Investing or gambling?

[Chris Drury]

Looking for a "sanity check" from the expert community.

Wife and I purchased a home in 2005 for $360k with one of those wonderful 80/20 interest only heloc deals and I am paying about $1300 per month (3.25%) plus taxes/insurance. 5/1 ARM

Bubble burst and now property is worth about $270k and slowly recovering.

2011 3rd baby came and needed more space so I found a great place nearby and locked in 30yr 4.25% fixed and moved in. I figured that if the rates rose I would at least be able to keep my new house.

I have looked at bank for options for refinancing my old house (now a rental) but the lenders don't offer any harp programs for HELOC loans. Plus it is no longer primary residence. Since I can't lock in the rate I am basically sitting in a ticking time bomb and am at mercy of rate increase. No one will refinance an underwater property.

Only good side is that I am clearing about $500 per month in rental profit (when things don't break) since I am only paying interest. I have been using that to pay off my car loans and student loans and make extra payments on my new house.

I have been speaking with advisors and have been told not bother trying to pay down the rental house principal since I would be "throwing good money after bad". 2 options:

1. Short sale or foreclose the rental in preparation for a rate increase. Seems like that would destroy my perfect credit and I would lose out on my potential rental profits. I am also worried about deficiency judgements. Seems stupid to me.

2. Continue to ride this out and see if the housing values recover before the interest rates jump. Continue paying off my other debts and leaving this "bad debt" for last.

I am betting on #2 and looking at opportunities to add additional rental properties that I can tap into equity or at least "dollar cost average" my portfolio. (3 or 4 winners to offset the one loser)

Any thoughts from the experienced community? Are there any programs or suggestions I am missing out on?

Btw I am really enjoying the rental process. I have a great team of folks for repairs when needed and found that our local area has a strong rental market.

Thanks in advance.