Dumping an Underwater Home Without Doing a Short Sale
Alternative Ways to Sell a Home with Negative Equity
Not every seller qualifies for a short sale, and not every underwater home is a strong candidate for one. A short sale is an agreement with a lender to sell a home for less than the amount still owed on the mortgage. A lender might agree to a short sale under certain conditions, including financial difficulties forcing the homeowner to sell, a depressed housing market keeping the market value below the amount owed, and a small enough difference between market value and amount owed that foreclosure actually would cost the lender more money.
Laws surrounding short sales vary by state. For example, some states require lenders to forgive any remaining balance after a short sale, while others allow lenders to still collect that money. Anyone considering a short sale should familiarize themselves with their own state's laws and seek legal and financial counsel.
A Real-World Example
Maria bought a home in Sacramento in 2005 and put down more than $100,000 in cash. She made a few minor improvements and updated the kitchen. Due to a declining market and climbing interest rates, she can't sell her home for the amount she owes, but she probably does not qualify for a short sale.
First, she has no financial hardship. She just has a home with negative equity. Second, short sales affect credit, and Maria doesn't want her credit rating to be affected or her FICO scores to fall. Third, she wants to buy another home. She feels her neighborhood has deteriorated over the years and she no longer feels safe there. One option might be a strategic short sale.
Strategic Short Sales
A strategic short sale is a short sale without a hardship. It's planned, calculated, and approved by a short sale bank, sometimes in exchange for a big cash incentive paid to the bank by the seller, but that is rare to see. However, a strategic short sale still might be an alternative for selling an underwater home like Maria's.
If she rents out her home, she would receive about $1,500 a month, significantly less than her mortgage payment, taxes, insurance that amount to $2,200 per month. Not counting vacancy factors, maintenance, or unexpected repairs, Maria would pay $700 a month to support her underwater home as a rental. Over 10 years, that's $84,000. So, if Maria offers anything less than $84,000 to the bank to release her from her loan and the bank accepts that offer, Maria could be ahead of the game.
Deed-in-Lieu of Foreclosure
Another option for Maria is to transfer the title to the property to the lender through a deed-in-lieu of foreclosure. In this case, the homeowner agrees to give up the home to the lender prior to the beginning of foreclosure proceedings, and the lender forgives the remaining balance on the mortgage.
This gets homeowners out of a negative situation more quickly, and lenders can avoid the cost and time necessary to foreclose on a home and evict anyone living there.
Exchange of Security
Maria or homeowners in similar situations also can consider an exchange of security, which essentially using the equity in a seond property to make up the difference on the underwater property.
This works only if a homeowner owns other property free and clear. The bank might agree to swap the security for the mortgage from the underwater home to the home without a mortgage. By switching out the security for the loan, the homeowner might be able to sell the underwater home at a reasonable price without a loan in place. The homeowner then can use the proceeds from that sale to pay down as much of the mortgage as possible. This is an appealing option if the debt that remains is less than the value of the property that previously was owned outright.