UNDERWATER MORTGAGE: Meaning and Available Options

Underwater Mortgage
MoneySense

If you have an underwater mortgage, it means you owe more on your home than it is worth. That is not a situation that any homeowner wants to be in, but it occurs more frequently than you might think! It’s natural to feel overwhelmed and stressed if you owe more on your home than it’s currently worth. Here’s everything you need to know about underwater mortgage refinancing and foreclosure: what an underwater mortgage is, how to tell if you have one, and what you can do about it.

That is entirely normal. Just remember that millions of Americans have been where you are—and they have survived. You have options, and we’ll go over the ones we recommend.

What is an Underwater Mortgage?

An underwater mortgage is a home purchase loan with a principal greater than the home’s free market value. This can happen when property values fall. In the case of an underwater mortgage, the homeowner may not have any available equity for credit. An underwater mortgage may prevent borrowers from refinancing or selling their home unless they have the cash to cover the loss out of pocket.

How Do I Know if I Have an Underwater House?

There are a few ways to tell if you have an underwater house or an upside-down mortgage. You may have noticed some clues in the previous section. Those who fall behind on their loan payments early in the term may be more vulnerable than others. When you compare your current and original principal, you’ll see if your late payments have resulted in an upside-down mortgage.

You’re underwater if your current principal is higher than when you took out the loan and the home’s value hasn’t increased.

Property depreciation is another indicator. Keep an eye on property prices in your area because falling values in your neighborhood will also affect your home’s value. This can include your immediate vicinity as well as the larger surrounding area.

To keep track, you can use a real estate database or speak with a local real estate professional who can explain the current and projected market. You can compare the amount you still owe on your loan to the approximate value of your home once you know its approximate value.

If you want a more precise assessment of the value of your home, you can seek an independent appraisal. A professional can come to your home and assess the property’s condition, then compare it to others in the area. If the appraiser’s estimate is less than the remaining loan balance, you have an upside-down mortgage.

What Can I Do If My Mortgage Is Underwater?

When faced with an underwater mortgage, it is difficult for any homeowner. Many people are emotionally attached to their homes, making resolving the problem even more challenging. Depending on your circumstances, some options may be preferable to others.

#1. Remain in the home

A variety of circumstances could cause your home to sink. It would be best if you were honest with your lender about your struggle to keep up with the mortgage payments. The lender may have options to assist you in avoiding foreclosure, such as a forbearance agreement, which would pause or reduce your expenses for a set period.

If you have fallen behind on your mortgage payments, you may be able to work out a repayment plan with your lender. If you want to pursue this option, you must discuss the time frame and parameters with your lender. However, you must be financially secure, with enough money left over at the end of the month to cover the extra costs.

The Department of Housing and Urban Development (HUD) also connects troubled homeowners with approved housing counseling agencies.

#2. Refinancing your underwater mortgage

Before refinancing your underwater mortgage, most lenders require that you have a certain amount of equity in your home. As a result, if you have an underwater mortgage, regular refinancing options will be unavailable to you. You can, however, use refinancing to improve your situation if your loan is owned or backed by Freddie Mac or Fannie Mae.

If you have little to no equity, Freddie Mac’s Enhanced Relief Refinance program may allow you to refinance your home loan at current interest rates. It’s intended for homeowners who don’t meet the requirements for traditional refinancing, but it still has requirements.

The high loan-to-value refinance Fannie Mae’s take on the relief refinances program. It, too, allows borrowers who make on-time loan payments to change the terms of their loan. The program has its own set of rules and benefits comparable to Freddie Mac’s.

#3. Sell your home

Some people may have to face the prospect of selling their homes. If you are unable to recover financially enough to pay the current mortgage payments on top of the missed installments, you must meet up, and you may be able to sell your underwater home and cover the difference with cash.

You could also consider a short sale as a solution. The property is sold for less than the amount owed on the seller’s mortgage in a quick sale. The proceeds from the sale are then used to repay the lender in place of foreclosure on your underwater mortgage.

The lender is also an essential player in the short sale process. You must negotiate the terms with the lender, who must approve the sale before it can be completed.

During the negotiation process, the borrower must demonstrate their financial difficulties to the lender. This could include a hardship letter and concrete documentation to back up their claim.

A short sale may help you avoid foreclosure on your underwater mortgage, which may jeopardize your chances of obtaining a loan shortly. According to Nolo, a person with a foreclosure on their record must typically wait two to eight years to get a new mortgage.

#4. Consider a deed in lieu 

If you cannot make your mortgage payments and are underwater, you should ask your lender if a deed instead of foreclosure is an option. If it is, you will submit documentation about your income and expenses to deed the house back to the lender and avoid foreclosure. The lender may require you first to try a short sale or loan modification.

A deed in lieu will usually, but not always, release you from all mortgage-related obligations and liabilities. If a deficiency occurs—the difference between the fair market value of the home and the total debt—the lender may attempt to hold you liable for the lack. A loan in lieu will harm your credit, but not as severely as a foreclosure.

#5. Allow your underwater mortgage to go into foreclosure.

If you cannot make up missed payments and your home is underwater, you may be forced to let the lender foreclose. While this may appear to be a simple deal on the surface—you get to leave the house that is causing you problems—it is not.

A foreclosure can cause your credit score to plummet, reducing your future chances of obtaining loans or lines of credit. Bad credit can also have an impact on other aspects of your life. Credit is used when you apply for rental housing, a cellphone contract, a car, or even a job.

If your debt exceeds the proceeds from the foreclosure sale, the difference is considered a deficiency. The lender can seek a deficiency judgment in some states to recover the deficiency. Overall, you may want to consider underwater mortgage foreclosure as a last resort.

Avoiding an Underwater Mortgage

Some factors that lead to an underwater mortgage are within your control, while others are not. Still, it’s better to avoid situations that could lead to an underwater loan. Staying alert can help you stay on track and avoid potentially harmful problems.

#1. Make on-time payments

Making on-time payments will help you build equity and remain in a more secure position if property values fall. There are a few ways to keep track of your loan payments and the value of your home.

Looking into rental or property-buying websites can help you determine the current value of your home. You can also check in to see how the market is changing, which can help you predict any future moves you might want to make. Of course, researching the real estate market can also help you keep track of the price of your home.

#2. Assess the market before you buy.

Knowledge will always be one of your best financial defenses. Before purchasing a home, it is best to conduct extensive market research and evaluation.

It would help if you investigated the neighborhood surrounding your potential property as well as the surrounding area. It would help if you bought in a location where the price will not drop immediately after you make the purchase.

This is especially important if you intend to relocate again within a short period. A real estate agent can advise you on current and anticipated market conditions, allowing you to make the best decision for you.

#3. Refinance

Refinancing your underwater mortgage isn’t just an option if you’re already having trouble making payments. You are the most knowledgeable about your financial situation.

If you believe you will have difficulty making regular monthly payments but still have equity in your home, you should consider refinancing.

Even if you are not currently in danger of having an underwater mortgage, you may consider refinancing. Many borrowers may benefit from the opportunity to pay at a lower interest rate with better terms.

Conclusion

At the start of the mortgage, most of the monthly payment is used to pay interest rather than the principal balance. As a result, if you stop making mortgage payments at the start of your loan, your principal balance will remain high, increasing the risk of an underwater mortgage. The good news is that an underwater mortgage may not stay underwater indefinitely. You can build equity in your home if you continue to make your mortgage payments.

Underwater Mortgage FAQs

Can I refinance if I am underwater?

Refinancing. If you are underwater on your loan, you will be unable to refinance. Before you refinance, most lenders require you to have some home equity.

What happens if you go upside down on your mortgage?

A mortgage that is upside-down is simply one in which the owner owes more than the house is worth. Being upside down may not have an immediate impact if you can afford the monthly mortgage payments and do not want to move.

What to do if you owe more than your house is worth?

Here are six options if you owe more than the value of your home and want to sell it.

  • Stay and pay.
  • Refinance.
  • Apply for a loan modification.
  • Consider a short sale.
  • Foreclosure/walk away

What happens if my house is worth less than I owe?

While being underwater on your mortgage will not prevent you from selling your home, you will be required to pay the difference between the sale price and the loan balance. So, if your house sells for $200,000 and you owe $225,000 on your loan, you must pay the lender $25,000 in cash.

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