Underwater Mortgage: What To Do

What is an underwater mortgage?

Being underwater or upside down on your mortgage means you owe more than the current value. That is: The asset is worth less than the amount you borrowed to buy it, or the amount of the debt you still have to repay.

If you buy a house when prices are high and the real estate market then retreats, your home’s value can depreciate, or shrink. As a result, you could wind up with a mortgage balance that outstrips that value. When that happens, you’re considered underwater on your mortgage. It’s also known as having negative equity.

For example, say Jane bought her home for $300,000, made a $30,000 down payment and borrowed $270,000. Two years later, a recession hits her city and Jane becomes unemployed, but has an excellent job opportunity in another state. She needs to sell her house and move, but she learns that home values in her area have declined and her house now has a market value of $250,000 — and, she still owes $258,400 on her mortgage. She is now underwater, or upside-down, on the mortgage.

How does an underwater mortgage happen?

An underwater mortgage can happen in any of the following situations:

• During times of economic downturns: Underwater mortgages usually occur during an economic downturn when home values fall. For example, during the 2007-8 subprime mortgage crisis, many borrowers ended up owing much more than their homes were worth.
• Selling a home soon after buying with a low down payment: Buying a home with little or no money down can leave homeowners upside-down if they try to sell soon after purchasing.
• Taking out a second mortgage: If you take out a second mortgage that depletes most or all of your ownership stake, it can also cause an underwater mortgage.

Housing values can also decrease due to rising interest rates, high numbers of foreclosures or natural disasters.

Signs that your mortgage is underwater

Keep an eye out for these signs that might indicate you’re underwater on your mortgage or at risk of it:

• Home values are dropping in your area. If property values for similar homes nearby are decreasing, your home’s value might be lower than what you owe.
• Your home appraisal comes in low. You can use a home value estimator tool to get a ballpark idea, but to know for certain, get a home appraisal. Once you know the value, you can use your mortgage statements to determine whether your loan is upside-down.
• You’re struggling to keep up with mortgage payments. Falling behind on your payments can be a sign of deeper financial trouble, especially if your home’s value has fallen and refinancing isn’t possible.

Why an underwater mortgage can be risky

While the idea of being underwater on your mortgage sounds scary, if you’re planning to stay in your home, it doesn’t have to impact your day-to-day life. Over time, you can right-size your situation by keeping up with your payments, paying down some of the principal, or waiting for your home’s value to rise. 

Still, there are some times when a homeowner should be concerned about being upside down on their mortgage. These times of risk include:

• Refinancing: It can be difficult to refi an upside-down mortgage. Most lenders won’t let you refinance if you don’t have enough equity, as it increases their risk. If you do qualify, you most likely will face higher rates or stricter terms.
• Selling: Trying to sell your home if you’re underwater can put you at risk of needing to pay the difference if you can’t make enough from the sale to cover your mortgage balance. Alternatively, you’ll need to apply for a short sale with your lender, in which the bank agrees to accept less than the total remaining mortgage balance out of the sale proceeds.
• Losing the home: When a home is underwater, you are at a higher risk of foreclosure if the payments become too much for you.

What to do if you’re underwater on your mortgage

If you find yourself underwater on your mortgage, you’ve got several options to consider.

1. Stay in the home and build equity

In an upside-down mortgage situation, you can choose to stay in your home and continue to make payments to reduce the principal balance on the loan. Over time, potential home price appreciation can also help you restore some or all of your lost equity. 

2. Explore new financing

You have fewer refinancing options if your loan is underwater, but you might not be totally out of luck. Talk to some mortgage refinancing lenders to see what, if anything, you can do to refi your upside-down mortgage. If your original loan is an FHA loan, you might be able to qualify for an FHA streamline refinance.

Unfortunately, Home Affordable Refinancing Program (HARP) loans were sunset in 2018, and Fannie Mae’s High Loan-to-Value (LTV) program has been suspended.

3. Consider a short sale

In a short sale, the lender must agree to accept less than the amount owed on the mortgage. Lenders will only consider a short sale as a final option before foreclosure. Be warned, however, that this type of transaction typically will stick to your credit report for up to seven years.

4. Walk away from your mortgage

Another option is to simply walk away from your mortgage — a move called a “strategic default” — but, like a short sale or foreclosure, doing so can be damaging to your future homeownership prospects and credit score. In short, this option also puts you in a precarious financial situation. If you walk away, your lender could even hold you liable for repaying the debt. Because of the long-term legal and financial consequences, this should only be used as a last resort. 

5. Let the lender foreclose

Finally, you could let your lender begin the foreclosure process on your home. Once this process is complete, the lender regains the home from the homeowner, who walks away from the property with their debt wiped clean but with a damaged credit score. Many people in foreclosure also file for bankruptcy to eliminate other debts.

There are long-lasting repercussions if you go the bankruptcy or foreclosure route. A bankruptcy and foreclosure can stay on your credit report for 10 years, and, like the other options, limit your ability to buy another home for several years.

6. Ask about a loan modification

If you’re struggling to keep up with your mortgage payments, a loan modification could give you underwater loan relief. 

A loan modification changes the terms of your existing mortgage, often by lowering the interest rate or your payments. But unlike with refinancing, a modification keeps your original loan in place rather than replacing it with a new mortgage.

7. Consider a deed-in-lieu of foreclosure

A deed-in-lieu of foreclosure allows you to give back ownership of the property to the lender instead of going through the foreclosure process. 

This could be an option if you can no longer afford the home, you can’t sell it, or you don’t qualify for other relief options.

A deed-in-lieu can sometimes be less damaging than foreclosure, but it will still affect your credit and future ability to borrow money.

Underwater mortgage frequently asked questions

• How can I avoid an underwater mortgage?
  

  You can help avoid an underwater mortgage by paying close or as close to the home’s appraised value as possible, and by making a higher down payment so you don’t have to take out as big of a loan. You should also plan to buy a home that you intend to stay in for several years. Sometimes, mortgages become underwater due to a widespread decline in property values, which you can’t prevent or avoid.

• Will an underwater mortgage affect my credit score?
  

  No, simply being underwater on your mortgage won’t impact your credit score. However, if you walk away from the loan (that is, stop paying), short-sell or accept foreclosure, your credit score will take a major hit.

• How long does it take to recover from an underwater mortgage?
  

  If you decide to stay in your home, you might have to wait anywhere from a few months to many years for the market to improve. If the underwater mortgage eventually leads to foreclosure, those negative marks on your credit report can last for up to 10 years. (A short sale also hurts your credit, but not as much as a foreclosure does.)

• How do you get out of an underwater mortgage?
  

  Getting out of an underwater mortgage may depend on how far the underwater mortgage is. Some homeowners may refinance or choose to continue making payments and wait for home values to recover. In more serious cases, homeowners may sell the home in a short sale or negotiate with the lender to avoid foreclosure.

• Can you refinance an underwater mortgage?
  

  Yes, sometimes you can refinance an underwater mortgage, but it can be tougher than refinancing a traditional loan. Some lenders may still approve refinancing if you have a strong payment history and stable income. Government-backed FHA and VA programs may also have loan options for borrowers with underwater mortgages.