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What Is An Underwater Mortgage And What Options Do You Have?

6-Minute Read
Published on December 22, 2021

Buying a home is a huge investment, and it’s typically done with the hope that the home will increase in value over time – or at the very least, hold its current value.

Unfortunately, that doesn’t always happen. Finding out you have an underwater mortgage can be distressing. Here’s what homeowners need to know about getting out of this situation.

What Does Being Underwater On A Mortgage Mean?

Sometimes referred to as an upside-down mortgage or having negative equity, an underwater mortgage occurs when a mortgage has a higher principal balance than what the home is currently worth. 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.

Essentially, you owe more on the home than it’s worth.

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?

When you purchase a home with a mortgage, your lender will only let you borrow a certain percentage of the home’s market value. Exactly how much depends on your financial profile and the type of loan you’re getting. VA loan borrowers, for example, can borrow up to 100% of the home’s value.

Conventional loan borrowers who qualify for a 3% down payment can borrow 97% of the home’s value. Whatever you don’t borrow, you cover with your down payment.

Lenders won’t lend you more than what the house is worth. This protects them in case you default; if they must sell the home during the foreclosure process, they want to be able to recoup as much of their money as they can.

Because of this, most people start out with at least a little bit of equity in their home (unless they qualified for a 0% down loan option). Typically, that equity will increase over time as they make payments on their mortgage and as the home appreciates in value.

It’s possible, however, for homeowners to lose equity and end up having negative equity – aka being underwater. Here’s how this can happen.

Housing Market Trends

Housing market trends in your neighborhood, town or even nationwide can have an impact on your home’s value. This is especially true when there’s an economic downturn that affects home values.

Overall home values can drop when there’s a lack of demand or an overabundance of supply. This can happen when mortgage rates go up or potential buyers suddenly aren’t able to afford to purchase a home.

A Decrease In Property Value

Outside of larger market trends, your home can also decrease in value if something happens that causes severe damage or disrepair that you aren’t able to fix.

For example, if a home experiences water damage due to flooding and the homeowner can’t restore the property, the value could decrease enough to put the mortgage underwater.

Not Enough Equity

Homeowners who make low or no down payments are at a greater risk of ending up underwater than those who make larger down payments.

Your down payment gives you equity in your home. The more equity you have, the more cushioning you have against slight dips in the market. If you only have, say, $5,000 of equity in your home, and your home’s value decreases by $6,000, you’d end up with negative equity.

Why Being Underwater Can Be Risky

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.

However, if you need to sell your home soon or you’re interested in refinancing, being underwater can hinder those goals.

If you try to sell your home while you’re underwater, the proceeds from the sale likely won’t be enough to pay off your mortgage. You’ll need to pay the difference yourself, or convince the lender to accept a short sale, which can hurt your credit score.

To be able to refinance, you also generally need to have some equity in your home – especially if you want to get a cash-out refinance.

How Do I Know If My Mortgage Is Underwater?

To know if you’re underwater on your mortgage, you need to have an idea of what your home’s current value is.

1. Find Your Remaining Loan Balance

Your current loan balance should be listed on your monthly mortgage statement, but you can also reach out to your lender or log-in to your online account to view this.

2. Determine Your Home’s Market Value

It can be difficult to know exactly how much your home is worth without an appraisal completed by a licensed appraiser, but you can get an estimate of your home’s market value online. Rocket Homes℠, for example, has a tool that allows you to input your address and receive an estimate of your home’s value.

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.

What Are Your Options If Your Mortgage Is Underwater?

If you find out your mortgage is underwater, try not to panic. There are options.

Continue Making Your Payments

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 get out of a negative equity situation, as well as give 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.

Sell Your Home

When you sell a property with a mortgage on it, the entire loan balance becomes due. Typically, home sellers will use the proceeds from their sale to pay off this balance. If you’re underwater, however, you likely won’t have enough to cover the full amount.

If you can’t wait and need to sell your home now, you can try to sell it and then pay out of pocket whatever is leftover on the mortgage. If you don’t have the funds to do this, you can talk to your lender about doing a short sale, where the lender agrees to accept less than the remaining mortgage balance. To do this, you’ll need to prove to them that you’re experiencing financial hardship and aren’t able to repay the full amount owed. A short sale will also likely hurt your credit score.

Refinance Your Mortgage

While most borrowers can’t refinance if they have negative equity, FHA or VA borrowers may be able to get some relief.

FHA Streamline

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 typically don’t need an appraisal.

VA Streamline

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).

Maximum loan-to-value ratios (LTVs) allowed for this type of loan vary depending on your lender, but you may be able to get an IRRRL with an LTV up to 120% (an LTV above 100% is considered underwater). For example, if your home is worth $200,000 and you owe $240,000 on your current VA loan, you could be eligible to refinance.

Freddie Mac Enhanced Relief Refinance

Underwater borrowers with loans owned by Freddie Mac were previously able to refinance with Freddie Mac’s FMERR program, which allowed qualifying borrowers in good standing to refinance loans with high LTVs, including those higher than 100%. However, due to the “extremely low volume” of applicants, this program has been paused until further notice as of May 2021.

Fannie Mae High Loan-To-Value Refinance

Like Freddie Mac’s program, Fannie Mae’s high LTV program has been put on hold until further notice. This program worked similarly to Freddie Mac’s, but was for borrowers whose loans are owned by Fannie Mae.

The Bottom Line

Though less common today, going underwater on your mortgage can happen. If it does, it’s important to understand your options. For many homeowners, it can be worth it to take a “wait and see” approach and continue paying off your loan.

If you’re interested in refinancing, you can get started online with Quicken Loans®.

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Molly Grace

Molly Grace is a staff writer focusing on mortgages, personal finance and homeownership. She has a B.A. in journalism from Indiana University. You can follow her on Twitter @themollygrace.