What Can You Do When You're Upside-Down?

Underwater homeowners

You're not alone. While more than 30% of mortgages were underwater at the height of the Great Recession, nearly 21% of homeowners still owe more than the market value of their homes, according to the third-quarter Zillow® Negative Equity Report.

"The whole problem with being underwater is that it's only a problem if you absolutely have to sell," says Cliff Perotti, a certified distressed property expert in Corte Madera, Calif.

But unlike other mortgage holders, some service members facing orders for a permanent change of station can't wait for the market to recover before selling their homes.

Accidental Landlords

As the rising tide of the real estate market has brought home values a little closer to market values, many underwater mortgage holders are choosing to rent out their homes -- at least for a while -- when they move on.

"There's a crush of accidental landlords who can't sell, but can rent out their homes and break about even," says Perotti.

Some people are refinancing to bring their mortgage closer in line with rental rates, lessening the financial burden.

"More families are choosing to rent their homes out for less and refinance to make up the difference," says Katie Savant, the government relations deputy director for the National Military Family Association.

Programs Offer Relief

Many government programs created during the recession to help struggling homeowners didn't apply to second homes or rental properties initially, but some have been expanded to include those homes, such as the Home Affordable Refinance Program, or HARP.

HARP was set up in March 2009 to help underwater and near-underwater homeowners refinance their mortgages without paying down principal. Generally, to be eligible, you must have a loan backed by Freddie Mac or Fannie Mae, have taken the loan out no later than May 31, 2009, have a loan-to-value ratio greater than 80%, and be current on payments during the past year.

VA loans aren't eligible because the VA has its own refinance program, which requires that you previously lived in the home, but need not be living in it now.

HARP is accepting applications until Dec. 31, 2015.

The Home Affordable Modification Program, or HAMP, can also help make mortgage payments more affordable. Expanded in June 2012, the program now includes homeowners applying for a modification on a home that is currently rented or that the homeowner intends to rent out.

Service members may also be eligible for HAMP if they're displaced due to PCS orders; plan to rent out the home and return to it at some point in the future; and were occupying the home as a principal residence immediately before the displacement.

HAMP enrollment ends Dec. 31, 2015.

Taking the Loss

Deciding to walk away from a home at a loss or transfer ownership back to the mortgage company is a big decision that you shouldn't make alone. Talk to a free housing counselor or a financial adviser to weigh your choices, which may include a short sale and a deed-in-lieu of foreclosure. A short sale is where the mortgage company agrees to let you sell your house for an amount that falls "short" of what you owe. And a deed-in-lieu of foreclosure is where the mortgage company lets you transfer ownership back to it.

Savant explains that the ramifications of these options can be costly and far-reaching, especially for service members. "Military families really have to be careful with short sales and foreclosures because the decisions they make could impact security clearance. If service members lose their security clearance, they could potentially lose their job."

Financial problems are cited in many security clearance cases reviewed by the Defense Office of Hearings and Appeals.

How a short sale or foreclosure affects a borrower's credit depends on whether payments on the loan were maintained. If they were, the credit score could have a short-term drop of 150 points, says Perotti. "If the borrower hasn't made payments for several months or years, the score can be reduced by 300 points or more and will take longer to recover," he adds. Even if you stay current in your payments and do a short sale, you won't be able to buy another house for at least a few years, says Perotti.

People with a foreclosure or similar default on their credit report can generally expect their score to start recovering after a couple of years, according to Craig Watts, public affairs director at FICO, the company that created the most widely used credit score, the FICO score. This is assuming the borrower stays current with payments on all other credit accounts.

If you really have no other option but to sell at a loss, the Home Affordable Foreclosure Alternatives program can help take a little of the sting out of a short sale or deed-in-lieu of foreclosure.

A HAFA short sale releases you from your mortgage debt after selling the property so that you aren't responsible for the difference between the sale price and the amount you owe. A HAFA short sale or deed-in-lieu also has a less negative effect on your credit score than a traditional short sale or foreclosure. It also can provide up to $3,000 for moving expenses.

Know Before You Go

Finally, it's worth saying: You might think you’re underwater, but not be.

"You may feel upside-down, but verify it first," says Mark Burrage, a director of home advice at USAA. "People go on real estate websites that are usually very conservative to value. Get your home appraised. You may find that you're not underwater at all. The market has been rebounding and online valuations may be lagging."

A home appraisal can cost just a few hundred dollars, but save you even more if you discover you're not underwater.

Some people also confuse being underwater with not being able to afford the closing costs and real estate agent fees associated with a home sale, which typically amount to 7% to 10% of the sale price.

"Many lenders have choices to help cover those costs," says Burrage. "You can also consider a 'for sale by owner,'" where you act as your own real estate agent.

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