With the U.S housing market still in trouble, more and more homeowners are having to become familiar with a term they’d never heard just five years ago: negative equity. Equity, as it pertains to mortgages, is the amount of the value of your house that exceeds the amount you owe on your mortgage. Negative equity is the value of your house below what you owe on it.
So, for example, if you owe $250,000 on your home but it’s only worth $200,000, you have $50,000 of negative equity. If you’re in this unenviable position, you’re not alone. According to real estate website Zillow, more than 28% of U.S homeowners are in a negative equity position because they owe more on their homes than those homes are worth.
Having negative equity makes it hard to sell your house because a potential buyer is very unlikely to make you an offer sufficient to cover your loan balance. And, even if they did make you a large enough offer to pay off your loan, their mortgage lender wouldn’t approve them for that amount because the appraisal results wouldn’t justify a large enough loan amount.
So, the question for those of us who are “underwater” in our homes is, how can I get out of this house? Fortunately, there are several options — some good and some horrible — for homeowners who are trying to get out of a bad mortgage loan. Here are six of those options and their impact on your credit:
1. Short sale
A short sale occurs when you sell your house for less than you owe your mortgage lender. Your mortgage lender is going to have to accept the lesser offer and if they do, you’ve “sold short.” In the aforementioned scenario, an offer of $200,000 would leave a $50,000 deficiency balance on the loan. That deficiency balance is often reported to the credit reporting agencies as being “charged off.” And, more commonly, the account is reported as being “settled for less than the full balance.” In either scenario, your credit score is likely to take a hit because both of those scenarios are considered derogatory by all credit scoring systems.
2. Strategic default
A strategic default occurs when a homeowner is still fully capable of making their monthly payment but simply chooses not to do so. Many homeowners are choosing to default because they realize they’re throwing good money after a bad mortgage and to them it’s simply a better business decision to stop paying despite being able to afford the payments. This is reported to the credit reporting agencies as a foreclosure, which is considered derogatory by all credit scoring systems.
3. Forfeiture or deed in lieu of foreclosure
Some people call this “jingle mail” because you’re essentially mailing your keys back to the lender and voluntarily moving out of the house. You avoid the process of judicial foreclosure and the embarrassment of the local sheriff evicting you in front of the entire neighborhood. This is reported to the credit reporting agencies as a forfeiture of your deed. And yes, it’s considered derogatory by credit scoring systems.
4. Buy and bail
The buy and bail occurs when you live in a house, apply for and qualify for a mortgage on a different house, close on the new loan, move to the new house… and then stop paying on your pre-existing loan. You’ve “bought” a new house and “bailed” on your old lender. This is an enticing, and arguably illegal, option for people who see similar homes in their same local area going for a fraction of what they paid for their existing house. The credit reporting of the previous home loan will be derogatory as it will undoubtedly identify that you defaulted on your loan. But, consumers realize that when you lock in a rate for 30 years or 15 years, the rate cannot change despite the negative change in your credit scores.
5. Loan modification
A loan modification occurs when your lender permanently or temporarily lowers the interest rate of your mortgage loan to a point where you can afford to make the monthly payment. There has been a lot of coverage of the President’s “HAMP” program, which is the government sponsored loan modification program. Prior to approving a loan modification, which is not a slam dunk, the lender will ask you to make trial payments, which are generally lower than your contractual payment amount.
A loan modification can damage your credit if the lender reports you as being delinquent each month during the trial payment period. If your loan was NOT delinquent going into the loan modification, then they’re not suppose to report you as delinquent during your trial payment period. However, if you were delinquent going into the loan modification then they are supposed to report you as delinquent even during the trial payment period.
6. Paying the deficiency out of pocket
The only truly clean way out of a bad mortgage would be to sell your home for as much as you can and then come up with any deficiency balance in cash at closing. This means the lender’s loan has been fully satisfied and will result in no negative credit reporting. Of course, you might have to come up with tens of thousands of dollars (if not more) just to save your credit rating. For many consumers, that price tag may be just too high.
Be sure to check out the Credit Sesame mortgage payment calculator and mortgage comparison calculator.