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How do I best address my interest only, deep underwater, timebomb of a mortgage mess?

My wife (then girlfriend) and I bought our home (3/1, 1008 sqft) in late 2006 for $435K, current value is maybe $260K on a good day. We did a 100% financing 5/1 ARM with IO option for 10 years on the first, purchase money HELOC second motgage to avoid PMI. At the time, it was just the two of us, we were both working good jobs, probably pulling in near $100K per year combined. We were a bit hesitant to do an IO option, but our broker sold us on it as a way to maintain flexibility in case of emergency, etc. We have never missed a payment, or been late on a payment. Unfortunately, we have also not really made much headway in paying on the principle. After 5 years, we still owe $433K. Our 5/1 is resetting in December.

Today, we are a single income family ($89K) and my wife stays at home with our 2 year old. It is very important to us that she takes care of our child, and anyway, she could maybe only net $200 or $300 per month after factoring in child care costs. We have still never missed a payment, but it is at the point now where we are right at the threshold of what we can afford. There are some months that we need to dip into savings to pay the mortgage. Our payments would go up with any refi into a conventional P+I loan, since we are making the IO payments right now. The very real possibility of maintaining this course for the next 5 years and then getting hit with the end of the IO period and $3,700+ per month mortgage costs is weighing heavily on us.

So what to do? We realize that we made a poor decision buying when we did, with the loan we did. Do we just stick it out and hope that in 5 years our house might be back to zero equity and try to refinance then? Do we take out another mortgage with the extra buying power we supposedly have (I'm told that we can qualify for $250K even with the existing mortgage), buy another and rent our current house? Do we try for a short sale even though we can afford the (interest only) payment? Play chicken with the bank and hope for a modification? We want to be proactive, because it is obvious to us that the situation is not sustainable in the long run. Our bank doesn't seem to care, because we pay. We really like our house, but we aren't willing to sacrifice our long-term financial stability for it.

What would you do in this situation´╗┐? Is there some option I am overlooking?

We are in southern California, if that matters.


How long before stories like this reach the UK?

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I think this guy has it right in the third paragraph. He can and should borrow more to buy (smartly this time) another place, rent out the original place, and sell in a few years when the market more favourable. Why would you sell any hard asset at a loss if you didn't need to?

I assume that's a joke.

If it's non-recourse, he should give the house back to the bank and go rent somewhere.

No way should he modify it and change it to a recourse mortgage.


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