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- When you owe more on your mortgage than your house is worth, the loan is referred to as "underwater," or in a state of negative equity.
- Having an underwater mortgage makes it harder to sell the home or refinance.
- If you have an underwater mortgage, your options include waiting for the home to appreciate, renting out your property if you need to move or requesting a short sale.
What is an underwater mortgage?
Buying a home is a generally sound investment, one that allows you to build generational wealth by amassing equity over time.
However, if you buy when prices are high and home values later retreat, your home can lose value. You could wind up with a mortgage balance that outstrips that value.
“Being underwater or upside-down on a home, car or any other asset means that you owe more than the current value and have negative equity,” says Greg McBride, chief financial analyst at Bankrate.
Being upside-down is much less common now than it was in the Great Recession. During the 2008 housing crisis, many borrowers were saddled with homes valued at far less than they paid. Housing markets can be unpredictable, and home values can decrease as a result of rising interest rates, high rates of foreclosures or natural disasters.
Underwater mortgages usually occur during an economic downturn in which home values fall, says Jackie Boies, senior director of Partner Relations for Money Management International, a Sugar Land, Texas-based nonprofit debt counseling organization.
How does an underwater mortgage happen?
Say Jane bought her home for $300,000, made a $30,000 down payment and borrowed $270,000. Two years later, 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 is valued at $250,000 — and, she still owes $258,400 on her mortgage. She is now underwater, or upside-down, on the mortgage.
In addition to declining home prices, homeowners can find themselves in this financial situation when they buy homes with little or no money down or borrow against most or all of the equity, says McBride.
“Note that even a stagnant home price can leave you upside-down if you wish to sell the home soon after because the transaction costs of selling could more than offset what little equity you have,” says McBride.
Another way to become upside-down would be borrowing secondary financing equaling more than 100 percent of the value of the home, or taking out a mortgage that would result in negative amortization over the life of the loan, says Holly Lott, a senior branch manager at Atlanta-based Silverton Mortgage.
Why an underwater mortgage can be risky
Most borrowers can keep making their payments and “over time can get right-side up by paying down some of the principal balance and/or seeing some appreciation in the price of the home,” says McBride.
Still, there are some times when a homeowner should be concerned about being upside down on their mortgage. These include:
- Refinancing: People who find themselves in hardship might find it nearly impossible to refinance, unless they qualify for a government program or certain types of mortgages, says Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington, D.C.-based nonprofit organization.
- Selling: If you’re underwater, you will also have a hard time selling. If you can’t make enough from the sale to cover your mortgage balance, you’ll be responsible for making up the difference. Alternatively, you’ll need to apply for a short sale with your lender, which is a type of sale where the bank agrees to accept less than the total remaining mortgage balance. This harms your credit score.
- Possible foreclosure: If a home doesn’t sell as a short sale, the next step is foreclosure. When a home is underwater, you are at a higher risk of foreclosure if the payments become too much for you.
Signs that your mortgage is underwater
Finding out if you’re underwater requires an assessment of your home’s current value. You can use a home value estimator tool to get a ballpark idea. 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.
What to do if you’re underwater on your mortgage
If you find yourself underwater on your mortgage, consider these options:
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.
“Essentially, you’re riding out the market until values take a turn and go higher,” says Lott. “During this time it would be beneficial to make extra payments on the principal balance of the loan while waiting for home values to rise.”
2. Explore refinance options
You have fewer refinancing options if your loan is underwater, but you might not be totally out of luck. Talk to a few mortgage refinance lenders to see what, if anything, you can do. If your original loan is an FHA loan, you might be able to qualify for a 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
You might also take the short sale route to avoid foreclosure and move to a more affordable housing situation, says McClary.
In a short sale, the lender must agree to accept less than the amount owed on the mortgage, making it a loss for them, says Lott. Lenders will only consider a short sale as a final option before foreclosure.
4. Walk away from your mortgage
Another option is to simply walk away from the 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.
Homeowners should obtain advice from a HUD-approved nonprofit housing counseling agency in these situations to “help identify solutions specific to your circumstances and community,” says McClary. There might be a way to resolve your situation besides walking away, which is really a last resort.
Finally, you could allow your home to go into foreclosure. During this process, the lender regains the home and the homeowner walks away with their debt wiped clean, but a credit score that is far worse for the wear.
Many people in foreclosure also file for bankruptcy to eliminate other debts.
There are long-lasting repercussions for these options, says Lott. 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.
Learn how to avoid foreclosure to find another way out of your situation. You could qualify for mortgage relief and be able to keep your home.
Underwater mortgage FAQ
When a mortgage is underwater, it means the balance of loan is higher than the home’s value. Unfortunately, it’s difficult to sell or refinance an underwater mortgage. If you’re in this situation, you have a few options, including waiting until the market course-corrects, pursuing a short sale or walking away from the loan.
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.
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.
If you decide to stay in your home, you might have to wait a few months or 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.)