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.