What do you do if you’re underwater on your investment property mortgage?
I have been there. Most likely, many who bought during the infamous real estate bubble have been there, too. In 2009, I thought the bubble had burst and prices dropped as much as they would. How wrong was I? I bought an investment property and quickly became underwater on it. I was drowning on that mortgage, and I didn’t know what to do. However, I had options, and so do you.
Let’s take a look at some baseline numbers to determine your best move.
Are you making a monthly profit?
The first thing you will want to do is look at the month-to-month profitability of the property. While a rental unit might not have equity, it might have profitability each month. To determine the profit you make each month, add up your mortgage, monthly taxes, monthly insurance premium, and anything else you pay. Then, subtract this number from the rental income you make on that property.
(monthly PITI, maintenance, 10% to reserves) – Rental income = Profit
Questions to ask yourself
1. Are you in the positive?
If so, hold out on selling. If you are making a profit, it makes sense to hold the mortgage and wait for the value to increase to build equity.
2. Are you breaking even?
If you are breaking even, it might be a good idea to hold the mortgage. Each year, you pay down the principal a bit more. Your rent check each month brings you closer and closer to the surface. Unless you truly don’t enjoy being a landlord, or it is more work than you can handle at this time in your life, keep it in your portfolio.
3. Are you in the negative?
Did your calculations show that you were in the negative? That doesn’t necessarily warrant selling. Can you foresee an eventual turnaround? Real estate historically increases in value as time goes by.
What if I have a negative cash flow/loss?
For my property that was underwater, I was making negative cash flow the entire time I owned it, but I could afford to cover that cost. I covered the negative cash flow for nine years, knowing that the market would turn around, and it did. Earlier this year, I sold it at a profit. While it didn’t make sense for me to hold it as a rental because my mortgage was too high to ever have a positive cash flow from rent, it did make sense to hold until I could sell for a profit. My renters helped me pay down my mortgage and I made a little money in the end.
Look at your scenario and ask yourself these questions:
- Can you afford a negative cash flow?
- Will your property ever regain its value?
- Do you have consistent renters that help pay down your mortgage balance?
If you answered “Yes” to these questions, it makes sense to hold the property. However, if you answered “No,” it might be time to look at your options.
Related: When to sell a rental property?
What are your options to sell an underwater property?
When you have an underwater property that you have decided to unload, you have three options:
1. Short sale
To sell a property with a short sale, the owner needs to negotiate with their lender to accept a lower payoff than the balance. An owner or their Realtor can call the lender and speak with the real estate short sale or work out department to begin the negotiation process. Once you have found a purchaser, the lender needs to approve the purchase price and might decline to pay certain added items such as inspections. After the lender approves the purchase price, you can request they do not report this to credit reporting agencies, and they may or may not comply with your wishes.
While no one wants to go through a foreclosure, sometimes choices are limited. When starting a foreclosure, the first step is defaulting on the loan. After 30 days, a lender sends a notice of default. This likely comes after they have reached out trying to change the loan payments to work with your financial situation. After 90 days of being in default, the owner gets a notice of sale. The last step is selling the property at auction.
3. Sell + pay loan balance
You can avoid short sales and foreclosures if you have cash on hand. The last option for homeowners is to sell the property for what it is worth and bring a certified cashier’s check to the closing for the shortfall. While it is not ideal to pay to get out of the mortgage, it keeps your credit intact.
Investment properties with underwater mortgages can make an owner feel helpless and stuck. However, there are options. In my situation, my property was underwater for about five years. I was losing money each month, but it was a manageable amount. I chose to wait it out, and eventually I sold for a profit. But each person’s financial situation is different. Look at yours to determine what the best move is for your lifestyle.