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By Jason Van Steenwyk
The problem of negative equity – owing more on your home than your home is worth, has become a severe economic challenge. Many homeowners find themselves out of work, and if they live in an area with limited job prospects, they find themselves unable to move. This makes unemployment more severe, and more difficult to escape. It also affects the liquidity of the housing market – workers with negative home equity cannot simply migrate to where the jobs are. It would cost them a prohibitive amount of money at closing, just to sell their homes.
If this is you, don’t expect miracles. Most of your options are unpleasant. But you do have options – and it’s important to make an informed decision on what course to take.
This is the simplest solution, of course. But that presupposes you being able to earn a living where you are, and the house being suitable for your family. That can be tough if you just got laid off as an auto worker in Detroit, and all the auto jobs are in Tennessee. It’s also tough on military families, who typically have to move every three years, whether they are upside down or not.
1. Some people just aren’t cut out for being a landlord.
2. Some houses may be difficult to rent in some markets.
3. You may lose some asset protection advantages. If you live in a non-recourse state, lenders have no legal right to go after your other personal assets to satisfy a mortgage secured by your personal residence. However, once that property becomes an investment property all bets are off. The lender can attach assets other than the property to satisfy the debt.
If you’re upside down, that means you’ll have to come up with cash at the closing to pay off the old lender. It’s going to hurt to write a check that big, for most of us. There are several advantages to doing so. First, you’d pay the money sooner or later, anyway, whether you stayed on or rented the house. Second, it’s simple. If you don’t want to be a landlord – and being an absentee landlord is extra tough – then this may be the way to go. Before you roll over and write the check, though, you might want to investigate some other options.
This is usually the worst of all possible options. But many homeowners, caught in an impossible situation, are simply moving out, and mailing their keys to the lender. The lender, of course, will quickly foreclose on the property.
This measure is called “strategic default.” However, this is problematic because it will immediately trash your credit. You will probably be unable to secure another mortgage for years. And it presents a tragedy of the commons problem: If banks have to build assumptions that a significant number of people will simply walk away from future mortgages if home prices fall, interest rates will have to rise in compensation. This will make it much more difficult for future borrowers to get mortgages, reduce the demand for housing, and create a vicious cycle.
Sometimes, though, it is the only way.
You can seek a restructure of your mortgage – usually via a reduction in monthly payments, but this doesn’t solve the issue of you being upside down on the loan. In fact, it may even prolong the problem, since the lower your payments, the slower your equity in the home will build, all else being equal. You may be able to accomplish a payment reduction by refinancing the loan to a lower interest rate, but you still have the same negative equity problem.
Under current law, there’s no obligation on the part of the banks to lower your principal outstanding to help you out of the jam unless they actually foreclose on a non-recourse loan. This will accomplish the same thing as a principal cram-down… except you’ll have to lose your home in the process. The bottom line – mortgage assistance programs are more suited to help those with cash flow issues, or whose income has been reduced due to the recession, and who can’t downsize in home, as they could in past years, because of their negative equity.
In some limited circumstances, members of the military may qualify for a special assistance plan called the Homeowner Assistance Program. This program was originally designed to help military homeowners who had negative equity in their homes, and who were facing an involuntary transfer. Remaining in the home is not an option for these people.
Recently, the eligibility for the program was expanded to include widows of deceased service members who died in the line of duty after September 11, 2001, or service members who had medical conditions forcing them to move.
If you have a VA loan, and you have negative equity, the VA may be willing to work with you to facilitate a short sale, under certain circumstances. You must have no other significant debt or liens encumbering the home, and it would have to cost less to effect a short sale, in the VA’s estimation, than it would to foreclose on the property. This can help VA mortgage holders to partially resolve a negative equity situation.