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What To Do If You’re “Underwater” On Your Home Loan

by Brett Backues on June 27, 2012
According to Time magazine, nearly one in five Americans owe more on their homes than the house is worth. Many Americans who need to refinance their homes are unable to do so because of the difference in what they owe and what their home is now worth.
Consider the alternatives
If you are one of these people, you no doubt feel overwhelmed. Financially, you may be "underwater," and continuing to make payments may seem to make no sense; but when you consider the emotional and long-term impact of losing your home, damaging your credit and self-esteem, you can’t imagine going with this alternative either. Sadly, you’re not alone in this quandary. Many buyers in the “hot” times bought their homes with little or no money down and never had equity. With heavy liability exceeding their assets, some just choose to walk away. 
Should you “stick it out?”
Financial expert Tobey Wilkins says the idea of "sticking it out" may seem somewhat pointless for those who find themselves "back of book" (owing more than their property is worth).  But, he says, it’s important to consider a number of factors which can justify continuing to make payments. Most experts believe the market will rebound and the situation of negative equity will correct itself. In the meanwhile, he suggests staying in your home, which you bought because you like the neighborhood and the house. Moving is very expensive, a consideration overlooked far too often.  And, importantly, not honoring your mortgage contract will affect your life in many ways, most notably damaging your credit.
How can I afford to stay in my home?
    •    Refinance your mortgage. To qualify, increase your credit score. You need a minimum credit score of 680 to qualify for a mortgage refinance. Aim higher, if possible, and acquire a rating of 740+ to score a lower interest rate and cheaper monthly payment. Pay credit card, existing mortgage payment and other loans on time each month.
    •    Get rid of debt.Pay off as much of your debt as possible to further increase your credit rating and reduce your debt-to-income ratio. High debt payments can stop you from refinancing a mortgage loan.
    •    Talk to your lender. Some actually offer in-house refinance programs for struggling homeowners, while most will see if you qualify for a government-sponsored program aimed at foreclosure prevention and providing borrowers with more stable loans. Ask about the Making Home Affordable program or FHA Short Refinance opportunity. If you’re eligible, these government programs help refinance underwater mortgages.
    •    Pay out-of-pocket. If you cannot get government assistance, use your own money and put a down payment on the new mortgage loan. The down payment covers the difference between what you owe and the value of the property.
Is there a point at which I should walk away?
Financial advisors note that there are two attitudes about walking away. First, there are those who think it’s unethical to default on an obligation for any reason. Second, there are those who believe walking away from a mortgage is nothing compared to the wrongdoings committed by bankers and Wall Street firms.
Ethics aside, at what point does it make sense to walk away? Arizona law professor Brent White suggests for borrowers who are more than 25% underwater — particularly in higher-priced homes where negative equity can top $100,000 — walking away makes sense. But before you do this, seriously weigh the variables.
    •    Research the difference between your mortgage payment and area rents — ask yourself if what you'd pay to rent a comparable house is more or less than payments on the one you already own.
    •    Assess the amount you're underwater and how heavily hit your area has been by the downturn of the US economy. Has there been widespread unemployment in the region? Was the market where you live seriously overbuilt, like in Phoenix or Las Vegas? Or did it suffer less?
Whether you choose to default on your mortgage or find a way to continue making payments is a very personal decision. If you have any questions or would like help in assessing your particular situation, contact MyCFOLink for a consultation.