What does an underwater home loan mean?

We’ve come a long way from the 2008 financial crisis, when one out of every four mortgages was underwater. Yet, it’s still not uncommon for homeowners to find themselves in these shoes today, and often at the most inopportune moments, like when you’re applying for a home equity loan. 

Having an underwater mortgage sounds scary at first, and it can be in some cases. In others, it might be a total nothingburger — it just depends on what you’re trying to do with your home and your financial situation. Either way, there are usually workarounds that can help. We’ll explore how an underwater home loan works, and how you can get past it. 

What does it mean to have an underwater mortgage?

An underwater mortgage means that you owe more than your home is worth. In other words, your mortgage balance is higher than the value of your home. This means you have negative equity in your house, and your lender has a legal claim to the entire value of your home — and then some. 

It’s rare for lenders to offer mortgages for more than the home is actually worth when you’re buying a new house. Generally, the trend goes in the opposite direction: you build positive home equity over time as you pay down the balance of your mortgage, while your home value (hopefully) rises.

Unfortunately, it doesn’t always work that way. 

What causes an upside-down mortgage?

Sometimes your mortgage balance grows over time, and/or your home value declines. This can happen for a number of reasons, such as:

• Your home fell into disrepair, lowering the market value of your house.
• You put your mortgage in forbearance, causing your principal balance to grow.
• The real estate market takes a downturn, resulting in lower housing prices for everyone. 

Some things can increase your likelihood of an upside-down mortgage. Taking out a larger loan against the value of your home and buying during a housing bubble leaves you at increased risk of an underwater mortgage. 

If you only put 5% down on your home, for example, it takes a smaller market downturn before your house is underwater compared to if you put 20% down. In fact, that’s why lenders generally require a down payment in the first place. 

Similarly, tapping into your home equity can increase your risk of an underwater home loan. You’re essentially working backward in your progress toward paying off your home. This puts you closer toward the crossover point where your home debts exceed your home’s value, especially during times of declining property values. 

How can I tell if I have an underwater mortgage?

You only need to compare two numbers to determine if you have an underwater home loan: the combined balance of your home debts and the estimated value of your home. 

If your home debts are lower than your home’s value, you have positive equity in your home. 

On the flipside, if your home debts are higher than your home’s value, you have negative equity in your home, and your house is underwater.

You can find this information in your most recent mortgage statement. Remember to include the current balance of any other home debts you may have, like a home equity loan or line of credit (HELOC). 

You can also get a rough idea of your home’s value by taking the average of a few estimates from online real estate websites, like Zillow, Redfin, and Realtor.com. Estimates are fine for these purposes; you don’t need to do a full home appraisal unless you’re applying for credit.

What happens if your mortgage is underwater?

Having an underwater home loan isn’t always a problem, especially if you’re able to make your mortgage payments just fine and have no plans to change things up. Underwater mortgages only cause problems if you’re trying to make certain moves:

• Selling the home: If the proceeds from your home sale aren’t enough to repay your mortgage, you won’t get any cash back. Lenders may accept less than you owe, but this adds extra wrinkles during the closing process that can deter buyers. 
• Refinancing the home: Lenders generally don’t approve refinance applications for loans over 97% of your home’s value, except in special cases. Often, they limit you to much smaller percentages than that.
• Tapping into home equity: Similar to refinancing, most lenders won’t approve home equity loans and HELOCs unless you have a significant amount of equity in the home.
• Paying back existing HELOCs: If you already have a HELOC on your home, your lender can shrink your credit limit or even cut you off from drawing new funds entirely if they think you’re at risk of ending up with an underwater home loan.

Notice that each of these consequences can limit your options for using your home equity or even getting out of your home, should your payments become unaffordable or you need to move. That, in turn, can increase your risk of foreclosure and credit score damage — but there are things you can do before it gets to that point.

What are your options if you're underwater on your mortgage?

Broadly speaking, your options for dealing with an underwater mortgage depend on whether you want to keep your home, or sell it. 

If you want to keep your home

You have a few more options if you want to retain ownership of your home and build equity over time:

• Wait: If you don’t need to do anything, the best option is to wait. The situation will resolve itself over time as you continue building equity each month with your payments.
• Refinance: Certain types of mortgages, such as the FHA Streamline Refinance, allow you to refinance to a lower interest rate more easily, even with an underwater mortgage.
• Bankruptcy: You may be able to file for bankruptcy and keep your home in certain cases, but it’s very important to work with a bankruptcy attorney to be sure. 
• Credit counseling: Nonprofit credit counseling agencies offer free or reduced-cost help in managing your debt problems, including housing issues with underwater mortgages.
• Loan modification: Some lenders offer programs to help ease the burden on struggling homeowners, such as lowering the interest rate or loan balance, without refinancing.
• Boost your home’s value: You can also build equity by undertaking high-ROI home improvements and upgrades.
• Pay down your mortgage: If you have access to extra funds, you can pay down the balance of your mortgage to increase your home equity. 

If you want to move somewhere else

An underwater home loan can feel like it’s trapping you in place, but that’s often not the case. Here are your main options:

• Short sale: If you can find a buyer, some lenders may allow you to sell your home for a lower real estate price than you owe on your mortgage. In addition, you may be able to ask your lender to forgive the remaining balance.
• Renting out your home: Many people become landlords inadvertently because they need to move elsewhere but are unable to sell their home. Renting it out can sometimes be a viable option to cover your mortgage payment in the meantime.
• Deed-in-lieu of foreclosure: Some lenders will let you voluntarily trade the keys to your home back to the bank in exchange for being cut free from the loan. This can carry tax and legal consequences, as with a short sale, so it’s wise to seek out expert advice.

Frequently asked questions

What causes a mortgage to become underwater?

If your mortgage balance rises, or — more commonly — if your home value drops, even through no fault of your own, it can cause you to become underwater on your mortgage. 

Can I get a HELOC or second mortgage if I’m underwater?

Probably not, unless your lender offers special programs. Second mortgages and even things like home equity investments typically require significant amounts of home equity to qualify. If you need to borrow money while your house is underwater, you’ll likely need to rely on unsecured debts like personal loans or credit cards. 

What’s the difference between being underwater and having negative equity?

There’s not really any difference between these two terms. Being underwater on your mortgage and having negative equity are the same thing. 

Final thoughts

Dealing with housing debt can be very frustrating, but you don’t have to go it alone. If you can afford it, hiring a financial advisor who works on a fiduciary basis (i.e., in your best interest) is often worth it. Otherwise, reaching out to a nonprofit credit counseling agency can help you get in touch with a housing counselor who can provide similar support.