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Shrinking net worth
Negative equity is rampant. We focus on one couple's predicament and solicit advice from three financial planners.
Growing your bottom line

What to do if you're upside down in your home

It doesn't seem like you're getting ahead if the values of both your home and portfolio are going backward.

The stock market has certainly tested the mettle of Americans in the last 15 months. Declining home values are even tougher to take. Some 16 percent of American households -- one out of six -- are underwater, according to Moody's economy.com. Among those who bought a home in the last five years, nearly a third (29 percent) owe more on their homes than they are worth, according to Zillow.com.

Having negative equity is like walking on a treadmill with an injured knee. You don't get anywhere, and it's painful. If you're lucky enough to be financially solvent, that puts you in the enviable position of being able to make the house payments, even though it feels like you're throwing hard-earned money into an abyss.

Below, we look at the predicament of a typical family. The "Smiths" are making payments on a house that lost one-third of its value over the past three years. We then ask three Certified Financial Planners for solutions, which they provide in their own words.

Negative equity options
Michael Kitces, CFP
Pinnacle Advisory Group
Columbia, Md.

Unfortunately, there really is no magical solution for this. The basic options available are relatively straightforward:

1. Reduce the asking price, and sell the condo for the best they can get. To the extent that the net proceeds after selling costs are less than the mortgage, they may need to make up the cost to the mortgage company by bringing additional cash to settlement. But at least this will get them out from under the current mortgage/property, and give them the capacity to purchase a new property. Of course, any payment they make to rectify the negative equity on the current condo would diminish the down payment they would have used for a new property!

2. Buy a new property, and try to rent the old one. Whether this is feasible or not will depend on a few factors, particularly whether it is even feasible to rent the current condo, and whether they can get enough rent to cover at least the mortgage, condo fees and other expenses of the property.

In addition, this is really only an option if John and Sandy have enough income to qualify for a loan to buy a new property (not to mention having enough for a down payment), while still maintaining the old mortgage. If this is an option, then once the equity balance is positive on the old condo, they can try to sell the property. Of course, it's worth noting there's a risk that waiting could just make the negative equity problem worse if the property declines further in value!

3. Stay in the current condo, and manage as best they can. This is obviously not the most desirable option, but it may be the best and the most economically feasible. At the end of the day, if John and Sandy cannot afford to pay off the negative equity balance (not to mention have a down payment for a new home, and qualify for a new loan in today's much more restrictive lending environment), then this is really the only option available. Of course, it's obviously not what John and Sandy want, but sometimes the best possible advice is for someone to just sit tight, keep making payments and saving, and wait for a better opportunity down the road.

I do NOT recommend for John and Sandy to simply try to abandon their current home to the lender since it's underwater. Doing so can destroy their credit rating, and may make it almost impossible to get a new loan for many years into the future. If they were to go down this road, it would virtually guarantee that they will not be able to get a new loan for a new larger home. It is hoped, it's not even a consideration, but with more stories arising of people trying to get out of their negative equity position by "just mailing the keys to the lender," I think it's worth noting that this is NOT a recommended course of action.

  What's your experience with investing?
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-- Posted: Oct. 27, 2008
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