At the peak of the Great Recession, a quarter of U.S. homeowners were underwater on their mortgage. By 2020, Attom Data Solutions reported that only 6.2% of homeowners with a mortgage were seriously underwater.
But that still comes to 3.4 million homes, and Attom only classifies homes as “seriously underwater” when home values drop 25% below mortgage balances. Which means millions more homeowners are underwater than Attom — the primary data provider on underwater mortgages — includes in its official numbers.
What Does It Mean to Be Underwater on Your Mortgage?
Also known as being upside-down, to be underwater on your mortgage means to owe more than your home is worth.
For example, say you bought a home for $250,000 and made a 3% down payment of $7,500. That puts your mortgage balance at $242,500.
The local housing market then drops by 5%, and your home value slips to $237,500. Suddenly you find yourself upside-down on your mortgage, owing more than the value of your home.
How Do People Become Underwater on Their Mortgage?
As illustrated above, you can fall underwater on your mortgage by the local housing market dropping in value. But that’s not the only way homeowners can become upside-down.
When homeowners fall behind on their mortgage payments, they can quickly rack up interest and fees that put their total loan balance over their home’s value. It’s a situation lenders want to avoid just as much as homeowners do, because lenders would lose money if they end up foreclosing on the home — which is precisely why lenders require a down payment.
Homes also can slip underwater if new information comes to light about their condition and needed repairs. Imagine a month after buying that $250,000 home you discover that toxic mold has festered behind the walls. You could be looking at a $20,000 renovation and mold remediation bill, which you would have to disclose if you were to list the property for sale. Your property value instantly drops by tens of thousands of dollars.
How to Tell If You’re Underwater on Your Mortgage
As simple as the definition for being underwater is, it’s not always easy to tell if your home is underwater. Although you can check your loan balance with a glance at your monthly statement, your home value proves far more slippery.
You can estimate your home’s value by searching for recent comparable sales on Zillow or Realtor.com. Look for homes as similar to yours as possible, from size to condition to location. But it’s not an exact science, because your home is only worth what a buyer would actually pay for it — which you can’t predict with precision.
Even if you spent the money to hire an appraiser, they would still only provide an estimate of value.
But being a little underwater doesn’t really impact you in any tangible way, as long as you can afford your payments and have no immediate plans to sell. If you do plan to sell, talk to a real estate agent about your home’s current value. They can provide you with a broker price opinion (BPO) before you list your home for sale.
Options If You Want to Stay in Your Home
If you find yourself underwater and you want to stay in your home, congratulations, because you have better options than homeowners who want or need to move.
Consider the following options, depending on your personal situation.
1. Keep Calm and Continue Paying
In many cases, the best option is simply to do nothing. Or rather, to keep making your monthly mortgage payments and let the problem resolve itself.
Because in most cases, your home equity will rebound. With every monthly payment you make, you pay down your loan balance. And most housing markets do appreciate over time as well, even if they experience an occasional dip along the way.
If you can afford your monthly payments and aren’t in a rush to move, don’t lose sleep over being underwater. In all likelihood the problem will correct itself in the long run.
2. Pay Down Your Mortgage Faster
Losing sleep anyway? You can always make extra principal payments to pay off your mortgage faster.
That could mean adding some extra money to each monthly payment. Or you could put one-time windfalls like bonuses or tax refunds toward your principal balance.
My personal favorite method is to switch your payment schedule to biweekly, to coincide with your paycheck. By making 26 half-month payments in a year, rather than 12 full-month payments, you effectively make one extra monthly payment every year — all without even noticing the difference in your budget.
Before making extra payments on your mortgage, look to your other debts. Mortgage loans tend to charge the lowest interest rates of all debt types, and you can usually save more money by paying off credit card debts, personal loans, student loans, and even auto loans before paying off your mortgage. Try the debt snowball method for quick traction in paying off your debts.
3. Force Equity with Updates
Beyond paying down your mortgage, you can also create equity from the other direction: by boosting your home’s value with home improvements. Real estate investors call this “forcing equity.”
You already know the concept, popularized by house flipping shows. By improving your fixer-upper, you lift the home’s value, ideally by more than you spend on the renovations.
Of course, it only works if your home actually needs repairs and updates. Or if you’re handy enough to make the home improvements at cost.
Because the average homeowner actually loses money on home improvements. According to Remodelling Magazine’s 2020 report, not a single home improvement adds more equity than it costs on average.
So think twice before writing a check to a contractor, and consider brushing up on your own handiness and making easy home upgrades yourself if you pursue this option.
4. Negotiate a Loan Modification
If you’re underwater on your mortgage and the lender has to choose between foreclosing on you and negotiating a loan modification, often they choose the latter. Lenders face a guaranteed loss when they foreclose on underwater homes, compared with a possible loss when they modify your loan.
Even so, don’t expect an easy go of it when you apply for a loan modification. Lenders don’t modify the loan for your benefit — they do it for themselves, and they often find ways to bend their bad situation to their own advantage. That sometimes means tacking on extra fees, restructuring the interest rate, or extending the life of your loan significantly.
Consider discussing loan modifications with your lender if you want to stay in your home but can no longer afford your monthly payments. If you can afford your monthly payment but simply feel nervous about being underwater, stick with the other options above.
5. Refinance Through Special Programs
Most underwater borrowers can’t refinance. Think about it: why would a mortgage lender ever lend you more than your home’s market value? It positions them for a loss if you default.
But Fannie Mae and Freddie Mac do offer special refinancing programs for underwater borrowers, which could theoretically help you.
Freddie Mac offers a program called Enhanced Relief Refinance, with a maximum loan-to-value ratio of 105%. You must be current on your mortgage, and must have made all payments on time for the past year. Freddie Mac, a quasi-government agency, designed this program to replace the Home Affordability Refinance Program (HARP) that ended in 2018.
Fannie Mae calls their program the High LTV Refinance Option, and it works similarly. Both programs work best for borrowers struggling with high-interest loans, who could avoid foreclosure and reliably make their payment with a lower fixed interest rate.
Options If You Want to Move
Not all homeowners have the luxury of time to simply wait out their negative equity. If you want or need to move pronto, yet you owe more on your home loan than its value, you do have options — just not especially good ones.
In descending order of desirability, consider the following options.
1. Keep Your Home as a Rental
The housing bubble and subsequent Great Recession saw many homeowners become “accidental landlords,” forced to move but unable to sell. Although you don’t hear the term as often today, it remains a viable option.
That’s true for some homeowners, anyway. It helps if your property can generate positive cash flow, so it earns you money each month rather than costing you money. And don’t assume that cash flow equals the rent minus the mortgage, either. Landlords incur far more costs than the mortgage payment, from vacancy rate to repairs and maintenance to property management fees to bookkeeping and legal fees. As a general rule of thumb, expect to lose around 50% of the rent to non-mortgage expenses.
Still, some homeowners keep their homes as a rental even with slightly negative cash flow. Losing $50 each month could sting less than losing $20,000 by selling the property, and eventually most homes do rise above the water line as they appreciate and the owner pays down the principal balance.
You could also offer your home under a rent-to-own model to secure a long-term tenant invested in your home and an eventual buyer with a single swipe of the pen.
2. Negotiate a Short Sale
The same logic applies to short sales as to loan modifications: lenders don’t do it as a favor, they do it to avoid the guaranteed losses of foreclosing on an underwater home.
In fact, the word “logic” often doesn’t apply. Most U.S. mortgage loans are owned by massive corporations who make short sale decisions based on complex bureaucratic rules, not based on your individual situation. Often these byzantine rules disqualify borrowers from short sales even though they would have saved the lender money. I’ve known borrowers who lost homes to foreclosure despite having a buyer lined up who would have paid far more than the foreclosure auction price.
Even so, it’s worth contacting your lender and applying for a short sale if you need to sell an underwater home. The worst they can say is no, and you’re no worse off than you are today.
As a final thought, note that short sales do come with tax consequences. The IRS adds insult to injury by taxing you on the forgiven debt as if it were income.
3. Cough Up the Difference in Cash
If you owe $250,000 and your property value has fallen to $200,000, you could sell it for $200,000 and come out of pocket for the missing $50,000. Ouch.
Actually, it’s worse than that. When you sell your home, you need to pay closing costs, which typically include 6% in real estate agent commissions. So in addition to all the other closing costs and your $50,000 haircut, you’d also owe $12,000 in agent commissions on that $200,000 sale.
Even if you sold the property without a real estate agent, you’d still owe the buyer’s agent commission. So it would save you only half the commission cost.
4. Offer a Deed in Lieu of Foreclosure
When you fall behind on your mortgage and can’t catch up, some lenders will accept the deed to the property rather than foreclosing on you.
You still lose your house, but you were planning on moving anyway. This way, you don’t end up with a foreclosure on your credit report, and avoid a money judgment.
It does come with a cost however. Even though it doesn’t appear on your credit report, future lenders will ask you under penalty of perjury whether you’ve ever given a deed in lieu of foreclosure. Expect a far more difficult loan approval if you answer yes.
5. The Nuclear Option: Strategic Default
Another Great Recession-era term, strategic default refers to simply walking away from your underwater home. The lender forecloses and eats the loss on the property, they secure a judgment against you for the loss, and the only people who win are their well-paid attorneys.
It hurts home values in the neighborhood, it hurts your credit, it hurts the lender, it hurts every other homeowner in America who pays private mortgage insurance specifically because of these defaults. Make no mistake: strategic default deals terrible damage to the economy at large, and to you personally.
Consider it as a last resort, after trying every other option on this list.
Contrary to popular myth, real estate doesn’t always appreciate in value. When property values fall rather than rise, homeowners can find themselves in a deep morass.
But real estate does usually appreciate, and as long as your city and neighborhood remain attractive places to live long-term, you can often weather fluctuations in property values without losing sleep. The greatest downside to homeownership, however, is the loss of flexibility. You can’t move easily, and never does that drawback hit harder than when you’re upside-down on your mortgage.