How do underwater mortgages happen?
A mortgage can go underwater -- or upside down -- in one of two ways. The first and most common is when housing prices drop. If a home's value drops far enough, as in the example above, it will eventually fall below the remaining balance on the mortgage. At that point, the borrower is "underwater" on their loan, and they have on their hands an underwater home.
You can also have an underwater mortgage if you fail to make your payments. When this happens, interest starts to accumulate faster and faster, and your balance could eventually outstrip the home's value.
Underwater mortgages were a major problem during the housing market crash in 2008. Because home prices had been overinflated, many homeowners found themselves owing more than their properties were worth once the housing bubble burst. This housing crisis eventually led to an unprecedented wave of foreclosures when struggling homeowners -- particularly those with adjustable-rate loans -- could no longer make their monthly mortgage payments.
The problem with an underwater mortgage
The biggest issue with an underwater mortgage is that if you sell the home, you won't make enough to pay off your loan, and you'll still owe money on top of it.
An underwater mortgage can also keep you from refinancing. To refinance your mortgage loan, many lenders will require an appraisal -- an assessment of your home's market value. If that appraised value comes in lower than your mortgage loan balance, you won't be able to refinance.
Finally, there's also an increased risk of foreclosure with an underwater mortgage. If you fall behind on your monthly payment schedule, you won't be able to sell the house or refinance to get back on track. This could put you at a higher risk of losing your house.
Are you underwater on your mortgage?
To determine if you're underwater on your loan, you'll need to look up what you still owe on your mortgage -- the total remaining balance. You should be able to find this in your online mortgage dashboard or by contacting your mortgage servicer.
You should also find out your home's market value. You can ask a local real estate agent to pull comparables in your area and give you an estimate of this, or, if you want a more accurate home value, hire a professional appraiser to do the job. This usually costs around $300 to $400.
From there, you just need to subtract your mortgage balance from the property value. As long as you come up with a positive number, you're golden. If you come up with a negative, though, that means you're underwater and owe more than your home is worth on the current market.
What can you do if your mortgage is underwater?
As a homeowner, it can be scary to learn that you have an upside down mortgage, but fortunately, you're not without options. The first, and often best, choice is just to stay put. The housing market is cyclical, so there's a good chance your home's value will rise again.
If it doesn't, that's OK, too -- as long as you keep making your payments. The more you pay down your loan, the more equity you'll build, and this can help offset any losses in home value.
You can also try the Fannie Mae High Loan-to-Value Refinance or the Freddie Mac Enhanced Relief Refinance, both of which are designed to help underwater homeowners refinance their mortgages and achieve more affordable monthly payments.
A short sale is also an option. This is when your mortgage lender agrees to let you sell your home for less than you owe them. To do this, you'll need to contact your lender and discuss your options.
The Millionacres bottom line
Having an underwater loan is never ideal, but it doesn't mean you're doomed to financial ruin. Either keep up your payments and stay put, or get in contact with your mortgage servicer to discuss refinancing or a short sale.
Need more guidance? Talk to a HUD housing counselor or financial advisor. They can guide you toward the best move for your particular situation.