Help A Reader: What To Do When You’re Upside Down On Your Mortgage?

upside down on your houseI’m really baffled that people are so tempted to just walk away from their house simply because it’s “worth” less than they owe on it. I put the worth in quotation marks, because what a house is worth is all relative. A house is worth what someone is willing to pay for it. Sure, you can base it on comparable sales in the neighborhood, but that gets very skewed when you are dealing with one of the biggest real estate corrections in the history of the United States. Just because a real estate agent or tells you that your house is worth $100,000 and you owe $150,000 doesn’t mean it’s going to be like that forever. It would only take a solid year of real estate recovery and lessening foreclosures/short sales in order for your property to start recovering in market value. Here’s a question we recently received from a concerned friend:

A friend of mine is upside-down on her mortgage…she has this brilliant idea to buy a new home, and then foreclose on her old one after she’s already in the new home. I know this is a bad idea, but I don’t know how to tell her WHY its a bad idea….can you help?

Here’s 5 Reasons:

  1. It’s going to ruin your friend’s credit. If she ever needs a car loan or tries to buy another house in the next 10 years, she’s going to have a hard time, because a foreclosure on your credit report is like dropping an atom bomb on it. It takes a long time to go away, and lenders will treat you like you have The Plague when they see your credit report.
  2. I hope she makes a lot of money. If she’s planning on buying another house before she sells the old house, she’ll have to disclose that she is carrying another mortgage, and that will take a signficant hit on her as she will need to prove to the new mortgage company that she can afford two mortgages. I’m assuming she wouldn’t tell the mortgage lender about her little plan to duck out on other other loan, because I doubt any lender would give her another mortgage if they knew that.
  3. Probably the most important reason NOT to follow through on her “great” idea is because the mortgage lender could go after her for the difference of the loan after they sell the house. If she owes $200,000 and they sell it for $150,000 at an auction, they could pursue suing her for the remaining $50,000. A lot of lenders haven’t been doing this, but now that foreclosures are dying down a little bit, there’s no telling what they’ll do. She can’t just assume that they WON’T sue her for the difference. If she has a good attorney who can advise her how to go through with the foreclosure proceeding, there are ways to avoid the lender being able to go after you for the difference, but if she just literally walks away and never contacts them to settle the foreclosure, then there’s a good chance the lender could sue.
  4. It’s going to be an emotional drain on her. Banks are nasty. They’ll harass you, they’ll find any way to contact you. It’s not pretty. You’ll be put through the emotional ringer when going through a foreclosure. It’s not as easy as it sounds to just walk away and never look back.
  5. It’s not ethical. I mean, you can justify it all you want or blame the real estate bubble on whoever you want, but YOU signed up for the mortgage and YOU made the decision to buy the house.

Can anyone else think of why this idea is a BAD idea? Or, you can play devil’s advocate and explain why you think it’s a good idea. The bottom line is that you shouldn’t panic if people are telling you that you’re upside down on your house. Unlike a car, houses go back up in value. Cars never appreciate, other than classic cars that are in pristine condition. Houses go up and down, and right now, a lot of real estate markets are EXTREMELY undervalued because of so many foreclosures and short sales. Once those die down, you’ll start to see the value of your home return to normal.

  • Jesse

    Number 5 is the kicker for me. I can’t understand how anyone could just turn their back on a promise they made to another, even if that other is a nasty ol’ bank. I am currenty upside-down in TWO mortgages and the thought of walking away never crossed my mind. I wasn’t buying the house for a quick turnaround so either way I will be waiting for at least five years, and by then my hopes are that the market will level off and I will have some equity. Either way, it’s not right to walk away from a mortgage regardless of the worth of the home.

    • Ben

      I really don’t like the “ethics” line of reasoning, because after all, the BANK also signed the mortgage and knew the risks, and the BANK has probably already made 100x the time and money they invested in fronting the mortgage. Not to mention, when the BANK loses money, Joe Taxpayer is the one who foots the bill anyway. Sorry, if you are underwater on 2 mortgages, and are going to wait for the market to return? you are never, ever going to make your money back. Walk away now while you can.

      It’s high-time that the banks take a hit, instead of the people.

    • getreal

      People turn their backs on their marriages all the time and walk away. Why would a mortgage be any different?

    • Phil

      its not right for the corporate bank leaders to destroy our economy and remain rich by recieving golden parachutes and get huge bonuses for doing so. the rest of us upside down middle classers get to take it up the tail pipe. if people can figure out a way to screw them back……..DO IT!!!!!!!!!!

  • Miss Honess Tee

    Why does your friend even WANT to do this? What is the point? Would she consider moving to a new house if she weren’t in this situation? Why doesn’t she just wait until housing prices pick up, or try to earn some extra money to add to the principal so that she ISN’T upside down on her mortgage? These bad economic times won’t last forever.

  • Jerry

    Its like Duestche Bank said today, Strategic Default may be the next big trend

  • The Ghola

    Another perspective which probably doesn’t apply to the girl, but what about all the people that for family needs require a different size home than they currently live? Being almost $200k upside down on a $350k mortgage means the current home is not even rentable to cover the mortgage. The banks foreclosed a bunch of units in my condo community early on and set the prices between 150-200k for 300-425k properties. They remain there today (70+ short sales or foreclosures later of about 350 units total in the community). In this instance, the banks directly created the problem by making loans on overvalued property (they wanted their money), then screwing the remaining owners by selling at a vastly reduced cost when the first set of ARMs came due and people couldn’t pay. Now the community is full of low end renters (from new investors snapping up the foreclosures and SSs) that could care less about the property and it’s turning into a ghetto. It’s not about morals or ethics. The bank created the problem, let them deal with the fallout. This community will never recover in 10-15 years regardless of the market in our city.

    • Scotisheyes

      We are going through the same thing.. We owe 100,000 more then what our place is worth.. we need to move because my 9yr old girl and 14 year old boy are sharing a room.
      They need to have separate rooms. Can you get a loan if you are upside down? I was told no! even if we have good credit..

      • donow

        We moved when our house was too small as well. Its a house not a prison.

  • Mike

    It is ethical to walk away. I’m sorry, but a house is an investment. If you bought stock, and you sold that stock before the price dropped, are you an unethical owner of that stock?

    When you walk away, depending on the state you live in, you may owe the lender, which can be resolved in bankruptcy if you are in a crisis. Buying a house is a business transaction.

    A home can be anywhere, and if you have the right mindset, you can be happy living anywhere as long as you have family and friends, and you are willing to take care of your family and friends.

    • bob45

      comparing a house to stock is stupid… stock is paid for outright… we’re talking about defaulting on a home “loan”

      • donow

        You and short sell a stock and the future value of the stock is secured by your credit – so its not ‘stupid’ to compare it to stocks. You simply dont know about investments.

  • B1znes2

    I understand her pain. I have thought about walking away, when I see people paying $500 less for houses double the size of mine and fully remodeled in the same and better neighborhoods. Why keep paying double the amount when you can own a large home for the price it cost to rent a 2 bedroom apartment.

  • Mark

    If someone paid $400,000 for a house that is now only worth $125,000 that won’t come back in value anytime soon. In areas like this, homeowners would be thrilled to only be $50,000 upside own. Don’t take my word for it – research historical price records in the area and you will see that is what values were 20 years ago. If you are financially able to buy a second similar house do it, you may never see prices this low again another time soon. There is nothing that says that you have to not own an upside down house in order buy another one at these prices. What you do with the old one after that is your business.

  • donow

    Really? Businesses get rid of bad investments all the time but its unethical for a human to do that – nonesense

  • blogK

    No need to be nasty people. Erik is bringing up good points and things to consider. He even wanted your feedback and why you think it’s a good or bad idea! Why must people feel the need to go the rude route?? Cant you just say your reasoning and leave it at that, without attacking the person?

  • Janice Hassel

    nice blog!!

  • Starr Stanley

    Well, it’s now 5 years after most of these original comments were posted and the housing market has STILL not recovered, and my house is STILL worth only slightly more than half of its original value, with no improvement in sight. Criminal bankers caused this problem yet the middle class continues to pay and pay and we are all trapped like rats in homes we can’t use or don’t want. It’s not so easy to stay put, either. When you stay in one of these homes, the cost of maintaining it can never be recovered. Rent it out? Get REAL! The expense of keeping up a home is bad enough when people have actual pride in the dwelling. Government programs do nothing to address the real problem, which is the size of the PRINCIPAL, not the amount of interest. We need a realistic program that approaches fairness, such as one where the evil banks split the principal losses with the mortgage holder. I say that only approaches fairness because how do you count the billions of $$$ of taxpayer bailouts in the equation? And the fact that none of the psychotic criminal bankers went to prison?