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'Upside Down' Home Sellers Owe More Than They Get

A nontraditional mortgage and a prepayment penalty mean Kimberly Pexton and her husband will owe $28,000 at closing.
A nontraditional mortgage and a prepayment penalty mean Kimberly Pexton and her husband will owe $28,000 at closing. (By Kevin Clark -- The Washington Post)

"The weight of the world is off my shoulders," she said. "Now I am able to move and relocate my life fully."

For Randy Morrow, however, the fallout from a bad investment will haunt him for years.

Morrow, a real estate agent for Keller Williams Realty in Arlington, bought a one-bedroom condo in February 2006 for $280,000. He intended to fix it up and sell it. But the repairs he needed to make were more extensive than he thought they would be.

For almost a year, Morrow paid the nearly $4,000-a-month mortgage on the Arlington house he lives in and $2,300 for the condo.

"The market at the time wasn't showing that it was going to get a lot stronger, so I decided it was best to take a loss and get out from under it," he said.

He sold the condo for $265,000. After paying a 3 percent commission to the buyer's agent, a loan prepayment penalty of $8,000 and other closing costs, he ended up owing the bank $33,000, which he did not have. He managed to persuade the bank to let him make monthly payments of $1,000.

Real estate agents point out another harsh reality in today's market: You don't even have to sell your property for less than you paid for it to end up upside down on your mortgage.

Kimberly Pexton and her husband bought a house in Fairfax County for $687,000 in June 2004. After deciding to separate, they agreed to sell it for $700,000. They had a mortgage that allowed them to choose how much they paid each month, adding the unpaid amount to their debt. Two days before the closing, scheduled for today, they discovered that they had a prepayment penalty of 2 percent of the price of the home. They will have to take about $28,000 to the table.

"It's the closing costs and commissions and all the other things you end up having to pay that tilts the scale," she said.

So far, lenders have been slow to come up with options to help sellers. "In the beginning, you couldn't even talk to them. Now the banks are talking," said Wilson, the Purcellville real estate agent.

Still, many banks are not willing to set up payment plans. Instead, they will force sellers to tap into other assets, such as retirement savings or cars. And if the lenders do forgive the debt, the Internal Revenue Service will consider it taxable income. On Wednesday, Reps. Robert E. Andrews (D-N.J.) and Ron Lewis (R-Ky.) introduced a bill that would make such a forgiven debt non-taxable.

"Who would you rather have coming after you, the lender or the IRS?" said Jerry Boutcher, chief executive of Monarch Title, a settlement company in McLean. "It's very complicated, and the consequences to the seller are very grave."

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