Sonali Sells

Q: We own a second home within five miles of our primary residence. This second home has been used as a rental, initially to persons we were not connected with in any way. For the past 10 years, two sets of relatives who were in need of a new start in life lived in the home. Each set of relatives lived there at different times. The current set has been there five years. The rental contract is for fair market value, though much less than the mortgage. Obviously, we have been paying the difference at a loss.

A few years back we obtained an interest-only loan on the home (prior to the current relatives moving in). We had the intent of selling the home within a couple of years. Now, the market is where it is. We are extremely upside down in the value of the home with no equity whatsoever. Financially, we are able to make the payment, but both my husband and I feel that we are just throwing money away each month. We would like to know what our options could be regarding this home.

We have heard from our tax person that if a short sale is done we could have a huge tax burden, which we cannot afford at this point in our lives (my husband is retired). We have excellent credit but feel that it would be extremely difficult to get a new loan because of the value and the fact that I am not working at this time. We have actually considered moving into the home ourselves and living in it for the required number of years and then selling it, but we are unsure how this would be beneficial.

A: There are several options available. But under no circumstances should you decide to walk away from the house; that’s merely burying your head in the sand and will have serious financial consequences for you.

Deed in lieu: Some lenders will allow you to give them the deed. This is “in lieu” of foreclosure. It will impact on your credit, but not as much as some of the other options below.

Short sale: This is an option whereby the house will be sold for less than the outstanding mortgage. Discuss this with your lender; sometimes you may not have to pay the entire difference between the sale price and the mortgage balance. However, this will impact your credit rating. Your tax adviser is correct. Because this is not your principal residence, you will have to pay income tax on the canceled debt. I call it “phantom income.”

Bankruptcy: You must discuss the pros and cons with an experienced bankruptcy attorney. However, filing for bankruptcy relief will not impact your credit as much as allowing the property to be foreclosed on.

Foreclosure: This is the absolute last resort.

Before you proceed along any of these paths, contact your lender and discuss your situation. It is often difficult to find a person with authority, but you should try as best you can. You may be able to work out some arrangement with the lender such as a lower interest rate, a loan modification, or a moratorium on making payments for several months.