Recently, Ben asked a question on Trulia. I tried to answer it there, but the guidelines against spam prevented me from linking a couple relevant articles, so I'm reposting it here.
I have a 10 year interest only loan with 7 years left and no equity. I am current on my payments but the home is about $150,000 up side down.
I make 3 figures a year and have a 7 plus fico. I was recently denied a loan for a second home because of the status of my current home, and they think I will " Buy & Bail " The bank also countered and said I need to sell my current home to qualify. I also contacted my bank for assistence/guidence but there was'nt one thing they can do or advise. We need a bigger home, Should I sell my home short sale status?
This answer is going to go against the grain, but I'm in the area and know exactly what you're struggling with. I could rent a house that is new and twice the square footage for what my mortgage payment is in the High Desert.
The first thing to remember is that CA is a non-recourse state. The only thing the bank can do is hurt your credit and foreclose. They can not go against your other assets. If the loan on the house was not used to take money/equity out of the house, and is the purchase money loan, there is a form to fill out so that you do not pay taxes on the banks loss on the loan.
As you have not paid any principal down, I would advise you to think of all the money spent as rent (that has been an interest deduction--call it a rebate on the rent). I don't believe prices are going up in the next 3 years. In fact, the there are a lot of reasons to believe the government is propping up the housing market, and the Association of Realtors spent a lot of money keeping the tax credit going.
If you need a bigger house, and the above applies to you as far as your loan goes, WALK AWAY FROM YOUR HOUSE. Possibly ask your lend for a "cash for keys" deal, where you give them a "deed-in-lieu" of foreclosure and they pay you a small amount to move. It will help you get your credit back faster.
Read these two articles( refer to my blog, Trulia won't allow me to post the links here--The articles are HERE & HERE), and portions of my blog that refer to reasons why the housing market is going to be stale. Don't worry about your credit score. A credit score is good for acquiring debt.
There are a lot of larger houses in our area that you can rent for $1500/month. You also won't have to deal with maintenance. There are even some rent-to-owns, but most RTO's and lease-options require you to assume all duties of an owner.
In two or three years, you'll qualify for a loan again. And prices are likely to be at or near the same levels UNLESS our country's economic policies end up in currency devaluation ala Venezuela or Zimbabwe in which case we all have bigger problems than home ownership.
Ben, If you've come here, do some research on "recourse vs. non-recourse states" and talk to your accountant to see where your mortgage falls as far as tax liability.
1 year ago