*This post was created in collaboration with Mortgage Maestro.
When your mortgage loan amount is higher than what your home is worth, your mortgage is considered “underwater”. Having an underwater mortgage can be risky and a hassle to deal with as it can affect your ability to refinance your mortgage or sell your home.
Let’s take a closer look at what it means to be underwater on your mortgage and what you can do to get above water.
Key Points About Underwater Mortgages
| What Is It? | Being underwater on your mortgage means the remaining mortgage balance is higher than the current value of your home. |
| Underwater Mortgage Causes | You’re at higher risk of having an underwater mortgage if your home depreciates and/or you miss mortgage payments. |
| Underwater Mortgage Solutions | If you’re underwater on your mortgage, you have options, including waiting for your home to increase in value, refinancing, selling your home, or opting for a deed in lieu of foreclosure. |
What Is An Underwater Mortgage?
An underwater mortgage is a mortgage where the homeowner owes more to the lender than what the home is worth. This can happen when the homeowner’s property value depreciates after purchasing the property.
What Happens When You Mortgage Is Underwater?
When this happens, the homeowner might not have any equity in the home. This can negatively affect a person’s available credit and prevent the borrower from refinancing the mortgage. The homeowner may not even be able to sell the home without putting in their own cash to cover the losses.
What Causes An Underwater Mortgage?
There are two key reasons why mortgages wind up underwater: Depreciation and missed mortgage payments.
Depreciation In Value
While real estate tends to increase in value over the long run, there may be times when value dips for a certain amount of time. Here are some reasons why:
Excess Supply Of Homes
A drop in home prices can happen when there’s an excess supply of homes available for sale in your area and not as many buyers looking. In this case, there is little demand for homes, and home prices can dip in response to attract buyers.
High-Interest Rates
Home prices might also dip because of very high-interest rates. When interest rates increase, it increases the cost of getting a mortgage. This can deter buyers from taking out a mortgage to buy a house. Again, this can result in a cooler market where there’s not as much demand as would be needed to fuel home prices.
Recession
When the economy is weak, consumer spending may lag. Not only are people less likely to spend money on everyday things, but they’ll also be less likely to buy a home. In this scenario, demand for housing can drop, leading to a subsequent dip in property values.
During these periods, mortgages with a very high loan-to-value (LTV) ratio may be at risk of ending up underwater. This happens when the loan amount borrowed is higher relative to the appraised value of a home.
Missed Mortgage Payments
You can also send your mortgage underwater if you miss your mortgage payments.
Early on in your mortgage, a larger share of your mortgage payments goes towards the interest portion of your loan. With every mortgage payment you make, less and less goes towards interest, while an increasing amount is contributed to paying down the principal.
Missing a mortgage payment means that the interest that was not paid will accumulate. Since mortgage interest rates are compounded, it will be more difficult for you to repay your loan because of a missed mortgage payment.
How To Get Out Of An Underwater Mortgage?
The sooner you find out that you’re underwater on your mortgage, the better. This will give you time to take steps to get yourself out of this situation. Here are a few options to consider to get yourself out of this predicament:
Option 1. Refinance Your Mortgage
Refinancing involves replacing your current mortgage with a new one on different terms. But to qualify, you’ll generally need to have some equity in your home first, as lenders typically don’t allow mortgage refinancing on an underwater loan.
As such, you’d need to make payments on your loan until you build enough positive equity to refinance. Once you have enough equity, you can enlist the help of a mortgage broker like Mortgage Maestro to help you refinance your home. They have access to a large network of lenders whom they can connect you to and offer the best rates.
Option 2. Stay In Your Home
Consider whether you think property values will increase soon. In this case, you may be able to build some home equity over the next little while as the value of your home appreciates. Even the slightest increase in home values can make a big difference.
Moreover, if your income increases in the near future, you may be in a better position to pay your home loan faster and get yourself out of an underwater situation.
Option 3. Sell Your House
If you don’t see any way for your home to increase in value in the next little while or your income can’t support additional mortgage payments, it might be time to sell. However, you’ll only be able to sell your home with an underwater mortgage if you have enough cash available to make up the difference between the amount you still owe and the value of your home.
Option 4. Sell Through A Short Sale
Another way to get yourself out of an underwater mortgage is to go through a short sale. This process involves selling your home for less than what you owe on your mortgage and asking your lender to forgive the difference. You’ll need to work with a real estate agent who is experienced in short sales to boost the odds of getting approved by a lender and finding a buyer.
Option 5. Ask Your Lender For Help
If you don’t want to sell your home, ask your lender if they would be willing to reduce your principal amount. In this case, your lender would lower your overall loan amount, which they may be open to to avoid a costly foreclosure process.
Option 6. Rent Out Your Home
If you have someplace else to live (temporarily), consider renting out your home to help you pay the mortgage. Or, you could rent out part of your home, such as a room or basement, to collect rent cheques to put towards the mortgage. You may choose to rent out your home until you’re no longer underwater on your mortgage or the housing market improves.
Option 7. Increase The Value Of Your Home
You can add equity to your home very quickly by making specific upgrades. If you have the money or the know-how to tackle these upgrades yourself, you could add value to your home and get yourself back into positive equity territory. Some of the best upgrades that bring in the highest return on investment include kitchen and bathroom remodels, adding an outdoor space, improving curb appeal, or finishing the basement to add more living space.
Option 8. Make Extra Mortgage Payments
If you have extra money and your mortgage contract allows it, you may choose to make extra mortgage payments. You may either make lump sum payments that go toward the principal or increase your payment amounts or frequency. These extra payments will go entirely to your principal, which will help you pay down your mortgage faster and add more equity to your home.
Option 9. Deed-in-Lieu Of Foreclosure
A deed-in-lieu of foreclosure involves signing over the deed to your home to your lender. In exchange, you are alleviated of your mortgage obligations. This can be beneficial for you and your lender because it can help avoid foreclosure, which is a hassle for lenders.
How To Check If Your Mortgage Is Underwater?
Follow these steps to see if your mortgage is underwater:
1. Verify Your Outstanding Loan Balance
Find out what you still owe on your mortgage, which you can do by looking at a recent mortgage statement or by checking your mortgage account online.
2. Find Out What Your Home Is Worth
You can get a rough idea of your current home value by doing an online search. You can visit a real estate website and type in your location to see what other properties like yours are being sold for. If you want a more accurate estimate, you may want to consider hiring an appraiser to come and evaluate your home and tell you exactly what your home is currently worth in today’s market.
3. Subtract Your Loan Balance From Your Home’s Value
To find out if you owe more on your mortgage than your home is worth, subtract your mortgage balance from the property value. For instance, if you still owe $450,000 on your mortgage, and your home is only worth $425,000, your mortgage would be considered underwater by $25,000.
How To Avoid An Underwater Mortgage?
The best way to avoid an underwater mortgage is to save up for a large down payment.
A very small down payment puts you at greater risk of ending up underwater on your mortgage if home prices decline shortly after you buy your home. The mortgage default insurance can exacerbate this. You’ll have to pay if you put down less than 20% when you first take out your mortgage. The less you put down, the higher your premiums will be.
Avoiding An Underwater Mortgage: Example
For instance, let’s say you buy a home for $500,000 and make a 10% down payment ($50,000). At that rate, you would be required to pay a 3.10% mortgage default insurance premium on the total loan amount. With a $450,000 mortgage ($500,000 – $50,000), your insurance premium would come to $13,950 ($450,000 x 3.10%).
If you roll this amount into your mortgage, you’ll owe 93.10% of the price you paid for your home (the original 90% + the additional 3.10% for default insurance). So, you’ll owe $463,950 in total ($450,000 + $13,950).
If the market cools for a while and your home is now valued at $440,000, you would be underwater on your mortgage by $23,960 ($463,950 – $440,000). Instead, if you had made a 20% down payment (which would come to $100,000), you would have an initial mortgage amount of $400,000. In this case, even if your home value dipped to $440,000, you would still have $40,000 in positive equity.
The lower the amount that you owe on your mortgage compared to what your home is valued at, the better. You’ll be at less risk of finding yourself underwater on your mortgage, so do your best to put down a large payment when you first apply.
Bottom Line
If you have a mortgage, be sure to keep tabs on it, as well as the value of your home. If you find that what you still owe on your mortgage is very close to the value of your home, take immediate steps to rectify the situation to avoid the headaches that come with an underwater mortgage.
Underwater Mortgage FAQs
Will being underwater on my mortgage affect my credit score?
Can my mortgage end up underwater even though I keep up with my mortgage payments?
What is “negative equity”?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
