Key takeaways
- Refinancing an underwater mortgage can be difficult, but not impossible. It’s easier if you have a government-backed loan such as an FHA, VA or USDA loan.
- It doesn’t always make sense to refinance out of an underwater mortgage, especially if you can still afford the monthly payments. Consider the costs, how long you plan to stay in the home and how property values seem to be trending in your area.
- If you don’t qualify to refinance and can no longer afford the payments, you might choose to seek out a loan modification or sell the home.
If you owe more on your mortgage than what your home is worth, you have what’s known as an underwater or upside-down mortgage, or negative equity. This can happen when property values fall, and especially if you made a small down payment and aren’t very far into repaying your loan. It can also happen if you’re behind on payments, or if you’ve overleveraged the property with additional loans.
Although not always an option, it might be possible to refinance an underwater mortgage. Here’s how.
How to refinance an underwater mortgage
1. Confirm the status of your mortgage
Compare your home’s current market value to the remaining loan balance on your most recent mortgage statement. If the home is worth less than what’s left to pay, your loan is considered underwater.
You can use a free online home value estimator to get a sense of your property’s worth, but keep in mind, if you’d like to refinance, the lender will likely order an appraisal to determine its value. This valuation might be different from the results of an online tool.
2. Understand your options
There’s more than one way to approach an underwater mortgage, so before you pursue a refinance, learn your options. You might choose to continue paying your existing mortgage, or sell or otherwise walk away from the property. It might not be feasible to refinance at all, especially if you don’t have a government-backed loan, haven’t had your loan that long or are behind on payments.
If you can refinance, here are the most common options:
- FHA streamline refinance: If you have an underwater FHA loan, you might be eligible for a streamline refinance, which doesn’t require an appraisal. The new mortgage needs to provide a “net tangible benefit” that helps you financially, such as a lower interest rate or a shorter loan term.
- VA streamline refinance: Also known as an IRRRL (Interest Rate Reduction Refinance Loan), this type of streamline refinance applies to VA loans and also doesn’t require an appraisal.
- USDA streamlined or streamlined assist refinance: If you have an underwater USDA loan, you might be able to refinance it with one of the USDA’s streamline programs, which don’t require an appraisal in most cases. For streamlined assist, the new mortgage needs to provide a net tangible benefit.
Keep in mind:
If you want to refinance an underwater mortgage, do not stop making the monthly payments. You won’t be eligible for a new loan if your current loan isn’t in good standing.
3. Compare mortgage refinance lenders
You don’t have to refinance with your current mortgage lender, and there might be other lenders more willing to work with you on an underwater loan. Generally, it’s best to compare at least three options.
Should you refinance an underwater mortgage?
Pros
- You might pay down your loan faster. You might be able to direct the refinance savings toward paying down your mortgage balance sooner. This could help your loan come up from underwater — albeit over time — even if home values don’t change.
- You might save on interest. If the refinance results in a lower interest rate, you’ll save money in the long run.
Cons
- You have to pay closing costs. A refinance comes with closing costs, including mortgage insurance for an FHA streamline and fees for VA and USDA streamlines. You might not be able to afford these expenses if you’re already having trouble making loan payments.
- You could lose money if you plan to move soon. If your mortgage is underwater because your home has declined in value, you might be planning to move in the near future. In so, refinancing might not be worth the cost. You can use Bankrate’s refinance breakeven calculator to estimate how long you’d need to stay in the property to start saving.
Alternatives if you can’t refinance an underwater mortgage
Keep your mortgage and continue paying
If you want to stay in your home and can still afford the mortgage payments, you can simply continue paying your loan rather than refinancing. An underwater mortgage itself doesn’t harm your credit, and over time, the property might regain some or all of its lost value — or, the balance might shift so you no longer owe more than the property’s worth.
Request a loan modification
A mortgage loan modification permanently changes the terms of your loan to make it more affordable. The changes could include a lower interest rate, an extended loan term or a reduced balance.
A modification is only an option if you’re experiencing long-term financial hardship that prevents you from paying your current loan. If this applies to you, contact your mortgage servicer — the company you send your payments to — to learn whether you’re eligible. If so, it could help you afford your payments and stay in your home, and potentially get your loan out from underwater.
Short sale
If you can no longer afford the mortgage and want to move, you might consider a short sale, or selling the home for less than what’s owed on the loan. Your lender has to agree to it, however, and the process negatively affects your credit history and score, which hurts your chances of obtaining a new loan in the future. Bottom line: This shouldn’t be your first option.
Deed in lieu of foreclosure or foreclosure
Some borrowers with underwater mortgages choose to walk away from the home and the debt, either through a deed in lieu of foreclosure or foreclosure. The former is the more proactive option, but both require you to move and have serious implications for your credit. Do not make this decision lightly. If you can still afford your payments, it’s far better to wait and remain in the home.
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