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How to refinance an underwater mortgage

Two-story home inundated by floodwater.
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Two-story home inundated by floodwater.
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If you owe more on your mortgage than your home is worth, you have what’s known as an underwater or upside-down mortgage. Mortgage loans can become underwater when property values fall.

This situation was commonplace during the Great Recession from 2007 to 2009. That’s when home values nosedived and continued to fall long after the recession’s end. Many homeowners with purchase or refinance loans that originated before the housing crisis ended up underwater after the crash.

Underwater mortgages can make it challenging to sell or refinance your property. Fortunately, you have options. Let’s take a closer look at what underwater mortgages are, how to know if you have one, and options for refinancing underwater mortgages.

How to refinance an underwater mortgage

What if you try to refinance the mortgage for a fresh start? Doing so can be tricky when you don’t have home equity. Banks generally require borrowers to have some skin in the game to get a home loan.

“Banks typically want to secure their interest with some amount of home equity, so it’s typically not possible to refi an underwater mortgage. However, renegotiating terms on the existing loan may be an option,” says Peter Palion, a certified financial planner in East Norwich, New York.

The first step when you have an underwater mortgage is to contact your lender to explore your options.

Step 1. Confirm your mortgage is underwater

Determining if your mortgage is underwater is simply a matter of identifying the amount you owe on your mortgage and comparing it to your property’s market value.

Determine how much you owe

Refer to your most recent mortgage statement to find your outstanding principal balance. If you need the most up-to-date information, call your loan servicer and ask for your loan payoff amount. The payoff amount includes the interest and fees that have accumulated since your last statement.

Know your home’s value

Once you know your mortgage payoff amount, you’ll want to determine the fair market value of your home. You can get a ballpark figure using real estate marketplace sites and comparing home values of similar homes sold in your neighborhood. However, getting an appraisal from a licensed home appraiser may deliver your most accurate value estimation.

Calculate your equity

A little math can help you confirm if you have an underwater mortgage. Determine your equity by subtracting your home’s balance from its value. For example, if your home is worth $300,000 and you owe $325,000, then your equity is -$25,000 ($300,000-$325,000=-$25,000). In this example, your mortgage is $25,000 underwater.

Step 2. Contact your lender

Call your lender as soon as you know your mortgage is underwater. Don’t procrastinate, even if you feel overwhelmed or uncertain. It’s best to let your lender know your situation and try to work out a reasonable plan.

Step 3. Learn your options

Will anyone refinance an underwater mortgage? You may be surprised to know that some refinancing opportunities exist for qualified borrowers. Here are a few options to consider:

Fannie Mae High LTV Refinance

There are some special programs available that offer assistance for certain homeowners with an underwater mortgage or who are having difficulty making payments.

If your mortgage is owned by Fannie Mae, you may be eligible for a High Loan-To-Value Refinance, or High LTV Refinance, which helps borrowers who don’t qualify for a standard refinance. Through this program, you may be able to reduce your monthly payment, lower your interest rate, get a shorter amortization term or move to a more stable mortgage, such as a fixed-rate mortgage.

  • Requirements include:
  • Your loan is owned by Fannie Mae.
  • You’ve had the mortgage for at least 15 months.
  • You are current with your payments.
  • You have not previously refinanced through Fannie Mae DU Refi Plus.

You can use the High LTV Refinance option more than once, as long as all the requirements are met.

Freddie Mac Enhanced Relief Refinance

If you’re not eligible for a standard mortgage refinance, whether due to low home equity or other reasons, the Freddie Mac Enhanced Relief Refinance may work for you. Check with your lender to find out if Freddie Mac owns your loan. If so, you may be eligible for the program, which can reduce your interest rate or change your loan structure.

Requirements include:

  • Your loan is owned by Freddie Mac.
  • You have not missed a mortgage payment in the past 12 months.
  • Your current loan must be seasoned for at least six months.
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Fannie Mae and Freddie Mac have paused the above refinancing programs until further notice.

FHA Streamline Refinance

If you already have a Federal Housing Administration  (FHA) loan, an FHA Streamline refinance may make sense . “Streamline” refers to the limited documentation and underwriting done by the lender. In fact, FHA Streamline refinances don’t require a home appraisal, making it easier for homeowners to refinance underwater mortgages.

Requirements include:

  • You must have an FHA mortgage.
  • The mortgage you wish to finance must be current.
  • You can now take out more than $500 cash using the streamline refinance process.

USDA Streamline Assist Refinance

The United States Department of Agriculture (USDA) offers a Streamline Assist Refinance that may be a good option for refinancing when you’re underwater. If you’re a current USDA direct or guaranteed home loan borrower, you may qualify for a refinance loan with:

  • Low or no equity
  • No home appraisal or inspection (unless you’re a direct borrower who received a subsidy during your loan term)
  • No credit review
  • No debt ratio evaluations.

Not all mortgage lenders offer USDA loans, so be prepared to shop around to find a suitable lender with the best interest rates.

Requirements include:

  • Must have a current USDA direct or guaranteed.
  • Must be current on loan for 12 months prior before refinancing.
  • Income must not exceed the adjusted annual income cap for your county or metropolitan statistical area.

If you can refinance, should you?

Refinancing an underwater mortgage is one strategy, but it is not the only one. You can also try to wait it out if you don’t want to move and believe your property value will eventually recover.

If you want to stay in your home long term and can afford the mortgage payments, you can choose to sit tight even though your mortgage is underwater. Over time, the property may regain some or all of its past value.

Meanwhile, analyze the reasons for your home’s drop in market value. If it’s due to an economic downturn, the low value may be temporary and you can wait it out.

“But it could be permanent if there have been changes in your local government, property taxes, school district, nearby construction, and any other factors that can impact the housing market,” says Niv Persaud, founder and managing director of Transition Planning & Guidance, LLC.

If that’s the case, you may need to figure out how to part ways with your home.

What to do if you can’t refinance

Short sale

You can attempt to sell your home on the market and persuade the lender to accept whatever price it fetches, even if it is less than the balance you owe on the mortgage. This is called a short sale, and cannot be done without lender approval. This can take many months and requires lots of paperwork.

A short sale may be suitable if the only other option is waiting for the bank to foreclose on your home.

Walk away

Some homeowners with underwater mortgages choose to “strategically default” and walk away from their unmanageable debt, forfeiting the home. This is far from ideal, but many homeowners did so during the Great Recession. Consider this option very carefully before proceeding.

Pay down your mortgage balance

If you’re looking to rise above water, paying down your mortgage may be the most straightforward route. Of course, allotting extra money to your mortgage may not be within the budget for many people. But, if you’re able to pay more towards your mortgage, you may be able to refinance when you owe less than your home is worth. Keep in mind, many lenders set minimum equity benchmarks for refinancing, often 20%.

Request a mortgage modification

One potential option for underwater mortgage relief is a loan modification through your lender. As its name suggests, this agreement modifies the terms of your home loan.

Make no mistake, a mortgage modification agreement is not a refinance, and your lender is under no obligation to grant you new terms. However, if your lender agrees to reduce your principal balance, it may be enough to get your loan above water, or closer to being right-side up.

Written by
Jeanne Lee
Contributing writer
Jeanne Lee writes about mortgages, personal finance and enjoys finding ways for people to hack their finances.
Edited by
Mortgage editor