What To Do If You’re Underwater on Your Mortgage

If you owe more on your mortgage than your home is worth, you’re said to be underwater or upside down on your home loan. If you’re paying your mortgage on time and can continue to do so, you should be fine. But if you’re underwater and need to refinance, you have no equity to borrow. And if you need to sell, you can’t make enough by selling the home to repay your current mortgage. Knowing how to avoid going underwater on your mortgage and what to do if it happens anyway can help you protect your long-term financial well-being.

What Is an Underwater Mortgage?

An underwater mortgage is one where the principal on the homeowner’s loan is greater than the home’s value.

A mortgage can go underwater if the borrower misses payments. That typically incurs late fees and additional interest added to the mortgage balance and could eventually increase it past the home’s value.

The other way a mortgage can go underwater is if the home’s value decreases to the point where it’s worth less than the balance on the loan.

Mortgages typically are structured to avoid going underwater, with each payment reducing the principal until the loan is repaid in full. Additionally, most mortgage lenders and loan types require a down payment, which ensures the homebuyer is borrowing less than the home is worth from the start.

If the borrower pays the loan on schedule and the home retains or increases its value, it will never be underwater. To go underwater, a borrower would have to add more fees and interest to their balance than their down payment amount or their home would have to decline in value more than the down payment amount.

Despite these guardrails, homeowners still can go underwater on their mortgage and find themselves in potentially dire financial straits.

Risks of Being Underwater on Your Mortgage

If you’re falling behind or going underwater on a loan, it’s important to understand the financial risks.

No equity

When a home is worth more than the owner owes on it, that’s called equity. For example, if your home is worth $500,000 and you owe $350,000 on your mortgage, you have $150,000 in equity.

Equity is valuable. You can borrow your equity with a home equity loan, home equity line of credit, or a cash-out refinance. You also can expect to get about that much — minus transaction fees — if you sell the home.

An underwater home has no equity, which can make it impossible to refinance your loan. Selling a home that’s underwater on the mortgage could result in you selling the home and transferring ownership while still owing money on your mortgage.

Growing debt

One of the most common reasons homeowners go upside down on a mortgage is missing payments. When you miss a loan payment, interest and late fees accrue and are added to your mortgage balance. If you fail to catch up, the interest charges can quickly grow your balance past what your home is worth.

Higher odds of foreclosure

While foreclosure is a risk for any homeowner struggling to make their mortgage payments, being underwater on a loan increases the odds of foreclosure.

What Causes Underwater Mortgages?

Knowing the potential causes of an underwater mortgage can help you avoid this fate.

Falling property values

Property values typically increase over time. But sometimes values fall rather than rise. Real estate also is a highly regional market, so prices often fall in some markets even while they increase in others.

If property values in your area start to fall after you buy a home, the decrease in your home’s value might be enough to push you underwater, even if you made a reasonable down payment and have kept up with your mortgage payments.

Low or no down payment

When you buy a home, you usually have to make a down payment. The size of the down payment depends on the type of mortgage you get. For example, a Federal Housing Administration loan requires a down payment of at least 3.5%, while a jumbo loan may require 10% or 20% down.

Lenders require a down payment to ensure the buyer is borrowing less than the home is worth, reducing the chances the loan will go underwater. You have to accrue more fees and interest on missed payments than your down payment, or your home would have to lose more value than your down payment for your loan to go underwater.

There’s a greater risk of going underwater if you make no down payment or a low down payment. Even a slight reduction in value or increase in the balance could put you underwater.

Missed payments

If you miss payments on your mortgage, you incur late fees, and additional interest will accrue on your loan. Both could increase your loan balance past your home’s market value.

Rising mortgage balance

Some types of mortgages have unusual features that make it easier for borrowers to go underwater. These loans are called nontraditional or nonqualified loans. For example, the balance on interest-only mortgages or loans with large balloon payments near the end of the loan term can increase. Such loans are rare and risky, so most borrowers avoid them.

6 Options for Homeowners Underwater on Their Mortgages

If you’re underwater on a home loan, don’t despair. Here are some steps you can take to get out of the situation.

1. Stay and Build Equity

If you’re underwater on your mortgage, the simplest option is to keep paying your loan. As long as you don’t need to refinance or sell, you’ll eventually pay down your loan enough to get above water again.

2. Modify Your Mortgage

If you’ve wound up underwater because you’re struggling to make payments, you might consider asking your lender about loan modification.

Loan modification involves working with your lender to change the details of your loan, such as the term, interest rate, and payment amount. The lender isn’t obligated to work with you, but if you’re facing financial difficulties, it may be possible to agree on a deal.

If you can modify your loan to make it more affordable, you won’t get above water right away. However, it’ll put you on a path toward paying down your loan balance.

3. Consider a short sale

If you owe more than your home is worth, selling your home has one obvious drawback: You won’t make enough from the sale to pay off your current mortgage. If you owe $300,000 and sell your home for $270,000, you’d still owe your lender $30,000.

One option may be to work with your lender on a short sale. Your lender agrees to accept less from the sale in exchange for releasing you from owing them any further money. You walk away without a house, but you won’t still owe the bank for a home you no longer own.

“Keep in mind that your buyer will need to work with an agent who is knowledgeable about short sales, and the buyer will have to use a specified lender,” says Marty Zankich, director and owner of Chamberlin Real Estate School, a San Jose, California-based school for real estate professionals. “This narrows your pool of potential buyers a bit.”

4. Walk Away from Your Mortgage

Another option is to grant your lender a deed in lieu of foreclosure. You give the home to the lender in exchange for the lender eliminating your debt. Like a short sale, you walk away owing no money on the home.

If you go this route, confirm that the lender will fully eliminate your debt and won’t pursue you for any money it could not recover by selling the home.

5. File for Bankruptcy

Bankruptcy is a legal process you can use if you’re unable to manage your debt payments. There are two main forms of bankruptcy: Chapter 7 and Chapter 13.

Chapter 7 bankruptcy eliminates almost all of your existing debts but often forces you to sell or give up all your assets, including your home.

Chapter 13 bankruptcy lets you restructure your debts. You file a plan with the court detailing how you plan to repay your creditors. In some cases, creditors will reduce your balance or eliminate it entirely, though this is most common with unsecured debt such as credit cards.

You may be able to keep your home under either form of bankruptcy, but it’s easier to do so under Chapter 13. To keep your home with Chapter 7 bankruptcy, you may need to qualify for a homestead exemption under federal or state law and be able to continue making timely payments.

6. Allow Foreclosure

The last option available is to simply let your lender foreclose on your home. You’ll have to move out and will have severely damaged credit, but with some work and time, you may be able to rebuild your financial foundation and credit score enough to buy a home again.

How To Avoid Going Underwater on Your Mortgage

One way to avoid going underwater on your mortgage is to make a large down payment. If you make a 20% down payment, you’d need to miss a lot of loan payments or have your home lose a lot of value to wind up underwater. You’d also avoid having to pay for private mortgage insurance. It’s much easier for fluctuations in the housing market to put you underwater if you make a small down payment.

Another tip is to try to buy in a stable or appreciating area. If you purchase a home in a strong market, the odds of it losing value are smaller than if you buy a property in an area where real estate values are known to be stagnant or falling.

Finally, the most important thing is to make sure you can afford your monthly mortgage payment and pay on time. Racking up late fees and interest by missing payments can drive your balance up and put you underwater. Timely payments will slowly decrease your mortgage balance and help keep you afloat.

FAQ: What To Do If You’re Underwater on Your Mortgage

Here are answers to common questions about what to do if you’re underwater on your mortgage.

The Bottom Line on What To Do if You’re Underwater on Your Mortgage

Being underwater or upside down on your mortgage can be a big problem if you want to sell or refinance your home, so take steps to avoid this situation, if possible. Offering a larger down payment and staying up to date with your payments are the best ways to avoid going underwater.