Underwater mortgage relief? Or just bail?

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Dear Dr. Don,
I will be 62 in February. I have gone through two divorces. My current home has an underwater mortgage. I owe $540,000 on it, and it’s worth about $450,000. I am working with my lender to get relief. I have approximately $150,000 in my 401(k) plan and more than $300,000 in a defined benefit plan from my consulting days. I am currently employed, making about $100,000 per year.

My question is: Would my lender provide any mortgage relief for my home because mortgage rates are low? I may rent out the home. If I can’t get any relief, I may walk out or do a short sale. Should I retire, take the $150,000 out of the 401(k), and invest in a condo for my retirement days so I don’t have a mortgage payment?

Thank you,
— Ahmed Aspires

Dear Ahmed,
While I encourage people to take a look at the big picture, and not just one aspect of their finances, you’ve put too many variables into the mix. While the divorces couldn’t have helped your finances, you should know what your financial obligations are to your ex-wives and children through what was established in the divorce decrees.

How does your mortgage financing impact your decision to retire? If you enjoy your work and you’re making six figures, why do you want that to stop? You have a little more than four years until you reach full retirement age for Social Security at age 66. Don’t retire early and file for reduced benefits at age 62 unless you have some pressing health issues that you didn’t mention in your letter.

Don’t raid your retirement accounts to buy a condo. While being mortgage-free in retirement is a sound financial goal, breaking open the retirement nest egg to do so isn’t likely to be your best move. You’ve spent your entire working career building this account, so don’t empty it in one fell swoop. You want to preserve a measure of financial flexibility with your retirement savings, not put it all into the purchase of a home.

As for your underwater mortgage, I’m conflicted when it comes to decisions about whether to walk away from a home. The price you pay in terms of damaged credit scores will stay with you for a long time: seven years. The lender may have recourse against you depending on where you live.

A short sale may limit the credit problems, but there’s a risk of damaged credit with a short sale, too, depending on how the lender reports it to the credit bureaus. But any cancellation of debt on a principal residence through 2012 should be free of federal income taxes, up to $2 million in principal residence acquisition debt.

If you can’t get the relief you need from your underwater mortgage and you can’t make the home work as your primary residence or a rental, don’t go down the short sale or tactical default path without discussing your situation with a real estate attorney.

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