Stop paying your mortgage immediately and sit in that house until you are absolutely forced to leave (this can take up to one year at this point). This is not a moral decision it is a business decision. Your credit will be ruined but it will improve over time. Do not wreck your future/retirement by holding on to a depreciating asset that will likely never recover its once highly overinflated value. Your credit score, house, "equity" are all based on the ego. These "things" have no bearing on your worth as a human being. They are only important because we want them to influence the way that others view us. Having piece of mind and actually being present with your family is much more important than a 780 FICO score. Have you ever heard anyone one his/her deathbed regret not having a high enough FICO score? In the end letting go of that albatross of a house may just allow you more clarity and freedom than you've ever known.

I work in the financial industry and the first thing I would tell Pete is to immediately cease taking loans/distributions from his 401K if at all possible. Walking away from a mortgage may seem like a bad decision, but it may end up benefiting him in the long-run, depending on his current situation. Bad credit can be repaired more quickly than you'd think, but dipping into your 401K can set you back many years in terms of your retirement planning. He might want to read this CNN Money article from June about the possibility of walking away from your mortgage: http://money.cnn.com/2011/06/07/real_estate/walk_away_mortgage/index.htm.

First of all, I don't think any of us are qualified to give advice about this dilemma. "Pete" should seek advice from a bankruptcy attorney IMMEDIATELY. With that said, it is impossible for any of us to know all the details. As bad as it may sound, a bankruptcy could be the best choice. If you skip your mortgage payments and default anyway, your credit is ruined but the lender could still come after you for a deficiency judgment. Also, the Debt Forgiveness Act expires 2012. If your foreclosure takes more than one year, then you will end up having to pay income tax on that debt. A Chapter 7 would discharge ALL debt so that should be the way to go. Your 401k can't be touched. If I were you, go see an attorney as soon as you can so you get this taken care of. This takes planning and you need your questions answered by a professional.

I think you need to talk to your lender about short selling your home. You think your house is priced right, but its probably not. Many homeowners difficulty realizing that. If you've reduced it twice, it is very unlikely you'll sell for your current asking price. I'd probably offer you 10-20k under the asking price as a buyer. That means not only will you probably walk away with nothing, you may even owe money on commissions, fees, etc.

Though, you haven't provided enough information for true advice. Are you young enough to give your 401k a chance to rebound? Do you and your spouse have advanced degrees or expect income to rebound once you land new jobs or do you expect your current incomes to stay the same? I wish you the best of luck. I'm currently in the housing market and one thing I've noticed is that houses priced right and in good shape are selling quickly. It does not appear your home is in that category. I would not rely on getting a full asking price offer.

Professional advice to weigh into your details and nuances is certainly in order, however, consider this:

If you miss even 3-4 months payments there will be very little marginal impact to your functional creditworthiness if you take it to a full foreclosure. A shortsale will hurt your credit just as a much as a foreclosure will.

Assuming that you will always need a place to live, if you're going to lose your credit over this, you might as well not lose your money too. Stay in payment free until they absolutely break your locks and evict you. The national average is running a year and a half from first missed payment to foreclosure completion. Contest the foreclosure with a "produce the note" defense, and you can stretch it beyond the average. You can delay the process even longer by renting your home, maybe even only part of it, who know's, it's uncharted law (http://weblogs.baltimoresun.com/business/realestate/blog/2011/03/staving_off_the_bank_by_renting.html)

I agree that professional input is needed here. Rather than dip into the 401k in the short-term, I'd (personally) be more inclined to use credit cards to tide me over for a while. If you've got good credit, you've probably got some credit cards with large credit limits. Sometimes they offer attractive 0% for a year balance transfer or "convenience check" offers to their best customers. True, this avenue does come with it's (potential) pitfalls, but might be useful in a pinch, depending upon your specifics. Again, consultation with a professional is best here. Good luck!

Bankruptcy DOES NOT GET RID OF ALL YOUR DEBT!!! Even on a chapter 7. There are debts that are not dischargeable and any lien that is on a property including any deliquent mortgage payments survive bankruptcy. If you do see bankruptcy, go to an attorney. And yes your 401K can be touched in bankruptcy, that is an incorrect statment Jack Daniels, it all depends on the assets in the bankruptcy and what the Trustee wants to do.

The credit card idea is a terrible one! UNLESS you think you are going to return to higher paying jobs VERY soon and you preference would be to keep this house and live in it for another decade.. Renting the house, if rent will cover PITI and repairs is an option. Check rents for comparable homes in your neighborhood on Craigslist. But since rents are on the high side, you will have to settle for small digs where YOU rent. This is definitely not the time to sell a house, especially as even in a good market little or nothing moves in the winter, whether rental or sale, frankly. But housing market is not going to turn around any time soon so a longer term solution than loading up credit cards is in order, I don't know enough about foreclosure or bankrupty to have anything to say on those options but don't be goaded into doing these either without doing a lot of homework first.

You're right that Ch 7's won't discharge everything, but most 401k's are off limits most of the time, and the mortgage debt (more accurately, the deficiency judgement, i.e. the amount the bank is short after selling the house) is dischargable as long as it's no longer secured. Translation, you can't discharge the debt but keep the house it's secured to, but once you surrender the house it's secured to, you can discharge the debt.

.OK I'm an attorney but this is NOT legal advice. I doubt anyone's ever been disciplined by the bar for a hypothetical answer to a message board question, but I just want to emphasize, you should probably get your own attorney before following anyone's answer. And this answer is merely what I would do in your shoes. That said, I guess you could take my background into consideration when you read this.

First off, I wouldn't be silly and keep paying the mortgage. You need to recognize that after all the taxes, fees, and commissions you're going to pay, plus probably price drops and/or cash to sellers at closing, you'd be VERY hard pressed to break even. In addition, you'd have moving and/or storage costs before you close. Do you own a big truck? Do you own tons of packing materials and have a lot of friends who can help you move big items? Probably not. Moving is time consuming... heck, just packing and unpacking is time consuming.Keep in mind, you are living in the house and haven't likely emptied it and depersonalized it fully. And if you're hard up for money, it's unlikely you house is perfectly maintained and updated. I would not believe your agent, your agent just wants to keep the listing.

Second, I'd use my 401k money to get a lawyer who handles situations like these. Stop payign the mortgage and use that money for the retainer. You need to know ALL your options, as they apply to you personally. Do not cheap out, a knowledgable and aggressive lawyer will net you thousands more dollars in the form of "cash for keys", mortgage modification, or at least some free time in the house by prolonging and fighting foreclosure.

Third, I'd empty my 401k and accept the penalties, whatever they are. If this ends up as a bankruptcy, you could possibly lose all of that money, or much of it, depending on the situation. (I'm using less strong wording than I'd use if you were a client, but it will be your attorney's job to talk sense into you on this issue.) Ostensibly, you're going to use the 401k money for household expenses--heck, you could even say its for utiliities, paying down bills, whatever.

Fourth, I'd probably taken an inventory of my overall situation and print out every bank balance, every account balance, every credit card balance, and also my most recent mortgage stub. Start to ask questions and consider all possible solutoins. Do not be afraid of either a chapter 7 or 13 bankruptcy. In my mind, I'd be thinking about ch 7, because I wouldn't place much value on staying in the house which is probably worth much less than a few yrs ago, with an outsized payment to match.

Lastly, I'd start reading books on living frugally, living with my means, living without debt, and post-bankruptcy living. Educate yourself. Don't be a pawn. If I were you, I'd look at whether I would be better off with or without the house and then try to make the logical decision, because owning up to the pain now would keep from throwing thousands away down the line.

Remember, the banks have lawyers working for them. If you are trusting a real estate agent on what to do in your situation... God help you.

If you can't afford an attorney, most of the local librarys offer Legal Help night once a week or once a month. You may need to sign up to get an appoitment, but they can help you get started on where to look and some other options.
The MD Bar associate puts out a Journal every month and in 2009 (can't remember the month) they did an article on Bankrutpcy that would be pretty helpful on life after bankrupcy if that is one of the possibilies you are looking for the future.