How to refinance an underwater mortgage

Homeowner reviewing financial documents, exploring options to refinance an underwater mortgage.

Key takeaways

Having an underwater mortgage means you owe more money than your property is worth, so refinancing your home may be difficult.
It's still possible to refinance an underwater mortgage in some cases, but it usually depends on the type of loan you have.
Underwater mortgages can happen for several reasons, including declining property values and missed loan payments.
Refinancing options are available for government-backed mortgages, such as FHA loans and VA loans.

When your mortgage is underwater, you owe more than the current value of your home. This can occur for a number of reasons, such as your property decreasing in value or missing payments on your loan due to taking on too much debt or job loss.

Because an underwater mortgage means you have negative home equity, you might find it challenging to refinance. Most lenders will typically loan you money if you own a certain amount of your home.

If you're not eligible for a refinance, the good news is it still may be possible to get out of an underwater mortgage and improve your financial situation. Keep reading to learn how.

What is an underwater mortgage, and do I have one?

An underwater mortgage, also known as an upside-down mortgage, happens when your loan's principal balance is higher than your home's value.

An option to find out whether your mortgage is underwater is by:

Checking your home's current market value
Reviewing your mortgage balance
Comparing both of these values

For example, say you owe $250,000 on your mortgage, but your house is only worth $240,000. Your property is considered upside down because your mortgage is $10,000 more than your home's value.

The quickest way to learn your home's market value is through an online estimator tool that compares your property with others in the area. For a more accurate figure, consider getting a professional home appraisal report.

Did you know?

If a home loses value, that doesn't always mean it's underwater. Let’s say someone's house has dropped from $500,000 to $450,000 since they purchased it due to decreasing property values, and they still owe $300,000 on their mortgage. They're not underwater because their principal balance is still less than their home's value.

Why do I have an underwater mortgage?

Underwater mortgages occur for all kinds of reasons, including:

Decreasing property values: If local real estate values fall after you purchase your home, it might be worth less than what you owe, which could lead to an underwater mortgage.
Missing payments: Falling behind on your monthly mortgage payments means you'll pay less toward your principal balance and build less equity. Missed payments can also accrue fees, potentially leaving you with a loan balance higher than your home's value.
Not maintaining your home: Your home value can lessen over time due to damage or a lack of upkeep or maintenance. When this happens, you may owe your lender more than the value of your property.

Refinancing underwater mortgages

You may want to refinance your home for a variety of reasons, such as lowering your monthly mortgage payments or reducing the interest you pay on the life of your loan. However, being underwater could make things tricky.

Many lenders want you to have at least 20% equity in your home to qualify for different types of refinancing. This reduces their risk of loss if you default on your loan. Having negative equity means you might not be eligible for a refinance at all.

Whatever the reason your mortgage is upside down, it can be helpful to contact your lender and discuss your options sooner than later. This step may be a bit unsettling, but it’s best to face this challenge head on and have the difficult conversation. Your lender might recommend refinancing alternatives such as a loan modification, which involves changing the terms of your mortgage if you're having difficulty making payments or provide other options. You’ll never know if you don’t ask.

Which underwater mortgages are eligible for refinancing?

Most lenders won't refinance underwater mortgages. However, several programs might offer assistance if you have a government-backed loan.

FHA streamline refinance

A Federal Housing Administration (FHA) streamline refinance doesn't involve an appraisal of your property, meaning you could refinance even if you're underwater. To qualify, you must be current on your FHA loan and meet other conditions set by your lender.

USDA streamline assist refinance program

The United States Department of Agriculture (USDA) streamline assist refinance program also doesn't require a home appraisal in most situations.

A few requirements needed to qualify are if you already have a USDA direct or guaranteed home loan, have made payments on time for 12 months before applying, and your income doesn't exceed your area's adjusted annual income cap.

VA streamline refinance

If you currently have a mortgage backed by the Department of Veterans Affairs (VA), you could get an interest rate reduction refinance loan (IRRRL), also known as a VA streamline refinance. This can help you lock in a fixed interest rate or get a lower rate to reduce your monthly payments. Like USDA streamline assist refinances and FHA streamline refinances, a VA IRRL does not require an appraisal.

Alternatives to refinancing an underwater mortgage

Don't panic if you can't refinance a mortgage that's underwater. There might be other options that could help you get out of this predicament.

Make extra mortgage payments

If refinancing offers better terms and interest rates than your current loan, you could pay more toward your principal balance and build up equity in your home. A lender might be more likely to loan you money once you meet its minimum equity requirements. Additionally, focus on making your payments on time every month to help show lenders how reliable you are.

Request a short sale

Being underwater can make it hard to sell your home as the sale price may be lower than your principal balance. You could opt for a short sale, which is when you sell your property for less than what you owe. This might be an option if you're unable to make payments on your underwater mortgage. Before choosing this option, it can help to consult with trusted real estate and financial professionals.

Short sales can be complicated and involve multiple steps, such as submitting a hardship letter to your lender and waiting for them to approve your request to sell your home.

Wait it out

If your mortgage is underwater due to a drop in property values, you can wait and see if the market or economy rebounds. Your home might regain value in the future, putting you in a better position to refinance.

As long as you continue to make payments on your mortgage, being underwater might not impact you in the long term, especially if you're not planning to sell your home for the foreseeable future.

FAQs about an underwater mortgage refinance

Can you refinance if you are underwater on your mortgage?

Most lenders require a certain amount of equity in your home before loaning you money, so refinancing an underwater mortgage can be tricky. It might be easier to refinance a government-backed loan that's underwater, such as an FHA, USDA, or VA loan.

Can my lender take my house if I have an underwater mortgage?

Your home is at risk of foreclosure if you fail to make monthly payments on your mortgage, whether it's underwater or not. If you can't afford payments, contact your lender, explain your situation, and see if they can help.

What happens if I walk away from my underwater mortgage?

Your credit score could drop if you stop paying your mortgage, request a short sale, or end up in foreclosure.

Where to go next

Learn more about mortgage refinances and what the process involves — What do you need to refinance your home?
Find out how much money you might save if you're eligible for a refinance — Mortgage refinance calculator.

Discover® Home Loans doesn't offer FHA streamline refinances, USDA streamline refinances, or VA IRRRLs. However, we do offer a low fixed rate on other mortgage refinance options for eligible homeowners.

The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover Bank or its affiliates.