An underwater mortgage can feel as if you're spinning your wheels and getting nowhere. You make a mortgage payment every month, yet your property doesn’t gain equity. An underwater mortgage means you own more than the property is worth. It's a frustrating situation to find yourself in, and at times you might feel stuck. Fortunately, an underwater mortgage doesn’t last forever and there are options available.
What Causes an Underwater Mortgage?
Buying a home is a big investment, but it can also be one of the best investments you make. For many people, their home is their biggest asset. In a perfect world, we would purchase a home and witness our property values increase little by little with each passing year, resulting in substantial equity. Of course, this scenario isn't guaranteed. With any home purchase, there's the risk of a property losing its value.
When home values rise, some people run out and buy a property for fear of being priced out of the market. But as quickly as home prices increase, they can come crashing down. If you bought high only to see your property value plummet one or two years later, you could end up with an underwater mortgage.
What Are Your Options?
Unfortunately, there isn’t much you can do to quickly dig yourself out of the hole. Even so, keep your head up. Recovery is a slow process, but you can get back on top.
1. Stay put for now
An underwater mortgage is easier to swallow when you don't have immediate plans to move. But if you are ready to downsize or upgrade to a home that’s more functional for your family, an underwater mortgage can throw a wrench in your real estate plans.
You can't change the present, but you can make the best of the situation. Staying put for the time being may be the only option. In the meantime, consider making an extra principal payment every month, if your budget allows this. If you have an extra $100, $200 or $300 a month, put this money toward your principal and start eating away at the negative equity. It's a slow process, but this approach points you in the right direction.
2. Ask your lender about HARP
An underwater mortgage makes it incredibly difficult to get a standard refinance. Typically, you need a minimum of 5% equity to refinance a conventional or an FHA mortgage loan. However, help is available if you owe more than your property is worth. Ask your lender about the Home Affordable Refinance Program (HARP). This program is designed to help struggling and upside down homeowners refinance. If eligible, you can refinance up to 125% of your home’s value and possibly benefit from a lower interest rate and a lower monthly payment. To take advantage of HARP, your mortgage must be guaranteed by Fannie Mae or Freddie Mac.
3. Negotiate a short sale
If you absolutely need to move and can't sell because you're underwater, there are two options for selling the home. You can price the home for less than you owe and pay the difference out of your own pocket at closing. This might be doable if you're only slightly underwater. If you owe significantly more than the home’s value, or if you don't have cash to pay the difference, ask your lender about a short sale. Getting a short sale can be difficult and some lenders will not entertain the option. Typically, qualifying requires going through some type of hardship, which you’ll have to verify. Getting a lender to approve a short sale can take up to several months. Be aware that a short sale will damage your credit score.
4. Rent out the property
The real estate market will eventually recover, at which point you'll see the return of equity. If you have to move before recouping equity, consider renting out the property. If you find a tenant to pay the mortgage, you can move into another property. Make sure you recognize the dangers of managing two properties. Being responsible for two homes can be costly. To manage expenses, get a home warranty for both properties, which helps cover the cost of repairing some of the home’s major components, such as the plumbing, electrical, HVAC system and appliances. If you rent out the property, try and rent the property for more than your mortgage payment. Deposit surplus funds in a special account for unexpected taxes, repairs and maintenance.
There is no true way to know for sure if you're home is underwater until you speak with a mortgage professional about your home's value.