Other ideas for underwater mortgages?

[Philip Brewer]

A commenter in my recent post on cutting spending pointed out that someone who's underwater on a mortgage isn't in a position to make the sort of drastic cuts in spending that I was recommending for people in dire straits, and asked for suggestions for dealing with that problem. I came up with these four ideas, and was wondering if anyone here had any further ideas.

With the proviso that you'd want to get good legal advice well in advance to actually doing any of these things, here's what I could think of:

1. A 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 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.)
2. Negotiating a lower balance. The federal government is pushing various plans to write down the balance due on mortgages to a reasonable fraction of the value of the house. That might make the house affordable to keep. It might just make it affordable to sell.
3. Walking 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. This is not universal! Don't just assume that you can give your house back to the bank.
4. Bankruptcy. Especially if a lot of your assets are in retirement plans (which you generally get to keep in a bankruptcy), bankruptcy is one option for households with an untenable cost structure.

Any other ideas?

[KevinW]

In general you can rent a house for more than the cost of its mortgage. If that's the case, the homeowner can rent their house to a tenant and live somewhere substantially cheaper. Eventually the mortgage will be paid down enough to be "above water" and the house can be sold as usual.

If the house could be made significantly more valuable through renovations, I might consider something like HUD's 203(k) renovation loan. However in principle I would be hesitant to recommend solving this kind of problem through further borrowing.

A common tactic among real estate investors is to identify these pre-foreclosure situations, and negotiate with the bank to arrange a short sale directly to the investor. In theory this can be a win-win-win since it has the same ultimate outcome as foreclosing and selling the house at auction, but is faster with fewer intermediaries and less credit rating damage. The homeowner might try calling one of those "we buy houses" numbers, but I would caution them that they will be dealing with a professional negotiator specializing in this circumstance, so they will probably want an advocate (e.g. lawyer) on their side. These days it's entirely possible they will be too far underwater for this to work out.

None of these are really that great, but I suppose being underwater is a nasty situation to begin with.

[Philip Brewer]

Thanks for the thought on renting. That's definitely a possibility--if you could rent out the property for enough to cover all its expenses, then you'd have the option to find really cheap housing for yourself and still be able to cut your expenses a lot.

[starshard0]

Being underwater definitely is a nasty situation to be in. Out of the five mentioned (4+renting) walking away sounds like the best and easiest, but like you said it's not universal.

[Julie Rains]

This isn't an idea but a thought -- underwater could mean $10,000 or $100,000 underwater, or more or less. I would think that strategies would deal with where you are in that continuum. If you can make your payments and, for example, you are $10,000 underwater then another option would be to do nothing (different), keep making your payments, esp. if you weren't planning on moving anyway.

[Philip Brewer]

Good to make that option explicit: If your house still serves as shelter, 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.

The original question came up in relation to the idea of radically cutting your expenses, such as by finding much cheaper housing--something that's a lot harder to do if you're underwater on your mortgage.

Thanks!

[khorrell]

Another option is to work with your lender on a loan modification. Under certain circumstances, a borrower may be able change the terms of their loan. It is similar to a refinance, but more geared for borrowers that are in trouble. For example, for a refi, you house will have to appraise for more than the loan. Not so for a modification. Some modifications might include extending the term of the loan, lowering the interest rate, or rolling in a past due amount (if the borrower is able to keep up the payments but is a chunk behind, perhaps due to a previous period of unemployment or other large unexpected expenses.)

In my experience, smaller mortgage servicers are often more willing to go through the work involved in getting a loan modification approved. It's been a while since I've been in the business, and I am hopeful that the larger companies are seeing the wisdom of such "unusual" practices. Particularly when the borrower isn't trying to get out of paying for the balance of the loan, I believe it is everyone's best interest to help those customers. However, if such a modification is just postponing an inevitable foreclosure, then it isn't really helping anyone.

Another available option that I haven't heard much about lately is called a deed-in-lieu-of-foreclosure. I imagine that the lenders have pretty much stopped doing them because there would be a flood of applicants. Basically, the borrower releases the deed of the house back to the bank before the foreclosure process. The benefit is that it saves the borrow and the lender all the fees assocated with a foreclosure process, which can be tens of thousands of dollars. On the downside, it will show up on the borrower's credit report, the lender has to be willing to take the loss on the house (which they'll take eventually anyway, but still disincentive), and the borrower may end up with a judgement against them for the difference. If the difference is forgiven, it may result in a tax liability. (Though not this year, based upon some legislation that went through earlier this year.) Also, I don't think that you can apply for a deed-in-lieu unless your mortgage is already past due. That's always a catch-22: many of the possibilities aren't available until you've gotten behind. I've seen borrowers be forced to stop paying their mortgages so that they could qualify for a program that would help them.

If anyone truly believes that the are inevitably headed to foreclosure, I would recommend that they at least try to get their lender to agree to either of these options, or a short sale. I know that the banks are swamped right now and with the huge number of borrowers in trouble, they can't keep up with the number of requests they're getting. Plus, IMO, the bigger banks sometimes dont get that they will have a loss, and that they're trying to mitigate that loss, not make it go away.

[Philip Brewer]

Several good points.

In particular, thanks for spotting that I left out several categories of loan modification when I suggested a balance adjustment--anything else can be adjusted as well: term, interest rate, payment.... And, 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.

Yes, deed-in-lieu is one form of "walking away," and probably one of the preferred choices--certainly better than just ignoring the problem.