Underwater Mortgage – Everything You Need To Know

In the realm of real estate and home ownership, few situations are as challenging and stress-inducing as finding oneself with an underwater mortgage. This phenomenon, while less common in stable or rising real estate markets, can occur during economic downturns, causing substantial financial strain for homeowners. However, understanding what an underwater mortgage is, how it happens, and the available remedies can empower homeowners to navigate this difficult situation more effectively.

Underwater Mortgage - Everything You Need To Know

What is an Underwater Mortgage?

An underwater mortgage, also known as an upside-down mortgage is a type of home loan that comes with a higher balance than the property’s market value. Furthermore, this can happen when you recently purchased a home and have been unable to pay down your principal, or if you made use of a smaller down payment with less home equity.

In other words, an underwater mortgage happens when homeowners owe more on their mortgages than the current market value of the property. Therefore, the mortgage loan balance is higher than the worth of the home property. You will not be able to sell the property without paying the difference between the mortgage balance and the sale price because this can be a significant financial burden.

How Does It Happen?

Several factors can lead to a mortgage going underwater, often related to changes in the housing market and the economy at large. Key contributors include:

Decline in Property Values

The most common cause of underwater mortgages is a sharp decline in local or national property values. During a housing market crash or economic recession, home values can fall rapidly, leaving homeowners owing more than their homes are worth.

Interest-Only or Negative Amortization Loans

Loans that allow borrowers to pay only interest for a certain period or make payments smaller than the interest owed can lead to an increasing loan balance, pushing a mortgage underwater if home values drop.

High Loan-to-Value Ratios

Homeowners who make small down payments may start with a loan-to-value ratio close to 100%. Even slight decreases in property value can push such mortgages underwater.

Home Equity Loans

Taking out a home equity loan increases the total amount owed on a property. If home values fall, this can contribute to the mortgage going underwater.

What To Do If You Have an Underwater Mortgage

If you find yourself with an underwater mortgage, where you owe more on your mortgage than your home is currently worth, it can feel like being stuck in a financial quagmire. However, there are several strategies you can consider to navigate this challenging situation. Here’s what to do if you have an underwater mortgage:

  • Evaluate your Long-term Plans.
  • Continue Making Payments.
  • Look for a Loan Modification.
  • Get Refinanced Through Government Programs.
  • Consider a Short Sale.
  • Explore a Deed in Place of Foreclosure.
  • Strategic Default.

Evaluate your Long-term Plans

Before making any decisions, consider your long-term housing plans and financial situation. If you intend to stay in your home for many years, the market value of your house might recover over time, and your mortgage might eventually no longer be underwater.

Continue Making Payments

If you can afford your mortgage payments and plan to stay in your home for the long haul, continuing to make payments can be a sensible option. This maintains your credit score and can contribute to building equity over time as the market recovers.

Look for a Loan Modification

You can get in touch with your lender to talk about the possibility of modifying or adjusting your loan. This is because some lenders can change or modify the terms of your mortgage, making it affordable for you. Besides, this can involve lengthening the term of the loan, decreasing the interest rate, or even reducing the principal amount that you owe.

Get Refinanced Through Government Programs

Although traditional refinancing might not be an option when your mortgage is underwater, government programs like the Home Affordable Refinance Program (HARP) previously offered help to homeowners in such situations. While HARP has expired, there may be other government or lender-specific programs available designed to assist homeowners with underwater mortgages.

Consider a Short Sale

A short sale happens when the lender allows you to sell your home for less than the amount you owe on the mortgage. On the other hand, this is possible if you wish to move and are unable to afford the difference between your mortgage balance and the home’s sale price. However, a short sale can affect your credit score negatively, but not as severe as foreclosure.

Explore a Deed in Place of Foreclosure

A deed in place of foreclosure involves voluntarily transferring the title of your home to the lender to avoid foreclosure. This option can also negatively impact your credit but may be less damaging than a foreclosure and can provide a quicker resolution.

Strategic Default

As a last resort, some homeowners choose to stop making payments and allow the bank to foreclose. This option has significant negative consequences for your credit score and future borrowing ability.

How To Refinance an Underwater Mortgage

Refinancing an underwater mortgage can be difficult because most lenders require some equity in the home as a condition for a new loan. However, there are programs designed to help:

  • Government Programs: Programs like the Home Affordable Refinance Program (HARP) were developed to assist homeowners with underwater mortgages. Although HARP has expired, similar programs may be available depending on your situation and location.
  • Lender Negotiation: In some cases, lenders may be willing to refinance an underwater mortgage to prevent a default. This often requires negotiation and demonstrating your commitment to maintaining the property and continuing payments.

Other helpful ways to refinance an underwater mortgage include:

  • VA Interest Rate Reduction Refinance Loan.
  • FHA Streamline Refinance.
  • Freddie Mac Enhanced Relief Insurance.
  • Fannie Mae High LTV Refinance Option.

These programs can be very helpful when it comes to refinancing an underwater mortgage so, feel free to check them out.

How To Avoid It

If you would like to prevent an underwater mortgage, this involves some judicious financial decisions, some of which include:

  • Make a significant down payment.
  • Buy a home well within your budget.
  • Avoid interest-only or adjustable-rate mortgages.
  • Keep an eye on home values in your area.
  • Regularly assess your home’s value versus your loan balance.
  • Consider extra principal payments when possible.
  • Avoid borrowing against your home equity.
  • Stay informed about economic factors that could affect the housing market.

In Conclusion

While an underwater mortgage poses a significant financial challenge, understanding the situation and exploring available options can help homeowners manage and, in time, resolve it. Making informed decisions when buying a home and preparing for potential market downturns are crucial steps in avoiding this difficult scenario.