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What is an Underwater Mortgage?

Malcolm Tatum
By
Updated May 16, 2024
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Underwater mortgages are mortgage arrangements that effectively leave the owner with more debt on the property than the current market value. Generally, an underwater mortgage situation does not arise when a buyer takes out a first mortgage. The condition tends to arise when a second or third mortgage is taken out, or if factors within the area cause the property to depreciate in value unexpectedly.

One of the most common ways of getting into an underwater mortgage situation is when a property owner chooses to refinance an existing mortgage. Lenders may offer the option of borrowing on the existing equity in the property. In some instances, this can be a workable option, assuming there is a large amount of equity built up. However, if the amount of equity is relatively small, this solution can quickly lead to a level of debt on the property that exceeds the current market value. When this takes place, the property owner is essentially in an underwater mortgage situation.

Another common way that mortgages take on an underwater aspect is shifts in property values. When rezoning or other changes in the area take place, there is the possibility that the market value for the property will drop below the total of the current outstanding mortgages. This essentially creates a situation where the owner would not be able to sell the property for enough revenue to pay off all the current indebtedness.

In some instances, an underwater mortgage situation takes place because the homeowner chooses to overextend the borrowing against the property. For example, there are many lenders who will extend a third mortgage on the basis of the credit history and job security of the applicant. However, if the owner loses his or her job and is unable to keep up the payments on all outstanding mortgages, the third mortgage effectively places the finances of the owner into an underwater situation.

A housing crunch can also create an underwater mortgage situation. When there is a demand for living space that exceeds the number of units available in the area, prices for any homes will rise significantly. The end result is that the market values temporarily rise, and mortgages are taken out to meet current prices. When the crunch is over and market values drop, owners are left owing more on their homes than the property is actually worth. At this point, the owner will find it virtually impossible to sell the property for enough to cover the cost of the mortgage, and may be more likely to default.

SmartCapitalMind is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Malcolm Tatum
By Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing to become a full-time freelance writer. He has contributed articles to a variety of print and online publications, including SmartCapitalMind, and his work has also been featured in poetry collections, devotional anthologies, and newspapers. When not writing, Malcolm enjoys collecting vinyl records, following minor league baseball, and cycling.
Discussion Comments
By missmsry — On Feb 22, 2013

My question is where were the bailouts when my house costing me $70,000 was worth $10,000 in 1985? I had to move out, find a cheesy apartment, rented my house out and still had to pay an additional $200 a month to make up the difference.

I worked and scraped for 20 years to get it to the point where I could sell, and only lose $4,000. I know life is not fair, but these people need to admit they screwed up.

By anon292824 — On Sep 22, 2012

Many house owners have private loans (loans that are not FHA, Fannie Mae, or Freddie Mac). Therefore, they do not qualify “loan modification” under the current law.

In my opinion, the only solution for all will be to level the mortgage of the home to the market value of the property.

By anon291575 — On Sep 15, 2012

Doesn't the Dodd-Frank Bill require banks to use appraisals to establish market value to determine if a home is under water or not? Can they use a county tax record market value to make that determination?

By anon282653 — On Jul 30, 2012

There is an answer for Anon277270, post #22.

There is help. There is a program from Freedom USA Investing that can help people like you. They buy the mortgage from the bank at a discount and then have you refinace from them at the discount. It's all legit and doesn't affect your credit. When you refinance, the mortgage will have equity in the property.

By anon277270 — On Jun 28, 2012

In 2006, I bought a house in a neighborhood where houses started at 185k, and now the builder starts at 90k.

I have interest only loans, can't refinance, can't sell and my lender won't help. They offered to do a short sale. All I want is for my lender to restructure so I'm not renting, even if I pay what I owe. But they won't help. They would rather I foreclose and sell it for 60-80k less. I'm confused.

By paaly1 — On Jan 17, 2012

What is the situation when the total of a first mortgage (refinanced at a lower rate and shorter duration, a year ago) plus an equity line of credit together exceed current estimated market value? All payments have been made on time and there is no likelihood of foreclosure.

Would both lenders require that payment be made against one or the other obligation to bring the total indebtedness to the acceptable percentage of total value?

By anon162228 — On Mar 22, 2011

Anyone have any idea on how to refinance a mortgage when I owe more than what it's worth, thanks to predatory lending?

Then, in a haste to get out from under that lender, I refinanced with an ARM that went sky high. I got a modification, but now income has declined again. Credit score is rated excellent, but no one will touch me. Why is it I am making nearly a $1,000 payment and no one will refinance so my payments are more manageable at $600. I just want to repay my debt. --SusanS

By anon151896 — On Feb 11, 2011

Everyone here is absolutely correct! We were first time home buyers in 2006, and basically anyone who bought between 2005- summer 2007 (before the crash) was sold a lemon.

I got my real estate license to understand what happened to us, and house prices were increasing during this time period 20 percent or more, when on average it should be 3-5 percent at most per year. So we were all sold a lemon. They have lemon laws for cars don't they?

With the biggest investment for many of our lives, I cannot believe the government has abandoned us all and yet bail out the big banks who gave us these bad loans. Where is an attorney? This is unethical and should be illegal. Everyone who bought during this time should be helped, why is no one talking about this?

By Chris Dix — On Dec 02, 2010

PRA is referred to as the 'waterfall test' because it is the last qualification checked for on HAMP eligible loans.

By anon118774 — On Oct 15, 2010

Called the "FHA Short-Refinance Option", (effective (Sept. 7, 2010-December 21, 2012), it requires banks to write down at least 10 percent of the unpaid balance on the first mortgage. It is targeted for homeowners who are paying on time, but saw large declines in home values. Check out this new refinance option.

By anon112569 — On Sep 20, 2010

I bought my home at the end of 2006 in a nice neighborhood that I love. I am in an interest only loan and have been making my payments on time. But, because I have no equity, no one will refinance me and the rates are so low, I'm totally exhausted dealing with my lender. Where is the help for people like me? --lgonzalez

By danjohnson — On Sep 06, 2010

I bought my house in 2005 and have always made my monthly payments on time. Unfortunately, my mortgage became over $125,000 underwater in 2008 and it just didn't make sense for me to stay in it anymore. I have been mulling over this for months and finally made the decision to "walk away".

By anon109217 — On Sep 06, 2010

Anyone knows the consequences of mortgage default?

By anon73352 — On Mar 26, 2010

I bought my house in 2005. I have not missed a payment. I live next door to the neighbors from hell. I would love to sell my house. Every real estate agent we talked to said we will never get what we paid for it. My property has declined by 75,000.

I played by the rules, read all my documents and have paid on time. There is no government program to help all of us who played by the rules. So I'm stuck being miserable in a house I'll never be able to sell. Is walking away and ruining my credit my only option?

By anon59479 — On Jan 08, 2010

It's a net plus to walk away when more than 21,000 lower than present value.

By anon53906 — On Nov 25, 2009

I've been in my house since dec 01. today's real estate market is in a shambles because a bubble was created when the fed lowered rates so low after 9/11.

there are other factors at work, such as increasing money supply and it having nowhere to go. Also, banks are not sending out appraisers for loan modifications because of the massive expense. Instead they are using websites to estimate value.

I live in Chicago and put down 41k when the house was bought and now it is underwater. Why should I not get help like those who purchased in 2005-2006? Plus, in all likelihood, values will continue to fall in 2010 and beyond. Simple over supply and less demand.

By anon53511 — On Nov 22, 2009

I think you left out the most appropriate definition how getting underwater happens, i.e. that would be the housing market collapse.

Due to no fault of responsible homeowners the value decreases by 25 percent or more and your stuck. To make matters worse, instead of rewarding good behavior and providing relief to those who played by the rules, the push is to help those who had no business in homes they could not and still cannot afford (i.e. rewarding bad behavior).

What would happen if the relief funds went to those who can afford current mortgages? Well the people with money, and relief to compensate for government created falling home prices, would have money to input into the economy. Sounds simple and it is.

Rewarding good behavior and not bad behavior is a solid solution.

By anon30250 — On Apr 15, 2009

I've read numerous options put forward on what steps to take if you have an underwater mortgage and still can and want to stay in your home. Rarely do I see mortgage acceleration put forward as a solution. This is surprising because the much quicker equity stake that an owner builds up acts, in effect, to mitigate the lost equity over a much shorter time than paying off over the full term of the loan. Do a Google search for underwater mortgage acceleration for ideas and solutions relating to this. This is of course a solution only for those who can afford their current mortgage payments and want to stay in their homes.

By mfnidley — On Feb 24, 2009

I think that anyone that purchased a home between 2005-2006 should have their homes refinanced with a lower principal balance that is where the price of a house should have been if all these sub prime loans hadn't been created at that time. People like myself will likely default on the loan because we can't stay in these homes forever. I have a 2 bedroom house in a bad area, and since purchasing the house have a family. I need to be in something bigger, but can't because of my situation.

If I wait, it will be many many years to get it to where I purchased it. I may have no choice but to ditch. I know many are in my situation, and I have no idea why the government didn't think about this situation. It seems that adjusting the principal is the best option, not bailing out sub prime loans.

By ckullhem — On Nov 24, 2008

Are there any good, reliable statistics on the current percentage of mortgages that are currently "under water". Some news analysts are indicating that 20% of the mortgages are "under water". Is there any reliable support for this number or any other?

Malcolm Tatum
Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing...
Learn more
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