Well, in my humble opinion, we’ve seen the worst of falling values, and home appreciation nationally has been almost robust lately. That would point towards perhaps keeping the home. 25K to close would equate to 125 months (over 10 years!) of $200/mn losses, even without any home appreciation between now and whenever you sell. You would also be giving up any future investment income on the money you bring to closing. One option might be to retain a management company to oversee the rental. While they would take a portion of the rent, at least you wouldn’t have to deal with collection and maintenance remotely. Also possible they might be able to rent the home for more than you’re expecting (possible, not probable), which would further help financially. You ultimately will need to weigh the pros of selling (finality, lack of monthly red ink, etc) versus the cons (loss of potential appreciation, putting out large sum to sell) to make your decision. One other item you may want to mull over if your time frame for buying a future home. While rental income can offset much of the cost of the mortgage on an investment property, you likely will still have at least a paper loss, which could make qualifying for a future home loan more challenging. Lots to consider, hope this at least helps some!
Your best bet sound like it would be to keep the house, as Ted mentioned, seems like the worst of the housing crisis is behind us. Having said that, there are some areas of the country that are still struggling, you did not mention what area you are in so hopefully is not a chronically depressed area. What I wanted to mention is that if you are in the military, and have that ARM, you may want to talk to your lender about a loan modification. Military personnel get special perks and if you can get a fixed rate, you will sleep better at night, even if you are worried about being a landlord. By the way, you can hire a property manager to handle that part for you. Most people hear horror stories about being a landlord, that happens to people who have no clue how to screen tenants and end up renting to deadbeats. An experienced property manager can smell these people a mile away and keep them from giving you grief. Shop around for a good property manager, find one with lots of experience. Fees are not that high, usually about 6-10% of the yearly lease amount.. very well worth it. A bad tenant experience can cost you thousands of dollars, an experienced property manger can help you avoid that pitfall. Best of luck.
First, I would recommend renting at a slight loss than selling at a huge loss. Property values are rising and you will soon be able to sell.
Second, I would refinance immediately. A 2% cap on the ARM may seem small until you see how it affects the payment. A 30 year mortgage on $205K at 3.5% is $920.54 where as the same loan at 5.5% jumps the payment to $1,164.
There are very attractive VA loans which are designed for the military. They can even help with underwater loans. Additionally, there are several loan modification programs designed to help underwater homes. Check with some banks and see what they have to offer.