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What to do if you have an underwater mortgage

Yahoo Personal Finance· Getty Images
Updated 6 min read

Sometimes, it’s hard to feel like you made a good investment by buying a home — especially if you owe more on your mortgage than your house is currently worth. This is known as being underwater on your mortgage, and nearly 600,000 people in the United States are in this position, according to a recent report by Ice Mortgage Technology.

We’ll explain why and how an underwater mortgage happens, your options for refinancing, and how to sell your house while underwater on a mortgage.

Learn more: Do you have home buyer's remorse? Here's what to do next.

If your outstanding mortgage balance is higher than your property value, you technically have an underwater mortgage (also known as an “upside-down mortgage”). However, this doesn’t mean you owe more than you borrowed, and your remaining mortgage principal balance hasn’t changed. An underwater mortgage can just happen if you bought your home in a competitive market and paid more than market value in a bidding war. You can also go underwater on your mortgage if housing market prices drop after you buy the home.

For instance, let’s say you bought your home last year for $400,000 and borrowed $380,000 with a mortgage. Over several months, home prices in your neighborhood drop, and the current value of your home is $370,000. You are underwater for $10,000, but this doesn’t change your mortgage payoff schedule.

If you have an underwater mortgage, you likely won’t be able to get a home equity loan or home equity line of credit (HELOC) anytime soon. These second mortgages often require you to have at least 15% to 20% equity in your house. If you have negative equity with an underwater mortgage, you won’t qualify for a home equity loan or HELOC.

If you need to borrow money, you’ll likely need to consider credit cards or personal loans instead. But this could also be a good time to go through your budget and compare auto and homeowners insurance policies, cell phone companies, and cable and utility providers to lower your bills and improve your financial situation.

Learn more: Home equity loan vs. home equity line of credit (HELOC)

You may not be able to refinance your conventional loan if you have an upside-down mortgage, but there are other options for lowering your rate or monthly payments. Even if you can’t refinance, you can contact your mortgage lender and ask for a loan modification. With a loan modification, your lender changes one or more terms of your mortgage. Reducing your mortgage interest rate or extending the length of your loan term to lower your monthly payments are both options at the discretion of your lender.

If you decide to extend your remaining term length — say, from 25 to 30 years — your monthly payment will be lower, even if you don’t get a lower interest rate. However, you will increase the total cost you’ll pay over time and possibly stay underwater for longer, depending on how quickly your home value increases.

You can still refinance an underwater mortgage if you have a government-backed loan, such as an FHA loan or VA loan. If you are unsure whether you have one of these types of mortgage loans, ask your lender.

In this case, you would want a streamline refinance (the VA also calls this an Interest Rate Reduction Refinance Loan, or IRRRL). With a streamline refinance, you refinance into the same type of government-backed mortgage (e.g., from an FHA loan into another FHA loan), and it doesn’t require a home appraisal to assess your home’s value. You can still refinance to take advantage of lower mortgage rates or switch from an adjustable-rate loan to a fixed-rate loan with a streamline refinance, even if you’re underwater on your mortgage.

You also may qualify for a short refinance, which involves replacing your current mortgage with one for less than what you owe. You can stay in the home rather than lose it to foreclosure, and you'll have lower mortgage payments. However, your lender must agree to a short refinance, and it will hurt your credit score.

Read more: 5 ways to prepare to refinance your mortgage

If you sell your home while underwater on your mortgage, you may owe more on your mortgage than the house sells for. This means you would have to pay the difference since you would have negative home equity. For example, if you still owe $300,000 on your mortgage and the house sells for $270,000, you would have to find a way to pay your lender the remaining $30,000.

To avoid paying the outstanding loan balance, you can discuss the possibility of a short sale with your mortgage lender. In this case, your lender agrees to forgive the remaining balance after you sell the home. If you are considering a short sale, you should talk with your lender as soon as possible.

The final option is foreclosure, meaning you walk away from the home, and the lender seizes your property. Both short sales and foreclosures will hurt your credit score for seven years, but short sales will affect your score less as years go by than foreclosures. Try to stay in your home if possible to avoid both of these options.

Learn more: How much does it cost to sell your house?

If your mortgage is underwater and you want to keep living in the home, nothing happens. You continue paying down your mortgage principal as usual.

The answer depends on why you want to sell and if you have the finances to keep making the mortgage payments. Do a thorough financial and lifestyle assessment before making this decision because selling when your mortgage is underwater is tough.

Yes, a home loan can go underwater, especially if home values drop in your area and you end up owing more than the home is currently worth.

Underwater mortgages occur when you buy a home for more than its value or when property values drop, resulting in you owing more on your home loan than the house is worth.

Yes. However, if you sell your home when you have an underwater mortgage, you probably won’t earn enough from the sale to pay off your mortgage when you move. You’ll likely have to pay off the outstanding principal balance, convince your lender to agree to a short sale, or foreclose on the property.

This article was edited by Laura Grace Tarpley