How to Deal with an Underwater Mortgage Loan

Millions of homeowners are underwater on mortgages and feel trapped. Refinancing is probably not an option when you owe more on your mortgage that your home is worth, so it's tough to tap your home equity. While an increasing number of people are walking away from their mortgages, that is likely not the best approach to dealing with financial problems.

Strategic Defaults

You may think that strategically defaulting, or walking away from a mortgage when you can afford the payments, can help you make a fresh financial start. While it may be possible to stop paying on a mortgage and remain in your house for a period of time, eventually the mortgage lender will come after you. Even if it doesn't seem like your mortgage lender is going to sue you for money owed when it forecloses (this is called a deficiency), it could in many states collect what's owed several years later, when you think you have put your financial problems behind you. Also, a foreclosure stays on your credit report for seven years and can even keep you from getting a job.

So what can people who are underwater on home loans do? Consider the following options:

1. Don't do anything. Unless you need to sell your home because of a job change or some other compelling reason, it may be best to just wait for home values in your area to rise again. No matter what happens, you are going to need a place to live. Avoid panicking about housing prices or getting caught up with trying to predict where the market is heading. As long as you can afford to make the monthly mortgage payments, keep doing so.
2. Arrange a short sale. If you need to sell, it may make sense to get your mortgage lender to agree to a short sale. When a bank accepts a short sale, it agrees to take less than what is owed on a home loan. When attempting a short sale it is important to find a real estate agent who is experienced with this type of deal as payment-in-full. In the best case scenario, the mortgage lender forgives the remaining debt, although you might still owe taxes on it. But the mortgage lender could also ask you to pay all or a portion of the forgiven debt, usually over time. If you think a short sale can help you, lining up a buyer could help convince your mortgage lender to go along with it. If you qualify, a government HAFA short sale may get you out from under your home. Got to MakingHomeAffordable.com for details.
3. File for bankruptcy. Going into bankruptcy should always be considered as a last resort. A bankruptcy stays on your credit report for 10 years, and can keep you from getting credit in the future. That means that you may be unable to get a mortgage or financing for an auto even if you have enough income. Bankruptcy does keep a mortgage lender from recovering a deficiency, however.
4. Get debt counseling. Perhaps your problems with managing mortgage payments and other bills is related to poor spending habits and has nothing to do with being underwater. If you are not handling money wisely, it probably wouldn't help the situation even if you were able to tap your home equity through a refinance. A debt counselor can help you put together a budget and work through issues contributing to money woes.
5. Try for a HARP refinance or a HAMP modification. If you qualify, you can refinance even an underwater mortgage to today's best interest rates, or modify an unaffordable payment to something more manageable. Got to MakingHomeAffordable.com for details.

Summary

• Strategically defaulting doesn't mean your mortgage lender won't try to collect on what you owe.
• You can choose to continue paying on your mortgage loan and wait for home values to rise.
• Selling your home could help you get rid of a home loan even if you get less than you want.
• Your mortgage lender might agree to a short sale and accept less that what you owe on your mortgage loan.
• Bankruptcy should be used as a last resort.
• Debt counseling could help improve spending habits while you remain in your home.
• HARP or HAMP may help.

Being underwater on home loans doesn't give homeowners a free pass to stop making payments just because they are upset about the housing market. There are other alternatives that can result in less damage to your credit.