Upside-down mortgage relief comes in several forms. When you owe more than your house is worth you are underwater and have negative equity. You do have options, though, depending on your financial situation. You can:
- Work with your lender to keep your home by reducing the mortgage principal, refinancing, loan modification, or even bankruptcy.
- Get out of your mortgage through foreclosure, short sale, or Chapter 7 bankruptcy.
Each alternative has consequences, and none of these will be easy. The good news is that if you stay objective and get good advice you can get through it and minimize the damage to your credit and lifestyle.
What is Upside-Down Mortgage Relief?
An upside-down or underwater mortgage is a situation where you owe more than the market value of the property. If you don’t need to sell immediately then this negative equity situation may not be a problem. However, if you are behind or have trouble making your payments, then this presents a huge dilemma. There are options, though, depending on what you want to do.
- Sell – short sale, deed-in-lieu, walk away (foreclosure)
- Keep – Principal reduction, refinance, loan modification, bankruptcy
Sometimes you don’t need to act immediately. You may be able to wait it out until housing prices go back up. Other times you may be able to rent out your house. Your financial situation determines which action is best.1
What Can You do if Your Mortgage is upside-down?
Which upside-down mortgage relief you choose depends on your situation. The best course of action, if you are able, is to stay in your house until the property values rise and you pay down your mortgage enough to have equity. If you can’t make your mortgage payments, you must decide if you want to try to stay in your home or get out of it. There are options for either decision.2
One option that may allow you to stay in your home is principal reduction. In this case, the bank would reduce the amount you owe to the market value. Your lender may rather keep your mortgage current rather than sell the property to a third party and lose as much or more money.
You should know that banks rarely do this. Banks usually foreclose and then sell the property instead. However, some banks do, and your bank might. If you want to keep your home, it’ worth it to begin a dialogue with your lender about what options they will consider.
You may be able to refinance an upside-down mortgage but not with a private bank and only if Fannie Mae or Freddie Mac owns or guarantees your loan. Private banks won’t refinance your loan unless you have 20% equity. So, Fannie Mae or Freddie Mac must own or guarantee your loan. Their refinancing options for underwater loans expired at the end of 2019, but you should check with them to see if they are going to extend their programs.
A loan modification also offers a chance that you can stay in your home. The idea is that the bank modifies your loan so that your monthly payments are lower. They may do this in one of several ways:
- Lower your interest rate
- Extend the repayment period
- Change an adjustable-rate to fixed
- Reduce the principal (not common)
If you are already behind on your payments this may not be the best option for you. Often, late charges and fees mean that even if you can get a refinance you may pay even more than your current loan. Even if you aren’t delinquent, it won’t reduce your principal (except in some very rare cases), and that is the underlying problem. Finally, if you consider this, beware of scams. There are many. Only use a HUD-approved counselor to help you.
Bankruptcy can help if you have an upside-down mortgage, but its primary concern is with unsecured debt. There two types of bankruptcy that individuals typically use:
- Chapter 7 liquidates possessions, including your house if necessary, to eliminate as much debt as possible.
- Chapter 13 restructures your debts under a court-ordered plan that includes your mortgage.
If you need to get rid of large amounts of debt and you won’t fight to keep your home, then Chapter 7 may be a good option. However, if keeping your home is your main concern then you should file for Chapter 13. Either way, don’t file for bankruptcy without consulting a good attorney who can tell you the process and consequences of it.3
Give the house back (deed in lieu)
Lenders sometimes offer to let the homeowner deed the property back to the bank. You don’t make any more payments and walk away from the property. The bank takes possession without having to foreclose.
This is a good deal for the bank, but not necessarily for you. Your credit will suffer in a similar way to foreclosure, and you won’t get any more than you would in a foreclosure.
Walk Away (Foreclosure)
Walking away from your mortgage is rarely a good idea even if the property is not a good investment. Foreclosure severely damages your credit score. Often scores drop 100 points, and it stays on your record for seven years. Also, some states grant the lender deficiency judgments allowing them to pursue you for the difference between what you owe and the amount they sold the house for.
After two or three years you may be able to buy another house if you don’t have any credit issues during that time. The interest rate, though, will be very high. The damage to your credit makes it harder to get any other loan, and it may even affect you getting a job.
In a short sale, the bank agrees to let you sell the house for market value, which is less than what you owe. It frees you from the obligation of paying your mortgage and any other liabilities that accumulated, such as late fees and penalties. It still damages your credit but not as much as a foreclosure.
If you do this, you should hire a realtor who is experienced with foreclosures and short sales. The realtor lists the property and receives offers just like any other real estate transaction. Your agent then submits the best offer with a hardship package to the bank. If your lender approves the contract, then it closes.
Banks agree to these because they are less time consuming and costly than a foreclosure. It is a good solution for the bank because of the minimized cost, and it is a good solution for you because you get out from under the loan. There is, however, one big downside for you. The Internal Revenue Service (IRS) considers the difference between what you owed and the amount you sold the house to be income. If the difference is substantial you can get a big income tax bill.
Final Thoughts on Upside-Down Mortgage Relief
Upside-down mortgage relief comes in a few different forms. None of them are pleasant, though. The reality of your situation, if you are underwater, is that you will probably lose your house.
You may be able to modify your loan and keep it if you can afford slightly lower monthly payments. Also, if you file Chapter 13 the courts may help you restructure your payments so that you can stay. Few banks will refinance or offer a principal reduction, so while they are possibilities, they are longshots.
If you decide to give up your home it will damage your credit, no matter what you decide. Some alternatives are better than others, though. Probably the worst thing you can do is walk away from your home and let the bank foreclose.
A short sale is probably the best alternative if your bank is willing to work with you. If they are not, then bankruptcy can protect you. Chapter 7 may sell your home and discharge your debt, but you must qualify.
The thought of losing your home is very emotional for anyone but try to be objective if you can. Seek advice from a real estate or bankruptcy attorney and/or a HUD-approved counseling agency.