An underwater mortgage is where the market value of a home today is lower than the current balance owed on its mortgage. In other words, selling the property won’t generate enough money to pay off that mortgage and will leave a shortfall. Some people describe this as having “negative equity.”
The good news is the number of homeowners having this problem has tumbled dramatically in recent years and continues to fall quickly. The underwater mortgage is a phenomenon that largely arose from a housing crisis caused by the 2007/08 credit crunch and subsequent Great Recession. By the start of 2012, some 12.5 million homes had underwater mortgages. By the end of 2016, that was down to 5.4 million, according to Realtytrac/ATTOM Data Solutions.
However, that is not much consolation if you live in one of those areas where home prices have yet to bounce back up to their earlier highs. Worst hit is Nevada, where 19.5 percent of homes were still underwater at the end of 2016. But things were still bad that month in Illinois (16.6 percent), Ohio (16.3 percent), Missouri (14.6 percent), and Louisiana (14.5 percent). And, of course, there are plenty of other states, areas, and neighborhoods where equity remains a big issue.
What an Underwater Mortgage Looks Like
Having negative equity is a pretty abstract concept, so let's look at a concrete example. Suppose you bought a home in Nevada around a decade ago when prices were at their highest. On the day you bought it, your situation may have looked like this:
- Purchase price (= home's market value): $200,000
- Down payment: $10,000 (5 percent of purchase price)
- Mortgage balance: $190,000
- Equity (= home's value – mortgage balance): +$10,000
In February 2017, according to CoreLogic, home prices in Nevada were still 31.7 percent below their peak. So using the same example, your situation that month might have looked like this:
- Home's value: $136,600
- Mortgage balance: $161,074
- Equity: -$24,474
This is based on a 30-year fixed-rate mortgage (FRM) with a 6.5 percent rate, which Freddie Mac says was close to the average in 2007. And it means, after 120 payments (10 years x 12 months) of $1,200.93, you'd still be down nearly $25,000. Worse, absent any future home price increases in your area, your mortgage payments alone won't start to buy you positive equity until payment 183 – in roughly five years' time.
Problems Caused By Underwater Mortgages
Negative equity can cause you real problems if you need to sell your home, refinance it, or borrow using a home equity loan or home equity line of credit. Indeed, if it is preventing you from refinancing to a lower rate, and that means you are struggling to keep up with your existing monthly payments, it might put you in greater danger of foreclosure.
However, absent those, having a mortgage that's underwater need hardly bother you. How does it affect your day-to-day life?
True, you lack that lovely warm feeling you used to get from knowing your home was quickly contributing to your net worth. And, if you dwell on it, you could get depressed that home has actually reduced that net worth. But, if you have a glass-half-full disposition, and recognize your losses are all on paper, you may well not think about your mortgage's situation from one month to the next, though, you should always look out for ways to improve your financial situation.
Solutions for Underwater Mortgages
That is not to say negative equity doesn't often cause serious and urgent issues. Suppose you want or need to sell your home or refinance to a lower mortgage rate. It can be hard to achieve either of those while your mortgage is underwater. However, it may not be impossible, though, that will depend on a number of factors.
Selling Your Home With Negative Equity
Some homeowners simply walk away from their properties and mail the keys back to their lenders. A better way is to negotiate a short sale with your lender. With one of these, you are allowed to sell your home at its current market value, which frees you up to move on with dignity.
However, in most states (California, Nevada, and Oregon are the exceptions at the time of writing) you will still owe your lender the difference between what your mortgage balance was on closing (plus, maybe, some expenses) and how much your home sold for. You may be able to persuade the lender to insert a waiver in your short sale agreement eliminating that debt, but you cannot insist upon one.
Absent such a waiver, in most states, lenders can come after you for the shortfall and frequently do. Calls from collections agencies and letters from attorneys are commonplace after a short sale.
However, it is less common for all that barking to end with a bite. Unless your lender thinks you have the financial resources to make payments, it may ultimately decide not to pursue legal action against you.
Wherever you live, and whether or not you negotiated one of those waivers in your agreement, a short sale is highly likely to make a serious hit on your credit score. And its negative impact on your ability to borrow – certainly at affordable rates – is likely to last some years.
Refinancing With Negative Equity
One of the worst aspects of having an underwater mortgage is the difficulty in refinancing it. Earlier, you read that average rates for 30-year FRMs were close to 6.5 percent in 2007, and if you compare that with today's mortgage rates, you'll see just how an inability to refinance to a less expensive mortgage must have affected some homeowners.
In reality, many were able to refinance or modify their loans as a result of various federal government programs. Discover more at How To Refinance an Underwater Mortgage. One of these was the Home Affordable Modification Program (HAMP), but that was shuttered early in 2017.
Another is the Home Affordable Refinance Program (HARP). This is scheduled to close in September 2017, so, if you need to take advantage of it, you should act quickly. Learn more about HARP's eligibility rules at How to Qualify for the Obama Refinance Program.
If your mortgage is backed by a federal government guarantee (that mainly comprises FHA loans, VA loans, and USDA loans), you may be eligible to refinance your underwater mortgage through one of various "streamline" refinancing programs. These allow you quick and easy access to better rates but no cash. Find out more at Streamline Refinance Options.