When you buy a house, the hope is that the value of your investment continues to go up over time. However, that’s not always the case. Markets flip occasionally. If the value of your home drops enough, you could end up with an underwater mortgage, meaning you owe more on your home than it’s worth. But you’re not without options.
What Is An Underwater Mortgage?
An underwater mortgage, sometimes referred to as an upside-down mortgage, occurs when you owe more on your mortgage than what the property is worth. In this situation, you have negative equity.
This can happen when the property’s value declines, pushing its market value below the outstanding balance of the loan that was used to purchase it.
Mortgages aren’t the only type of loan that can go underwater. Other types of secured loans, such as auto loans, can end up underwater as well if the balance on the loan is greater than the value of the asset that secures the loan.
How Does An Underwater Mortgage Happen?
Although underwater mortgages occur because you have a higher mortgage balance than the value of your property, it’s worth taking a minute to examine how this happens:
- Decrease in property value: You might experience a decrease in property value if the market shifts such that homes are selling for less than they were when you bought your home, particularly if you bought recently and have yet to build up significant equity through payments. Your property may also lose value if there is significant damage and you don’t have the funds to repair it. This is why lenders require homeowners insurance.
- Missed mortgage payments: If you don’t make your scheduled mortgage payments on time, you’re not building up equity with every mortgage payment as you normally would be. But even if the value of your home stays flat, it’s possible to owe more than your balance because missed payments accrue fees.
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Risks Associated With A Mortgage Underwater
Being underwater on your mortgage isn’t necessarily a huge issue if you can afford to keep paying it off and you plan on staying in your home for a while. The problem comes if you want to sell or refinance your mortgage.
Selling
If you’re selling a house while your mortgage is underwater, you’ll have to pay your lender the difference between what you sold the home for and the remainder of your mortgage balance. Paying off the balance does mean avoiding potential negative credit ramifications, but you’ll end up losing money on the home.
Refinancing
To refinance your home, most mortgage loan options require a minimum amount of equity. There are exceptions, but it’s worth noting that you probably won’t be able to take cash out of your home. Most cash-out refinance loans require you to leave at least 20% equity in the home after a refinance. VA loans alone allow the conversion of the full value of the home to cash.
Foreclosure
Foreclosure is an outcome you want to try to avoid at all costs. In a foreclosure, your lender takes your property because you defaulted on your loan, usually because you haven’t been able to make the payments. It should be noted that this has a significant and long-lasting impact on your credit score in addition to forcing you to find other living accommodations.
Speak with your servicer about your options if you find yourself having trouble with your payments.
How To Know If Your Mortgage Is Underwater
To know if you’re underwater on your mortgage, you need to find both your outstanding loan balance and your home’s value.
1. Find Remaining Loan Balance
Your current loan balance should be listed on your monthly mortgage statement, but you can also reach out to your mortgage servicer or log-in to your online account to view this.
2. Determine Home’s Market Value
The most accurate way to determine what your home is worth is to get an appraisal or other formal home valuation. However, people typically only have that done if they’re looking to refinance or sell in short order.
If you’re just trying to get a decent idea of where you stand, you can get a pretty fair estimate by putting your address into any number of online real estate sites.
3. Calculate The Difference
Here’s the formula to determine if you’re underwater on your mortgage:
Home value – mortgage balance
If your home is worth more than what you owe on your mortgage, you have positive equity. For example, if you owe $250,000 on your loan and your home is worth $400,000, you have $150,000 in equity.
If your home is worth less than what you owe on your mortgage, your mortgage is underwater. For example, if you owe $250,000 on your loan and your home is worth $200,000, you’re at a $50,000 equity deficit.
Other Alternatives For Homeowners With Underwater Mortgages
If you find out your mortgage is underwater, try not to panic. There are options.
Explore Refinance Programs
Because refinancing any mortgage typically requires a certain amount of equity, your ability to get a new loan on your existing home while underwater will be limited, but there are options for those who currently have FHA or VA loans.
FHA loan borrowers who are underwater on their mortgages may be eligible for an FHA Streamline refinance, which offers the opportunity to lower your rate or change your term without the need for as much documentation as a typical refinance. With this type of refinance, you usually don’t need an appraisal.
VA loan borrowers who are underwater may be able to get some relief with a VA Streamline refinance, also known as an Interest Rate Reduction Refinance Loan (IRRRL).
Neither the FHA nor the VA set a maximum loan-to-value ratio (LTV) for these refinance options, so you may be able to qualify regardless of what you owe on your home in comparison to its value. However, lenders may set their own standards.
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Build Up Equity
If you can afford your monthly mortgage payments and don’t plan on moving anytime soon, the best thing to do in this situation might be to just wait it out and keep paying your mortgage. Paying down your balance will help you build up equity, as will giving your home time to appreciate in value.
Over time, home values tend to trend upward. If your home’s value has taken a temporary hit, waiting a few years can give you some time to experience enough appreciation to naturally get out of being underwater on your loan.
Consider A Short Sale
In a short sale, you get approval from your lender and/or servicer to sell your house for less than what it’s worth. To do this, they often require that you show a hardship or extenuating circumstances surrounding your mortgage payment trouble. It’s not always an option.
When you and your lender or servicer agree to a short sale, it’s important to note that they have control over accepting or rejecting any offers. The negotiations will be handled between your lender and the real estate agent. In exchange for keeping the home up prior to the sale, you may receive some assistance to relocate.
In some states, lenders may obtain a legal judgment against you for the amount you owe on your mortgage balance following the short sale. There’s also typically some negative credit impact, although it will be less negative than a foreclosure.
Deed-In-Lieu Of Foreclosure
A deed-in-lieu of foreclosure involves voluntarily signing your home over to your lender rather than going through a full foreclosure process. While the credit impact is similar to that of a regular foreclosure, your servicer or lender may be able to give you some money for moving assistance in exchange for keeping up the property while the deed-in-lieu is finalized.
As with a short sale, you have to get approval from your lender or servicer to do a deed-in-lieu of foreclosure. You’ll have to have a hardship or extenuating. The investor on your loan may obtain a legal judgment against you for the amount you owe on your mortgage and what they get for the sale of the property.
The Bottom Line
If you owe more on your home than the value of the property, you’re in an underwater mortgage. If you plan on staying in the home for a while, this isn’t as big of a problem. If you want to refinance or sell, it’s an obstacle, but you may have options. Be sure to talk to your lender and/or mortgage servicer.
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Kevin Graham
Kevin Graham is a Senior Writer for Rocket Companies. He specializes in economics, mortgage qualification and personal finance topics. As someone with cerebral palsy spastic quadriplegia that requires the use of a wheelchair, he also takes on articles around modifying your home for physical challenges and smart home tech. Kevin has a bachelor's degree in journalism from Oakland University.
