If the lousy economy has got you struggling to make your mortgage payments, there's a good chance you've entertained at least a passing fantasy about turning in the keys and closing the door on your housing woes.
You wouldn't be alone. Some 27% of the 250,000 homes sold in November were unloaded at a loss, according to Zillow.com. What's more, 21% of owners of single-family homes with mortgages - a total of more than 12 million families - were sitting on "negative equity" last fall, Zillow says. (For background reading, see How To Handle An Underwater Mortgage.)
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Relief is available from lenders - in theory, anyway. The federal government's Making Home Affordable incentive program is aimed at encouraging banks to lower interest rates for homeowners whose total housing payments (debt service plus property taxes and insurance) are greater than 31% of annual gross income. Unfortunately, such modifications are proving difficult to negotiate. What's more, even a modification isn't going to dig out of a financial hole people who have other big liabilities, like medical bills.
"Ask yourself if you really, really want to stay in the house," suggests Beth Gamel of Pillar Financial Advisors in Waltham, Mass. If you could stand to part with it, it might be worth running the numbers on what walking away would mean. Begin by inviting at least two seasoned real estate agents to assess your home's market value. Emphasize that you're not interested in the savviest asking price but what the home is actually likely to fetch on the market. From that, ask what your gross proceeds would be after commissions, legal costs and other expenses.
From estimated gross proceeds, subtract the amount you paid for the home. If its current market price is less than you paid, you'll end up with a negative number, meaning you may be on the hook to repay your lender more than you earn from the sale.
Say, for example, that your agent says you could clear $500,000 in gross proceeds from the sale of your house. Suppose also that it would cost you $37,200 a year ($3,100 a month) to rent and that the annual operating expenses are roughly $12,000. Your home's net operating income of $25,200 is 5% of the gross proceeds. You can compare that yield to the 4.65% return on 30-year Treasuries or other possible alternatives for your savings.
The bottom line: If your net operating income ($25,200 in the case above) is equal to or greater than your mortgage payments, you could lease your house for a year or two and collect enough in rent to cover your house payment. Then, when your economic fortunes improve you'd have the option of moving back in again or selling the house in a stronger market.
If the amount you could earn renting out your home is far below the yield on low-risk bonds and your rental income would be dwarfed by your mortgage payments, it's a sign that you're fatally overstretched. The good news is that you can probably rent your own house, or one very similar, for a fraction of what you're paying to own it.
In that case, your smart move would be to turn over your keys to a buyer. If you end up with any cash proceeds, you could invest them and rent. Even if you walk away without a dime, you could take the difference between what you're paying to own now and the lesser cost of renting and plow it into a down payment in the future. The deeper you are in the red, the more favorable is the math behind turning in the keys.
"The degree of negative equity should be one of the largest considerations," says Dan Hartman, a mortgage advisor at Province Mortgage Associates in Providence, R.I.
Ideally, you'll want to arrange a short sale, which will deliver less of a hit to your credit rating than a foreclosure. You should expect either option to knock 100 points off your credit score, says Carrie Coghill Kuntz, president of financial advisory DB Root & Co.
If your bankers won't agree to a short sale, consult an attorney. "Your lender doesn't have to accept your property in release of your debt," warns Kimberly J. Sims of Dallas law firm Riney Palter. Instead, you could end up without your property and with a judgment against you, she warns.
One group that has caught on to the financial sense of walking away is retirees. Some elderly homeowners who borrowed against homes in the Northeast to buy second ones in Florida have been allowing their older homes to fall into foreclosure, notes Scott Testa, a business professor at Cabrini College in Philadelphia. That strategy makes sense, however, because Florida's homestead exemption law prevents creditors from forcing the sale of in-state properties.
The nonprofit credit counseling industry (which receives financial backing from banks) is not a big fan of homeowners handing over the keys. In fact, it's an invitation to "chaos for the lenders, builders, neighborhoods, taxing bodies, families and school districts," says Gail Cunningham, a credit counselor and spokeswoman for the National Foundation for Credit Counseling. People "not only have a financial obligation to repay their debts, but also a moral one," she says.