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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 because it can be difficult, if not impossible, to earn a profit when trying to sell an underwater home. In fact, if you need to sell when you have an underwater mortgage you’ll end up paying out of your own pocket just to sell. What can you do if you owe more on your mortgage loan than what your house is worth? We take a closer look at your options below. If you need more of a comprehensive review of your personal situation you may want to consider speaking with a financial advisor. 

Underwater Mortage Options

You have a few options if you find yourself with an underwater mortgage. Not all of these options are pleasant, but they all can be done and some could get you out from underneath your situation. Let’s take a look at the four most common solutions to an underwater mortgage.

1. Don’t Sell Your Home

The best choice when you have an underwater mortgage 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. Plus, you may not have much of a choice if you owe too much to sell because you’d have to bring a lot of money to closing. 

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.

2. Refinance Your Loan

underwater mortgage

If your home is underwater, refinancing isn’t a way to sell your home but it could be a good solution to provide some relief in the form of a lower interest rate and a lower monthly payment. This is 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.

3. Short Sale

If you absolutely need to sell your home when 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 because they have a better chance of being paid back in full if you end up in foreclosure, even if they have to take a hit for a while. A short sale will also cause your credit score to fall, which is something to keep in mind. You’ll struggle to get another mortgage in the near future with a short sale on your credit.

4. Strategic Default

underwater mortgage

Some homeowners who are 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 a 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 just as a bankruptcy would.

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. The best option, though, is to stay in your home until the housing market hits a point, or you pay enough on your own, that you’re no longer underwater. If you absolutely must leave, you can consider things like short sales or strategic defaults but all of those solutions will damage your credit.

Tips for Staying Afloat in Your Mortgage

  • For help with mortgages, consider finding a financial advisor who can help you strategize on your real estate or any other investment. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • 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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