit rating will be harmed). The interest rate you pay, and the downpayment required, are actually adjusted to take into account the risk of your choosing option B, so the lender has, in fact, been compensated for your default already. This is not a moral issue, unless you seek to avoid the consequences through some sort of fraud, I suppose.

Corporations default on loans they can't pay back all the time, definitely including mortgages. Why do we hold ourselves to a higher standard on a similar transaction?

[kitty]

The problem with those who just walk away is that they don't just hurt the bank, they are hurting all of us. Because of non-payments, we have current crisis. Bank hires a lot of people whose jobs are at risk when the bank is loosing money. So, I think it is morally wrong to just walk away.

At any rate, if they don't have to move, I don't see a problem. The house prices go up and down. If they can afford payments, there is no reason to sell - they can just live there until the prices come back up.

If they indeed have to move, there is another option. They can rent the place out, collect rent and wait for prices to come up. The post didn't say how much they could rent the place for, but even if they get a little less than what they pay, they may come up even with tax deductions. Everything is deductible when you rent - not only mortgage, but repairs as well. They will have to deduct depreciation from their income every year, and depending on how much the house is worth, it can come up to a nice amount. Sure, if they later sell for more than cost+improvements-claimed depreciation they'd have to pay taxes on depreciation, but a) the prices have to go back up for it to happen b) recaptured depreciation is taxable at max 25%, so if they are in a higher tax bracket, they'll gain a few percentage points. Not to mention that if they can invest the tax savings from deducting depreciation.

I bought my previous condo for 125K in early 90s (it was 157 in late 80s...). I paid 40K down and took 95K mortgage. A few years later the price dropped to below 90K - less than what I owed. Yet I continued paying. When in mid-90s the prices started to come up a bit I bought a townhouse, but instead of selling at a loss, I rented it out. Now the same place is selling for 300K, even in this market - I sold a bit too early, but still with a very nice gain - enough to pay off mortgage on my townhouse. The moral of the story - there is value in being responsible.

[kitty]

Oops, a typo. When I said, I paid 40K, I meant to say 30K. It was 30K down, 95K mortgage...

[David Carter]

Its just like any other investment. Sometimes you lose. If you have to move, you have to move. Man up, take the loss, learn and move on. Simple as that.

PS do you not have a feed?

[largebill]

I keep hearing on the TV and radio about people who owe more than their house is worth. That's all bs. You get a 15 or 30 year loan. What the home could sell for in year 2, 7, or 12 is unimportant. A home should not be evaluated the same way one looks at day trading. We owned in Virginia Beach for 15 years before moving to Ohio. The first few years we were there home values didn't change hardly at all. However, by the time we decided to move the resale value had doubled. Folks need to calm down and take a longer view at something like this.

[mbhunter]

What can he do? Well, he could (1) sell at a loss and cover the difference between what's owed and the proceeds from the sale, or (2) stop making the payments, trash his credit rating, or (3) stay put, make the payments, and enjoy his house until he pays off the mortgage or the home's value once again exceeds what's owed on it. He bought high and now he's immobile unless he pays a hefty price.

I doubt anyone was holding a gun to his head and yelling at him to sign the purchase contract and the mortgage papers. He didn't have to buy. He didn't buy with stupid financing like many others, and he didn't buy more house than he could afford, but he did buy near the top of a hot market.

That sounds harsh, but I have to remember that I would likely have been in the same predicament had I bought only a few years after I did. The best thing he can do is enjoy his house, make it a home, and wait for a recovery. He's not homeless.

[Sarah]

I should have added that I don't disagree with the people who say that unless he has to move, there's no reason to sell the house *just because* he's underwater.

kitty, the mortgage lender sets its interest rate based on the assumption that a certain number of borrowers with that particular credit rating/assets will pay late and/or default. The lender has already made its money off accepting that risk. The current crisis has many causes, but the root issue is greedy assumptions about ultimate payoff made by people who had no incentive not to assume that everything would turn out for the best. These companies, by the way, do not experience a single moral qualm over walking away from their contracts when they can't fulfill them. I see no reason why a person should be responsible to bail *them* out.

[kitty]

Sarah, you make good points. At the same time, you seem to view these companies as abstract entities, but the banks are comprised of people. Some of these people are executives or those reps that were giving out bad loans - yes they deserve to loose money, but usually they aren't the ones who suffer. Most of these companies employees, though, had nothing to do with loans. They are actuaries, IT personnel, secretaries, cashiers. There are also you and me who invest money in these companies via our 401K even if we don't specifically buy their stocks.

Additionally, when someone walks away from a home and there is a foreclosure, the prices of the neighborhood homes go down as well. By walking out you hurt them as well.

Besides, as I mentioned, why not just rent out the place if they have to move? If there is no option, it is one thing, but they should certainly investigate it. If they move far away, there are companies that would manage your property at a small fee. Because of tax deductions they may even make a profit, hold on to the house and sell it when the prices go back up. Here is how depreciation works: say your house value is 100K. Divided by 27.5 is $3636 - this is the amount you have to deduct from your income every year in addition to mortgage interest, taxes, repairs, condo or homeowner assoc. dues. Higher home value - more depreciation. You deduct it regardless of what the market is doing, whether it goes up or down. It can help a lot even if rent is a little less than payments. Certainly, you need to have some reserve to be able to afford a couple months worth of payments if there is a problem finding tenants. It may not work for them, but it is something they should investigate. They may be glad they did if the prices go back up.

[FMF]

David --

I do have a feed. Look at the various options on the left side/column of the blog.

[Sarah]

The lender *is* an abstract entity, Kitty; it is a legal individual in its own right. While I certainly am sympathetic to any individuals who might face layoffs or other job difficulties as a result of the relatively high rate of foreclosure recently, it seems to me that the people who bear the responsibility for any financial difficulties of those companies are the executives who set the origination policies (or chose to purchase the CDOs) in the first place, knowing full well how mortgages work. I do not see why the original poster should suffer to protect the employees of the lender who was happy to reap the rewards of lending in the first place. The lender certainly wasn't knocking on the borrower's door during the good years offering to give back a cut of the profits. If there is obligation, it has to go both ways.

[Kurt]

"The lender certainly wasn't knocking on the borrower's door during the good years offering to give back a cut of the profits. If there is obligation, it has to go both ways."
The lender didn't sign a contract saying it would give back profits. Likewise, the lender never comes knocking looking for a cut of the profits when an owners sells the house for more than she paid for it. Don't know if you've thought of it that way, but it's a crucial element that appears to have been overlooked.

I only see one mention of a short sale in the comments.

My neighborhood was recently outlined on both Dateline and a feature in the New York Times as being a "bedroom community" left to waste in the bubble. I put 20% down on the house, all of which is gone in today's value and another $10-40k depending on how you look at its value.

My builder has gone under in an unfinished neighborhood, and I would guess every 1 in 10 houses is vacant, with another 2 out of 10 up for sale or in some stage of foreclosure. I would wager that less than 1 out of 10 homes is owned by someone who is not in debt on their home in my neighborhood.

Now.. that all being said. I'm not going anywhere, and I'm continuing to invest in my home to make it as comfortable and beautiful as I can. However, lenders in this area are so hurt by the number of foreclosures that they are;

1) Permitting short sales in ridiculous numbers.
2) Forgiving parts of loans and refinancing to avoid foreclosures.

Seeking out either of these is an option to the person asking the question. I would guess that he would not qualify though unfortunately, unless he could make a real threat of walking away from the home. Typically these options are only being permitted for people who just don't have the income to afford their payment.

A friend of mine is a realtor who is making a killing on short sale commissions right now. I'm in Phoenix, and Las Vegas is a similar situation to us out here.

Blame who you want, and accuse anyone taking these options of being a bastard to the housing depression as a whole, but at least give him his options.