What to Do if You're in Too Deep
by Carla Fried

April 13, 2007

Feeling stretched by housing costs? Then it's time to give yourself a helping hand.

Bo and Ana Apostolache loved their three bedroom home on a cul-de-sac near Irvine, Calif. when they bought it six years ago. Best of all, they could easily cover the $1,400 monthly payments on their $175,000 mortgage. Over the next few years, as interest rates dropped and their home price tripled in value, the couple refinanced several times and tapped $200,000 worth of equity to pay for home improvements—and a Barbados vacation. By 2005, although they had doubled their loan balance, their payments had increased by only $400 a month, thanks to an interest-only adjustable-rate mortgage with an initial rate of just 3.75%. "It worked fine at first," says Bo. Until it didn't. A year later, their rate adjusted up, adding another $400 in monthly payments, and Bo lost his job as a mortgage broker. Out of desperation, the Apostolaches took a $200,000 home-equity line of credit, in part to help cover the payments, but then quickly realized they were in over their heads. "Borrowing that much was the biggest mistake of my life," Bo admits. "I guess I just got caught up in the real estate frenzy."

The Apostolaches' situation may be extreme, but they certainly aren't the only ones who went a little crazy during the recent real estate boom. Convinced that prices would continue to rise indefinitely, people felt free to supersize their homes; the median size of an American home has increased 16% in the past decade, to 2,227 square feet. Bigger homes, of course, come with higher property tax bills, and they cost more to wire and keep heated and cooled. Meanwhile, lenders churned out new types of loans with low initial payments and, as the real estate market spiraled to new heights over the past few years, loosened borrowing restrictions. Traditionally, lenders had refused borrowers whose debt obligations exceeded 36% of their gross monthly income; during the boom, many lenders accepted debt-to-income ratios of 50% or more, says Don Sprague, a financial planner and mortgage broker in Boulder: "There's a big difference between how much a lender can qualify you for and how much you can actually afford."

Stretching the limits of affordability wasn't a problem when interest rates were plummeting and home prices were zooming. Then, homeowners who had trouble making payments could easily refinance or unload their home for a big profit. That's no longer the case. Recently lenders have begun tightening their standards, and if your home hasn't appreciated, you may not be able to refinance easily. In the meantime, many borrowers who took a short-term low-rate loan or home-equity line of credit a few years ago have seen their payments shoot up by hundreds of dollars a month. And another $1.5 trillion in mortgage debt is up for readjustment this year, according to the Mortgage Bankers Association.

For some, the new realities of the housing market are tough to swallow. When a job opportunity led Kristen and Darren Boucher to uproot from Las Vegas to Des Moines last year, they held on to their former home out of a hope that the formerly sizzling Vegas market would quickly bounce back. But the couple have been unable to find renters to cover the costs and now spend almost a thousand dollars a month to make up the shortfall. They're starting to dig into savings, and Kristen has suspended her Roth IRA contributions. Still, she's optimistic. "My husband is ready to move on, but I am having a hard time letting go," Kristen says.

If you're among the many homeowners now straining under the weight of a too big housing payment, you're not doing yourself any favors by ignoring the problem. "If you are shortchanging other goals, such as saving for retirement, that's a sign it might be time to rethink what you are doing," says Bobbie Munroe, a financial planner in Atlanta. Instead, try the following strategies to avoid having your home wreck your finances.

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