What to do when you are upside-down on your mortgage …

upside-down-houseRyan – one of our Millionaires … In Training! – is upside down on his mortgage; if you can’t afford the payments (and, I have some guidelines to help you decide when that point has been reached), then I would generally suggest that no matter whether you are right-side up, upside down, or sideways, that you should get out!

But, Ryan is a high-income earner and high-saver already so he has decided to … well … I’ll let him tell you:

If I could wave a magic wand, I would not be upside-down on my mortgage, but that will correct itself over time as we are not planning on moving soon. While we could short sell the house and rent, we will not likely do that. We are emotionally tied to the house and would not, in my opinion have much upside with a rental because we would have to either float the note on our mortgage or pay the taxes on the difference on a short sale, all to pay MAYBE $1000/month less and not have the mortgage interest to write off come april 15th. An appreciation of our home of around 5%/year, starting in 2010, [should help by] bringing us back to an equity position around 2012.

A home performs two functions: housing and investment.

Like most dual-purpose things, owning your own home is probably a poor compromise on both …

… in my experience, you can usually rent a better house than you can afford to buy AND can usually find much better returning investments.

Yet, I recommend that one does own their own home, for a number of reasons:

1. Often it can turn out to be a person’s only investment,

2. It is a ’safety net’ in case all else goes wrong,

3. You have continuity of tenure (the ‘landlord’ won’t kick you out, as long as you keep up with the payments)

4. Over time, you may build up equity that you can ‘release’ to kick-start other investing activities.

For me, it was always 3. (and, the associated ‘emotional attachment’ that comes with calling your house your ‘home’) that held the most sway as I always expected to make my ‘fortune’ elsewhere. And, I have never actually used the equity for investing (except for my brief HELOC-fueled stock speculation experiment of 2007/2008).

So, I would suggest that you ask yourself the following TWO questions:

i) Can afford the payments? If so,

ii) If I were to invest in a house right now, given my current net worth, is this the house that I would invest in ?

If the answer to both questions is YES, then stay. If the answer is NO, then sell/move … be it into a rental or to purchase another (provided that the changeover costs/hassles are worth it).

This is a question that we all need to ask ourselves at least once per year (or, whenever the market and/or our financial position changes), as – in effect – we are ‘buying’ our house every year (by missing the opportunity of selling and putting the money to work elsewhere).

Given the size of our ‘investment’, we should never take the rent/own – buy/sell decision for granted 🙂

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11 thoughts on “What to do when you are upside-down on your mortgage …

  1. @ AJC – I agree that plenty of investments, if not most, will give you a better APR than your house, but what about leverage?

    $500,000 House( $400,000 Bank’s money, $100,000 Your Down Payment) * .05(expected year 1 appreciation = $25,000

    $100,000(Your would be down payment) * .15 (from a successful investment or business venture) = $15,000

  2. @ Ryan – This is POSSIBLY true IF you gain market appreciation; that’s called ‘speculation’. On the other hand, if you put the same money into a cashflow positive rental, then you make money on the rents and any future appreciation is a bonus; that’s called ‘business’ 😉

  3. @ AJC – touche.

    On question ii, I’m assuming you are saying would you invest in your home at its current price, and without being upside down, right?

    As always, thanks.

  4. Begin underwater is terrible. But at least it sounds like Ryan can still afford the mortgage (which does give him many more options). If he is committed to being in the house for several years, I’m sure he won’t have to suffer through a short sale.

    You didn’t talk about the impact on your credit of a short sale. From a quick web search,it seems that it would lower a 720 rating by about 200 point if you had late payments, and you couldn’t convince the bank to go for it if you weren’t late several times. Yeetch. That will impact your ability to borrow money, get any other loan you need, your credit cards, and all that junk. Want to buy an investment rental? Forget it!

    I’m actually convinced that if my wife and I stayed in our downtown apartment and invest the difference instead of getting a house we would better off right now. In my part of the US, rents did not increase at the rate of house prices. But I also feel that we would have been more extravagant and not invested the full.

    Still, a house is a home. And we are fortunate enough to be neither underwater, nor concerned about missing a payment.

    Now if only someone would do my yardwork for free.

  5. Ok… after reading the above I want some options on my situation. Married, three school aged kids. Currently own a home with a high mortgage that is worth just about $50K more then we owe. Not the home of our dreams. We are not in foreclosure. I am self emplyed and my husband is a Police Officer. We can make our monthly mortgage but it eats up about 60% of our monthly income. We have no savings, a mininal 401 plan, no large other debt. We are both in our mid thrities. We can rent a much nicer home in our area for about $1k less then our mortgage a month. If you were us, would you sell and rent or keep the house?

  6. @ Alexandria – I am not you, so I can’t give you the answer! 😉

    But, this is a GREAT question and I will address in a more general way in a f/u post. Stay tuned and thank again!

  7. Pingback: Speculating on your own home? « How to Make 7 Million in 7 Years™

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  9. from what Ive read I think were screwed, but Im not even sure what we can do. Here is the senario- my husband and I bought this house about 10 years ago in the boom herewith both of us working we could afford the mortgage and our lifestyle easily. Ive been laid off and weve been living on my savings which is now gone and im on unemployment, which is fast running out. were about 100K upside down, we got a trad loan 30 yr fixed, but without 2 incomes were sinking fast. we dont necessarily want to stay in this house, infact we want to move to a part of the country where the cost of living is less.
    any clues? what should we do? how do we get out of this when getting out would cost more than we have even if we spent our retirement to get out. we would have less than nothing left!

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