What if You're Upside Down on Your Mortgage and Need to Move?

In my previous post about being upside down on a mortgage, I said that you're probably not going to be able to move anytime soon. Well, what happens if you're upside down and need to move? You have options, but none of them are magical or ideal. This post will describe a few of them: borrowing money to make up the difference, negotiating a short sale, and foreclosing.

Two big variables that will greatly affect your situation are 1) the amount you are upside-down and 2) the degree to which you can afford to keep paying your mortgage. If you are upside down $50,000 versus $5,000, you're in a much more difficult situation. Likewise, if you're able to keep making your mortgage payments until you figure out a long-term solution, you're in a much better position than someone who is unable to make his or her payments. If you can't make your payments now, consider renting out the home after you move or drastically changing your current budget to make ends meet. When you move, rent a small inexpensive place. If your kids are in college, consider asking them to take time off or to absorb some of the costs themselves. Major lifestyle changes are difficult, but the effects of a foreclosure or a short sale can be detrimental; all efforts should be exhausted to ensure that neither of those two occur.

If you are upside down on your mortgage and are put in a position where you need to move -- whether it's because of a job transfer or an unexpected layoff -- the most ideal option is to keep your home until you are no longer upside down. This can be achieved by saving money to match your negative equity or waiting for the market to pick up. Three alternatives are described below in order from best to worst as they relate to your overall financial (and emotional) wellbeing.

Option 1: Borrowing the money
This is an option as long as you're slightly upside down and not really upside down. If your negative equity is no more than $10,000, you're not in such a tough place. By borrowing money to get out of the pinch, you're protecting your credit score from getting hit by a train and ensuring that you'll be able to get another loan sometime in your lifetime.

The best place to get a loan for $10,000 or less would be from a friend or family member. But if you borrow money from someone, they'll need to charge you interest (at least 4.52%) in order for the IRS not to consider it a gift. A person is allowed give gifts to another up to $12,000 per year.

If you're fresh out of rich relatives, there are other places to look. If you, your child, or your spouse is enrolled in college, you may be eligible to take out an additional student loan. The federal government will allow students and parents to borrow money in excess of actual tuition and fees to cover living expenses. It would not be uncommon for students and parents to be able to borrow an extra $7,000 or $8,000 per semester which is available in cash. These loans have a relatively low interest rate (between 6% and 8%), are repayable over a long period of time, and their interest is generally tax deductible.

I hate to say it, but if you're unable to get a favorable loan from a family member or the government, you may have to resort to using a credit card convenience check or obtaining a high-interest personal loan. I'm not usually a proponent of putting things on your credit card that you can't pay off immediately. But in this case, when a foreclosure or a short sale are your only other options, the convenience check is the lesser of two evils. I'd rather see you incur five or ten thousand dollars of credit card debt if it means you'll avoid a foreclosure or a short sale.

Option 2: Negotiating a short sale
Short selling is when you negotiate with the mortgage lender to accept a fair market price for the home instead of the amount that you actually owe. This is more likely to be accepted when home values in a certain area have dropped significantly. Though mortgage lenders are not required to modify your agreement and accept less than you owe, they may be willing to because it may prevent a foreclosure, which is very expensive for a bank. Basically, they would rather forgive $10,000 on your loan than incur $70,000 in costs associated with a foreclosure.

Short selling is similar to foreclosing, but it will ultimately cost the bank less money and permit you to buy another home a bit sooner. It is preferable to a foreclosure, but is only offered by some lenders to some borrowers, depending on the circumstances. I had to do a bit of research to confirm this, but short-selling on your home will cause as much immediate detriment to your credit score as a foreclosure.

Expect your FICO score to drop 200 or 300 points. Your new score will most likely preclude you from qualifying for a rental lease without a cosigner. However, with two years of good credit history following a short sale, you will probably be able to obtain a mortgage through special government-sponsored programs. If you had foreclosed, you most likely would be unable to qualify for another mortgage for at least four years.

If you want to short sell your home, two things need to happen. 1) The mortgage lender has to be willing (it helps to have a lawyer assist with the negotiations) and 2) you need to prove your insolvency. Basically, you need to show that you have no money that can be freed up to pay for the difference between what you owe and what the house is worth. If you have equity in another property, a car that is paid off, or a student enrolled in college, the bank will see these things and ask why you're not dipping into your other equity, selling the car, or taking your kid out of college to pay what you has originally agreed. Essentially, before the bank concedes a short sale, they will need to be assured that foreclosure is the only other option because you have no other means to repay the loan.

Option 3: Foreclosure
This is clearly the worst thing for everyone. Your credit score will be destroyed and its affects will be long lasting. You will be unlikely to receive any other type of loan for a few years. The only good news is that no negative item - including a foreclosure - can stay on your credit report for more than seven years.

Being upside down on a house is a tricky situation -- especially for those that need to move. If you're upside on the mortgage for your current residence, save as much as you can so you can eventually bring get rid of the negative equity. If you need to move, do whatever you can to keep the home until house values go back up. If you cannot keep the home, try to borrow money from a friend or from the Department of Education. Remember that it's better to put an extra five or ten thousand dollars on a credit card than go through a short sale or foreclosure. If you're unable to obtain the cash to get out of the red, try to negotiate a short sale. It's effects on your credit are detrimental, but not as long-lasting as a foreclosure. If your lender is unwilling to engage in a short sale, then foreclosure may be your only option.