What Is an Upside Down Mortgage and What Can You Do?

An upside-down mortgage, also referred to as an “underwater” mortgage or negative equity, occurs when the outstanding balance of a home loan exceeds the current market value of the property.

Understanding Negative Equity and Its Causes

Negative equity arises when the amount owed on a mortgage is greater than the home’s market value. This concept is closely tied to the loan-to-value (LTV) ratio, which compares the outstanding loan balance to the property’s current value. When this ratio climbs above 100%, negative equity is present.

A primary cause of negative equity is a decline in real estate values, often due to economic downturns or shifts in local housing markets. If a homeowner purchases a property when prices are high and values subsequently fall, the home’s worth can drop below the mortgage amount.

Another contributing factor is making a low or no down payment at the time of purchase. A smaller initial equity buffer means that even a modest decrease in home values can quickly push the homeowner into a negative equity position.

How to Determine if Your Mortgage is Upside Down

To ascertain if your mortgage is upside down, compare your current outstanding mortgage balance to your home’s current market value. If the mortgage balance is higher than the estimated value, the property is in negative equity.

You can obtain your current mortgage balance from your latest monthly mortgage statement. These statements provide a snapshot of your loan details. Alternatively, contacting your mortgage servicer directly will provide this information.

Estimating your home’s current market value can be done through several methods. A professional appraisal offers the most accurate valuation, typically costing between $300 and $500. Appraisals consider the home’s condition, features, and recent sales of comparable properties in the area.

Real estate agents can also provide a comparative market analysis (CMA), which assesses value based on similar local sales. Online valuation tools offer quick estimates, but their accuracy can vary, as they rely on algorithms and public data.

Implications of an Upside Down Mortgage

Selling the home becomes problematic because the sale proceeds will not cover the outstanding mortgage balance. This means the homeowner would need to bring cash to closing to pay off the difference.

Refinancing a mortgage also becomes difficult with negative equity. Lenders generally require a certain amount of equity, often around 20%, to approve a refinance. Without this equity, homeowners are typically unable to secure new loan terms or lower interest rates.

Access to home equity products like home equity loans or lines of credit is generally unavailable. These products are based on the homeowner’s available equity, and negative equity means there is no collateral to borrow against.

While negative equity alone does not always lead to foreclosure, it can exacerbate the risk if the homeowner experiences financial hardship. If a homeowner cannot make payments and cannot sell the property to cover the debt, the risk of default and foreclosure increases.

Navigating an Upside Down Mortgage

One common approach is to continue making regular mortgage payments and wait for market values to recover. This strategy is suitable for those who can comfortably afford their payments and do not need to relocate.

Another option is to explore a loan modification with the lender. A loan modification involves changing the original terms of the mortgage, such as the interest rate, the loan term, or even the principal balance, to make monthly payments more affordable. Lenders may consider modifications to avoid the costly and lengthy foreclosure process.

A short sale is an alternative where the lender agrees to allow the homeowner to sell the property for less than the outstanding mortgage balance. The proceeds from the sale are given to the lender, who accepts them as full or partial satisfaction of the debt. Homeowners typically submit a hardship letter and financial documentation to their lender.

A deed-in-lieu of foreclosure involves the homeowner voluntarily transferring the property deed to the lender to satisfy the mortgage debt. This process allows the homeowner to avoid a formal foreclosure action, which can have more severe credit implications. Lenders may agree to a deed-in-lieu to avoid the expenses associated with foreclosure proceedings.

If a homeowner needs to sell and has sufficient other assets, they can choose to bring cash to closing. This means paying the difference between the sale price and the outstanding mortgage balance out of pocket. This option allows for a conventional sale even with negative equity, but it requires significant personal funds.