In simpler terms, you have an “underwater” mortgage if your mortgage has an outstanding balance that is higher than your property’s value. This is also known as a negative equity mortgage or upside down mortgage.
How an Underwater Mortgage Works
To illustrate how an underwater mortgage works, here’s an example:
Current Property Value = $300,000
Current Outstanding Mortgage Balance = $400,000
Home Equity = $100,000 (Negative Equity)
In this example, you are $100,000 underwater on your home loan since your outstanding mortgage balance is $400,000, while your property only has a current appraised value of $300,000. Because of this, you now have an LTV or loan-to-value ratio of 125% — note that a lower number is better since an LTV ratio higher than 100% means underwater status or negative equity.
What You Can Do If You Have Underwater Mortgage
One of your options is to apply for the Home Affordable Refinance Program (HARP) by the federal government. If you qualify, you’ll be allowed to refinance your home loan — without regard to how much your negative equity is — from 105% to as much as 125% of the value of your property. But, you can only be eligible for HARP if your mortgage loan is backed by Fannie Mae and Freddie Mac.
You can also choose to go with HAMP or the Home Affordable Modification Program by the federal government. This is if aside from an underwater mortgage, you also have missed monthly mortgage payments. Although this program can offer government incentives as high as $1,500 to lenders who’ll process your modifications, approval for the loan is still up to the lender. Additionally, your mortgage must be a government-backed loan.
If All Else Fail…
If you don’t qualify for HARP or HAMP and your mortgage is deeply “underwater,” the most ideal thing to do is to simply walk away, just rent for a couple of years, and then purchase a home again when you’re sure you’re financially ready. Just carefully weigh all the pros and cons, as well as risks, and make a viable plan for the long haul. This is a monumental decision, so treat it as such.