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underwater mortgage

When you owe more money on your mortgage than your home is worth, your mortgage is considered to be underwater.

No homeowner wants to be underwater. It can be difficult, if not impossible, to earn a profit when trying to sell an underwater home. Few buyers will spend more than $200,000 on your home if that’s all it’s worth today. These buyers don’t care that you owe $250,000 on a mortgage loan that you took out six years ago.

What can you do if you owe more on your mortgage loan than what your house is worth? You have several options, though not all of them are particularly pleasant.

Stay Put

The best choice is to stay put. You can’t lose money on an underwater sale if you don’t sell your home. This is a good choice if you like your home and your neighborhood.

Unfortunately, life has a way of changing this plan. Maybe you or your spouse needs to move because of a job relocation. Maybe you’re going through a divorce and you have to sell your home. In such cases, you might be stuck with a loss if your home’s value hasn’t rebounded by the time you need to move.

Refinance

underwater mortgage

If your home is underwater, refinancing won’t help you sell if for enough money to bring in a profit. But refinancing can bring some relief in the form of a lower interest rate and a lower monthly payment, something that might help erase the sting of being underwater.

The problem? Most mortgage lenders require that you have at least 20% equity in your home before they’ll approve you for a refinance. That won’t be the case if you’re underwater; instead you’ll have negative equity. The federal government, though, does offer its Home Affordable Refinance Program, better known as HARP. Under this program, lenders are given financial incentives to refinance the home loans of owners who owe more on their loans than what their homes are worth.

You will have to meet certain requirements to participate in HARP. Your mortgage loan must be owned or guaranteed by Freddie Mac or Fannie Mae and you must be current on your mortgage payments. You also can’t have missed any payments during the past 12 months. And even if you do meet these requirements, lenders don’t have to approve you for a HARP refinance. If your credit score is low or your income is not high enough, you might struggle to convince a lender to refinance your home even through HARP.

Short Sale

If you absolutely need to sell your home even if you’re underwater, you might be able to convince your lender to approve a short sale. In a short sale, your mortgage lender agrees to let you sell your home for less than what you owe. In such a sale, you can price your home more aggressively to move it quicker. Say your home is worth $150,000 but you owe $180,000 on your mortgage loan. Instead of hoping for a buyer willing to pay that $180,000, you can sell your home for $150,000 or $140,000. Your lender would take the loss.

Short sales can be challenging, though. Your lender must approve any offer you receive, even if you think the offer is good. If your lender rejects an offer, your sale will fall through. Some lenders won’t even consider a short sale. A short sale will also cause your credit score to fall.

Strategic Default

underwater mortgage

Some homeowners, convinced that their homes’ values will never recover, simply walk away from their homes. They stop making their monthly mortgage payments even if they can afford them. This is known as strategic default. Some argue that this is unethical. Others say that owners shouldn’t be expected to keep making payments on what has become a bad investment. Know, though, that walking away from your mortgage will send your credit score plummeting. And when you eventually fall into foreclosure — the end result of a strategic default — this negative judgment will remain on your credit report for seven years.

Bottom Line

A mortgage is underwater when you owe more money on it than the home itself is worth. If you find yourself underwater on your mortgage, there are a few options you can consider, including refinancing. The best option, though is to stay in your home. If you absolutely must leave, you can consider things like short sales or strategic defaults.

Tips for Staying Afloat in Your Mortgage

  • For help with mortgages, consider finding a financial advisor. SmartAsset can help find the right one with our free financial advisor matching service. You answer a short series of questions and we match you with up to three advisors in your area. We fully vet our advisors and they are free of disclosures. You talk to each advisor before choosing how you want to proceed.
  • Thinking about buying a home and worried about how much you can spend? Use our calculator to see just how much house you can afford.
Dan Rafter Dan Rafter has been writing about personal finance for more than 15 years. He is an expert in mortgages, refinances and credit issues. Dan's written for the Washington Post, Chicago Tribune, Phoenix Magazine, Consumers Digest, Business 2.0 Magazine, BusinessWeek online and dozens of trade magazines.
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