Continuing declines in the housing market in some parts of the country have left many homes still “underwater” across America. While these homes may not be physically floating in water, their owners no doubt feel like they are drowning in debt. One reader writes:
My first mortgage is paid. I took out a line of credit on this house for $81,700 in 2007. I am 72 years old and retired. I have since moved out of state. I would like to sell this house, but the homes in this area are only selling for $40,000 – $45,000. I cannot afford to pay the difference. What are my choices?
I am sure you are well aware that you are not the only person in this situation! It’s unfortunately quite common. According to CoreLogic, just over 11 million homes — about one in five homes with a mortgage — are in negative equity, meaning mortgage balances are greater than the value of the home.
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First, it’s important to realize that when you paid off your first mortgage, the lender that holds the home equity loan moved into first lien position. So even though this loan may have originally been taken out as a second mortgage, it is no longer a second mortgage. The reason that is important is that sometimes when a homeowner is underwater on both a first and second mortgage, the second lienholder is more willing to negotiate because it knows that in order to foreclose it has to pay off the first mortgage. That doesn’t sound like it’s the case here.
One thing you need to do before you can make a decision about this house is to meet with a tax advisor with experience in issues related to 1099-Cs. If you are able to get out from under this loan without paying the full balance, the IRS will consider any cancelled debt taxable income. You’ll owe taxes on it unless you can show that you qualify for an exception or exclusion, such as the insolvency exclusion, or the Mortgage Debt Forgiveness Relief Act (which is currently slated to expire at the end of 2012 unless Congress extends it). This is vitally important because you don’t want to end up in a situation where you owe the IRS a big tax bill you can’t pay.
[Related Article: A Slew of Tax Tips to Clean Up Your 1099-C Mess]
With that information in mind, you can consider:
A short sale. This is a sale of your home in which the lender allows you to sell the home for less than what you owe. If you are able to sell your home this way you want to get an attorney to look over the agreement to make sure you aren’t on the hook for any deficiency balance.
Walking away and letting the home go into foreclosure. This can be risky because the lender may decide to sue for any balance left after the home is eventually sold. But it is a popular option in some cases.
Filing for bankruptcy. This may allow you to put this home behind you and avoid taxes on any cancelled debt. An attorney can help you figure out the pros and cons of this approach.
[Learn More Here: Underwater On Your Home: Your Six Options]
You may have some tough decisions to make here, but getting advice from experienced professionals who are helping other homeowners in similar situations should help you decide which approach is right for you.