What Does It Mean to Be Underwater on Your Mortgage?

It’s a tough spot to be in.

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You may have heard the term "underwater" with regard to a mortgage, especially if you were following the news during the 2008 housing crisis. A large number of homeowners were underwater on their mortgages back then, and some have still not managed to resurface.

If you're underwater on your mortgage, it means you owe more on your home than it's actually worth. Imagine you bought a home two years ago and took out a $250,000 mortgage to finance it. If your home is now only worth $200,000, but you have $230,000 remaining on your mortgage, you're underwater -- or upside down -- on that loan.

Generally, people wind up underwater on their mortgages when housing prices fall rapidly. This could happen on a nationwide level, or a local one. For example, if a local school closes down, or a number of businesses in an area close in rapid succession, home values in your neighborhood could start to plummet. This could lead to a scenario where you're underwater, despite having kept up with your monthly mortgage payments.

What to do if you're underwater on your mortgage

Being underwater on a mortgage isn't ideal, but in some cases, it's not so terrible, either. If you can afford to make your monthly mortgage payments and intend to stay in your home for a number of years, your best bet is to keep doing just that, and wait for the market to pick back up again. Chances are, it will, in time, at which point you'll have the option to sell your home (should you choose to) without taking a loss.

If you're struggling to make your mortgage payments, that's a different story. Under normal circumstances, refinancing would be an option, but unfortunately, you can't refinance a mortgage when the amount you owe is higher than your property is worth. In fact, most lenders require you to have 20% equity in your home in order to refinance. What you can do, however, is apply for assistance through the Home Affordable Refinance Program, or HARP.

HARP was created following the 2008 housing crisis, and it could allow you to refinance if you're underwater on your mortgage. To qualify, your mortgage loan must be owned or guaranteed by Freddie Mac or Fannie Mae, and you can't be behind on your payments. Missing a payment over the 12-month period prior to your application could also disqualify you. HARP is a good option if you're eager to stay in your home.

If you're looking to sell your home but you're underwater on your mortgage, you can always put it on the market, get what you can for it, and pay your lender the difference. For example, if you sell your home for $200,000 but owe your lender $230,000, you'd pay $30,000 to wash your hands of that property. Clearly, that's not an ideal route to take, but if you have the money, coupled with a pressing reason to move, it's a good way to make a clean break without damaging your credit.

If you don't have the money to make up the difference between what your home sells for and what you owe your lender, you can look into a short sale. In a short sale, a lender agrees to sell your home for less than what you owe on your mortgage, and that lender basically eats the difference. In this case, if your lender agrees to a short sale and your home sells for $200,000, your lender would be short the $30,000, and you wouldn't have to pay it.

To qualify for a short sale, you'll need to prove to your lender that you can’t afford your monthly mortgage payments, and don't see the situation changing anytime soon. A short sale may seem like a "get out of jail free"-type solution, but be aware that it'll hurt your credit, and make it harder for you to borrow money for a period of time after completing the process. That said, it'll do far less damage to your credit than a foreclosure.

If you're underwater on your mortgage, but are managing your monthly payments just fine and aren't looking to sell your home, then there's no need to panic. But, if you can't keep up with your payments or do need to sell, it's a different story. In that case, explore your options for relief, and you'll hopefully escape the situation with your finances and credit score as intact as possible.

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