Options When You're Underwater on Your House

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In this Jan. 3 photo, a realtor sign marks a home for sale in Franklin Park, Pa. The partial federal government shutdown is complicating even more the process of getting and managing mortgages. (AP Photo/Keith Srakocic)

Every year, thousands of military service members receive Permanent Change of Station (PCS) orders. And some portion of those service members will own houses and need to figure out what to do.

Sell, rent or something else? That question is hard enough when the financial situation with the house is stable, but the options might be entirely different if you owe more than the house is worth, or if the costs of selling are more than the amount of equity in the property.

As a quick refresher, there are several reasons why someone might owe more than their house is worth. The housing market may have declined since they bought, or they may have rolled closing costs into the loan, or had no down payment, or lived in the house only a few years so that they hadn't actually paid much principal yet. How it happens is important to mitigating risks in the future, but not a lot of help when you're stuck with a house that you can't afford to sell.

Unfortunately, while there are many options, none of them is great, and all have different costs and benefits.

Pay the Shortage Outright

While it is incredibly painful, in some cases, it's better to cut your losses early by selling the property and paying the shortfall out of pocket. If you don't have savings to cover the difference, you may need to get a personal loan to cover the difference. It's not ideal, but sometimes it is the best option.

The benefit of this option is that you are done with the property and won't have any further losses. The downside is that you are giving up any possibility that you can decrease the amount of loss.

Renting

Renting is a popular choice, with landlords hoping that their property will increase in value over time, and that eventually their loan balance will be low enough to afford to sell. That will happen eventually in almost all situations, but it takes time, and a lot can happen along the way.

If you are considering renting, be sure to thoroughly understand how to evaluate the cash flow on a rental property, assess risk and liability, calculate potential appreciation timelines, and determine short-term and long-term tax consequences. The key is to be sure that you're not losing more money along the way, either because the rent doesn't cover the property's costs or unanticipated expenses crop up. You also have to consider the accruing taxes along the way, including depreciation recapture taxes and, depending on the timeline, potentially capital gains taxes.

The benefit of this option is that you may be able to decrease or eliminate any loss. The downside is that you could end up losing even more money along the way, or that the property will impact your other financial goals, such as purchasing another house or contributing to retirement savings.

Leaving the Family Behind

In some situations, it may make sense for the family to remain in the home while the service member moves to the new duty station. The primary risk with this option is the costs of maintaining two households, and traveling back and forth. This option may be more attractive if there's a reasonable expectation that the service member will return to a local area duty station in the future, or if family circumstances support it otherwise (like a high school senior, etc.).

The benefit of this option is that you may be able to make up some of the shortfall in your house's value. The downside is that you may spend more money to support the costs of living apart, and obviously not every family wants to live apart.

Pursuing a Short Sale, Deed-in-Lieu or Foreclosure

If you have no other possible choices, talk to your lender's loss mitigation department to see what options it may be able to offer. Be sure to consider the financial, ethical and military ramifications of each option. Before proceeding with any decision, be sure to check with your command's security manager, installation personal financial counselor, and probably even your chain of command. Any type of mortgage workout, including a short sale, deed-in-lieu of foreclosure, or foreclosure may have an impact on your security clearance.

The benefit of this option is that you will no longer be responsible for the property's mortgage. The downsides include possible impacts on your security clearance, impact on your credit score, potential tax consequences, and possible difficulty securing housing at future duty stations.

If you've looked at your situation from every direction, and still can't figure out what to do, you may find help from your installation's personal financial counselor (or educator or specialist or whatever your base calls them). Base financial educators have different areas of expertise, but most should be able to help you look at the pros and cons of each option and at least narrow down your choices.

Being stuck with a house that you can't afford to sell is never fun, but careful consideration of all the aspects of the options can help you make the best choice for your specific situation, and reduce the cost and stress of whichever path you select.

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