What to do When Your Mortgage is Underwater

Struggling to keep your head above water? You’re not alone. Thousands of American households are struggling with an underwater mortgage, a term used to describe homebuyers who owe more than their house is worth.

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Underwater mortgages were a massive issue a decade or so ago, when the housing market collapsed, property values plummeted, and many homeowners were shocked to discover that their dream homes were stuck in negative equity and their financial situations were bleak.

What to do with an Underwater Mortgage

When your mortgage balance is higher than the value of your home, you’re in a situation referred to as being “underwater” or “upside-down”. It’s a position that any borrower can find themselves in, one that affects all homeowners regardless of the loan amount, the home’s value or their income.

How easy it is to escape this situation will depend on how big your monthly mortgage payments are compared to your income, whether you have any additional unsecured debts weighing you down, and whether or not you have missed any payments. 

In any case, you have a few options to escape this dire situation.

1. Consider a Short Sale

A short sale happens when the lender agrees to sell the home for less than it is worth. It will hurt your credit score, but not as much as a foreclosure, and it can be a great option if it works. That “if” is key, as the lender may refuse, and you may struggle to find a buyer. 

What’s more, while you won’t necessarily need to cover the difference, you may need to pay taxes on it and if it’s in the thousands or tens of thousands of dollars, as it so often is, that can be a hefty sum. To be on the safe side, you should speak with a lawyer. You will also need to hire a real estate agent to help you sell the property.

2. Go for a Loan Modification

A loan modification is the act of changing a loan to better suit your needs. It’s like refinancing, and it has the same goal, which is to reduce your monthly payments, your mortgage rate or the balance of the loan.

They don’t always work as you might expect or hope, with surveys suggesting that many loan modifications result in an increased monthly payment and less favorable rates and terms over the long-haul. It’s also an industry rife with scams, so make sure you check this list from the U.S. Department of Housing and Development to find a suitable and legitimate counseling agency in your area.

3. Consider Renting the House

Depending on the size of your mortgage payments, outgoings and the local housing market, it may help to rent the home out. This is a solution that won’t work for everyone, though, as you’ll need to make sure that the rent payments are higher than your mortgage payments when accounting for maintenance, insurance, and taxes, and you’ll also need to prepare yourself to be a landlord.

If it’s your only home, and you can’t stay with your parents or friends, this is a terrible idea, because whatever you save by renting the home you’ll likely lose when you rent a place of your own. If you own several properties and can move into one of these for the time being, it’s well worth considering this option.

4. Wait

The bad times will pass and sooner or later you’ll get back into the black and can start building equity again. Therefore, one of the best options is to simply ride it out. Do all you can to keep making those mortgage payments, clear more of the loan balance, build more equity, and move one step closer towards owning 100% of your house.

It doesn’t matter if you end up paying $200,000 for a house that is only worth $150,000, everyone else is in the same boat. If your parents or friends tell you they have just sold their house for $350,000 despite only paying $200,000 for it 30 years ago, you’d be ecstatic for them, and no doubt a little jealous. After all, that’s a $150,000 profit.

But if they had a 30-year mortgage, there’s a good chance they paid close to $400,000 for that house when all the interest payments are accounted for. The truth is, most residential properties take decades to earn more than the buyer paid, and while your situation may seem a little bleaker, you’re only one boom away from flipping that underwater mortgage on its head and securing a great return on your investment.

If the house is your home and not merely an investment property, and if you can keep meeting your obligations (mortgage payments, property taxes, insurance) then just stop worrying, keep paying, and start reducing your equity and improving your loan to value ratio.

There’s no way of knowing what the future will bring. Home prices could keep falling in your area and another housing crisis could topple its market value. But at the same, that home value could skyrocket, and your issue could be remedied before you know it. 

Often times, the best thing you can do is avoid speculation, don’t make any rash decisions, and continue doing what you’re doing, especially if it’s keeping a roof over your head.

5. Forget About Refinancing and Home Equity Loans

While refinancing and home equity loans are great options for homeowners seeking better rates, it’s not an option available to you if you have an underwater mortgage. Lenders secure equity loans against the value of the home, or rather, against your stake in the home. If you’re underwater, your stake amounts to very little and they simply can’t help you.

6. Foreclose

Foreclosure can hurt your credit score and remain on your credit report for 7 years. It can be tempting to just accept this eventuality and draw a line through the experience, but it’s incredibly costly and unless you have the means to buy a new house and get back on the market, it’s an option that should be avoided at all costs.

Do what you can to fight the foreclosure. It can be soul-crushing to keep making monthly payments on a house that isn’t worth what you paid for it, but it’s often better than the alternative.

If you can’t keep meeting those payments, consider a deed in lieu of foreclosure. With a deed in lieu, you hand the keys back to the bank, your credit score will take a hit and you will feel the effects for 7 years. However, it will get you out of a tough spot and your mortgage lender may offer you several thousand dollars to help you cover rent.

That way, you can offload the burden of your underwater mortgage, shack-up somewhere for a few months, find a new home, and then start again. Your credit score will suffer, and your credit report will be marked for the next 7 years, but with a little repair work and some rebuilding, you can get another home loan and start over.

Thanks to FHA loans, you can get a mortgage loan with a credit score as low as 500. It’s important, however, that you don’t rush in. Underwater mortgages often occur because of sheer bad luck and bad timing, as opposed to buyer mistakes, but with a high-interest rate and a low down payment, you’re not getting off to the best start and risk it happening all over again.

Take some time to assess your situation. A few months and a clear focus on the following will greatly improve your situation:

  • Build your credit score (clear credit card debt, stop applying for new credit)
  • Save for a bigger down payment
  • Speak with a credit counselor or personal finance expert
  • Assess the real estate market to find cheaper homes in budget-friendly locations
  • Ask friends and family if they can help 
  • Look into different mortgage types
  • Compare rates from different mortgage lenders