Underwater Mortgage on Rental Property

[atlantalee]

My husband and I each own a house.  We currently live in mine and rent out his townhouse for $1100/month, which covers the mortgage, property tax, and insurance.

Unfortunately he bought his house in 2005 for $165k with $0 down (Two mortgages at 5 year and 7 year fixed, so both are now variable).  He'd like to get rid of it, as he doesn't particularly like being a landlord, and it's not profitable.  The problem is that it's valued around $90-$100k.  Since he's only got about $20k equity in it now, he'll need another $50k or so just to sell it.

I personally think he should just keep renting it out until the market improves, save his money in an investment account that will pay better than the 3.25% interest rates on both his mortgages, and hope to refinance before those variable interest rates rise.

Another option I've considered is trying to sell it, and taking out a Home Equity Loan against my house to pay off whatever the difference is.  My mom very generously provided a significant down payment on the house we live in, which I expect to give back to her whenever I sell the house, so I'd be a bit nervous about borrowing against this.

As a last resort option, we could move into the townhouse and rent out my house.  As I said, thanks to my very generous mother, my mortgage is very low compared to what it would be if I had just put down 20%.  So we could rent out my house for about $500/month more than what I pay for mortgage/insurance/taxes, and put that toward the townhouse.  While this sounds like the best financial option, it puts us a bit farther from the places we frequent and adds 4 city miles to my commute one-way.

Thanks in advance for sharing any advice you might have.

[Karl]

Have you considered a short sale on your husband's property?  It might make the most sense in terms of reducing your (plural) overall debt.

Karl

[Another Reader]

Getting a short sale approved might be difficult, as you can afford the payments.

What's going on with property values in the area?  Are they increasing?  If so, just rent it until you reach a point you can tolerate the loss.  As long as the variable interest rates stay low, this is a viable approach. 

BTW, he has no equity, he just paid the loans down $20,000.  He still owes more than the property is worth. 

[DoubleDown]

If you have a reasonable expectation that your husband's property will recover its value over the next few years (or as long as he can continue to hold it), and if there are no large expenses looming (like replacing the roof or something), then I agree that your first choice is the best (hold it and continue to rent it). Hopefully he might even see rents increase until the property has gone up in value to at least pay off the loans. Most likely he's at least getting a tax break being able to write off the interest and other expenses.

I definitely would not take out a loan just to be able to bring cash to closing in order to sell it.

Personally I wouldn't move into that house if it would make your own lives less enjoyable through longer commutes, etc. I don't think it's likely worth the $500/month it will cost in your own time and enjoyment.

I'll throw out as a fourth option, even though I don't like it, that depending on your state's laws, he MAY be able to foreclose on it or turn it over to the bank for a short sale without having negative repercussions other than a significant hit on his credit for a few years. In some states, though, the bank can still pursue him for the lost money by going after his other assets, so proceed with caution and carefully find out your state's laws before undertaking that. Also any loan amount forgiven may be considered taxable income by your state, and I don't recall where the IRS stands on that issue currently.

[James]

I personally think he should just keep renting it out until the market improves, save his money in an investment account that will pay better than the 3.25% interest rates on both his mortgages, and hope to refinance before those variable interest rates rise.

I agree with this option, with the exception that I don't believe he can do better than the 3.25% without short term risk.  Since he is underwater I would apply all savings to the mortgage as you go along, and sell as soon as it can pay off the mortgage.


Lets just say he saved up $30,000 and had it in the market and the market drops 50%.  At that point it's possible housing prices also drop, resulting in both less money to put toward the mortgage and less value in the house.   I would say the safe bet is to simply pay down the mortgage asap.

[atlantalee]

Thanks very much for your responses and info.  This question has been bothering me for a while, and I'm so glad I have a place to get some educated advice.