How to refinance an underwater mortgage

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When a home’s current market value is lower than the amount still owed on it, the mortgage is said to be “underwater.”

That’s bad news for the homeowner.

“You have zero equity in your home. It’s considered underwater because it should be the reverse. Your outstanding mortgage balance should be less than the market value of your home,” says Niv Persaud, founder and managing director of Transition Planning & Guidance, LLC.

How does this unfortunate situation occur? Property values in a neighborhood may go down after you purchase a home, but the mortgage balance outstanding doesn’t change. Or, if you miss one or more mortgage payments — particularly early in your repayment period — interest charges could start to pile up on the loan, increasing the amount owed.

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.

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.

Learn your options

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

Fannie Mae High LTV Refinance

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.
  • You have not previously refinanced through the Home Affordable Refinance Program (HARP) program, which has expired.

All home types are eligible, and the program does not have an expiration date.

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 Persaud.

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 an underwater mortgage

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.

Featured image by Camerique/ClassicStock of Getty Images.

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