Key takeaways

  • 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 staying put and waiting for the home to appreciate, trying to get a new loan or requesting a short sale.

What is an underwater mortgage?

“Being underwater or upside-down on a home, car or any other asset means that you owe more than the current value,” explains Greg McBride, chief financial analyst at Bankrate. 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.

For example, if you buy a house when prices are high and the real estate market then retreats, your home’s value can depreciate, or shrink – and, 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?

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. During the 2007-8 subprime mortgage crisis, for example, the housing market collapsed, and many borrowers were saddled with homes worth far less than they paid.

Housing values can also decrease as a result of rising interest rates, high numbers of foreclosures or natural disasters.

Underwater mortgages are much less common now than they were in the Great Recession. Back then, some 12 million borrowers were in a negative equity state. Today, just over one million are, a record low, according to real estate data analyst CoreLogic.

In addition to declining home prices, homeowners can find themselves in this financial situation when they buy homes with little or no money down, says McBride: “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.”

Another way to become upside-down would be to take out a second mortgage that depletes most or all of your ownership stake; borrowing 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.

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, 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.

Why an underwater mortgage can be risky

Scary as it can seem, being underwater doesn’t have to affect your day-to-day life, especially if you’re planning on staying put. 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 times of risk 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, in which the bank agrees to accept less than the total remaining mortgage balance out of the sale proceeds. This sort of transactionharms your credit score.
  • 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.

“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 new financing

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 to refi your upside-down mortgage. 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.

5. Let the lender foreclose

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 rather tarnished. 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 underwater loan relief and be able to keep your home.

Underwater mortgage FAQ

  • 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.)

Additional reporting by Taylor Freitas