Our Daily Bleg: A Real-Estate Dilemma

Mike, a 30-year-old engineer, writes in with a real-estate dilemma in which he’s considering a tricky tradeoff: is it worth sabotaging his own credit rating in order to walk away from a house that’s worth far less than his mortgage?

I am hoping he can glean some good advice from those of you who may work in related fields. (Considering your fervent response to a recent post about homeowner bailouts, he probably won’t be disappointed.) Here are the details:

My question is about my current housing situation and when (if ever) it makes good economic sense to walk away from an underwater home. My new wife and I bought our home in Temecula, Calif., as a place for us to start a family, not as a get-rich-quick investment or because we expected the value to go up in the near term. However, we never expected the value to crash the way it has.

We bought the house in early 2007 for $445,000 and put $50,000 down (the lender encouraged us to put zero down, but even though $50,000 was a huge amount of money for us, we felt more comfortable with some equity in the home and a lower monthly payment). So our mortgages totaled $395,000. Now that the market has crashed in our area, our house is worth about $250,000.

Our home value is now about $140,000 less than we owe on our mortgage and our $50,000 down payment is essentially gone. Although our monthly mortgage payments are high, we can still afford to make them, but should we? If we walk away and buy another house with my parents cosigning on the loan (or even just rented a place), we could save almost $1,000 a month in payments and maybe even have positive equity in the next few years. If we stay in our home, we’ll be stuck for many years, and if the market ever does get back to what we paid, the best option we’ll have will be to break even with a sale and then buy another house with an inflated value.

I’m certainly concerned about the ethical side of it, and know that walking away is not “the right thing to do.” But my question is from a purely economic perspective and I’d be saving a significant amount of money by lowering my monthly payments and erasing $140,000 in debt.

Since California is a “non-recourse” state, all the loan company could do is take the house. And the Mortgage Forgiveness Debt Relief Act of 2007 states that through 2012 the I.R.S. will not count forgiven debt as taxable income. So the only financial downside appears to be a destroyed credit rating. Am I missing anything?

So the big question is: how much is my credit rating worth? Is it worth more than $140,000 plus $1,000 per month?

Now imagine a few hundred thousand Mikes, or maybe a few million, and you can see why real estate will remain a mess in many parts of the country for years to come.

How flexible will his bank be in a renegotiation? There is the chance, of course, that his own home will regain its value in time, but that time frame is a big question mark. Some of you may want Mike to double down and buy another house while values are low, but I doubt that is an appealing option.

Please give Mike the best insights you can.

Leave A Comment

Comments are moderated and generally will be posted if they are on-topic and not abusive.

 

COMMENTS: 164

View All Comments »
  1. Carl Bunch Credit Repair says:

    Credit repair expert speaking here:

    First of all, if you walk away, you won’t be ABLE to buy another house for at least 2 years (even if your parents offer to co-sign) because you will have a foreclosure on your credit report, not to mention the fact that your credit score will be in the low 500s , which means all of your credit cards will jack up their interest rates on you, reduce your available credit, and maybe cancel the card outright.

    Your best option is to file bankruptcy. You can keep your credit cards, and as long as you don’t make any mistakes after the BK, your score will be in the high 600s-low 700s within a year. You still won’t be able to buy another house for at least 2 years, but with BK you can keep a high credit score.

    Potentially the best option, though risky, is to stop making payments, wait for the Notice Of Default, then have an experienced lawyer demand the lender produce the mortgage. Most mortgages have been chopped up and securitized and if a lender can’t prove they hold the entire mortgage, they don’t have the right to foreclose. You can live in the house for free and have a credit repair expert like myself use the documentation to fix your score.

    Thumb up 1 Thumb down 0
  2. jonathan says:

    I doubt a bank will cut the mortgage by enough, but it’s worth waiting a few months to see what the federal government does and how that affects the banking industry. If things continue as is, the only sensible choice is to talk to the bank and tell them you’ll give them the keys.

    Thumb up 0 Thumb down 0
  3. Christian says:

    WALK AWAY.

    Ethical issues aside, this is a no-brainer. The only thing I would perhaps try first is to negotiate a write down with the bank that brings your loan value closer to the value of the home.

    If they won’t deal walk away. Your credit rating will be fine in a few years.

    Thumb up 0 Thumb down 0
  4. Henrik says:

    You said you didn’t buy the house as an investment, so even from a purely economic perspective you should consider if you actually like living in that house. Having a home you feel at home in has to have at least some value to you, even if it doesn’t reflect in the market price.

    Thumb up 0 Thumb down 0
  5. C. Larity says:

    Pay your bills, deadbeat.

    Thumb up 0 Thumb down 3
  6. Al Shealy says:

    Since you’re willing to sacrifice integrity for money, why not just rent out your wife for a few years and pay off the whole thing very quickly?

    Thumb up 0 Thumb down 3
  7. Jim says:

    omg the same greed that got us into this mess is going to make it worse!

    This guy bought a house, has no problem making the payments but wants to WALK AWAY because of the current market?
    How long was the family planning on living there in the first place?

    Does he do this with a new car as well?
    You buy a new car, drive it off the lot and there is no way you can sell it for what you paid for it. Should you just walk away from that as well?

    The only reason I could see to walk away would be if he had to relocate for work and would not be able to sell the house.
    But that does not appear to be the issue here.

    Thumb up 0 Thumb down 1
  8. Peter says:

    Just a comment on the math here…

    The savings of going into foreclosure would be a $140,000 change in net worth OR a $1000 a month in savings (actually less, since you’re payments are tax deductible), depending on how you look at it. You don’t get one on top of the other.

    That being said, the interest rate and terms of the loan may also be relevant here, and $140,000 is nothing to sneeze at if you struggled for years to come up with the $50,000.

    Thumb up 0 Thumb down 1