An underwater mortgage is a situation in which a homeowner owes more on a mortgage than the current market value of the home. This can happen in any type of economic climate, but is especially pertinent in times of recession or a market downturn. It is important to understand the implications of an underwater mortgage, as it can have significant financial and legal ramifications for homeowners.
Underwater mortgages are caused by two main factors: a decline in the market values of homes or an increase in the amount of debt taken on by the homeowner. Since mortgages are typically taken out in order to purchase a home that will increase in value over time, an unexpected drop in the market value of a house can make it difficult for the homeowner to refinance or even sell the property.
The Effect of an Underwater Mortgage
The effect of an underwater mortgage can be significant for homeowners. First, the homeowner may be unable to make significant repairs or improvements to the property without taking out additional loans that could further increase their debt risk. Second, an underwater mortgage may prevent the homeowner from being able to use their home equity in order to secure additional credit, such as for a home purchase or major ticket item. Third, an underwater mortgage can make it difficult to sell or refinance the property.
Finally, if the mortgage is not serviced appropriately, homeowners may have difficulty getting out of their underwater situation due to negative equity. Homeowners with an underwater mortgage should speak with their current mortgage provider in order to determine the best path forward. In some cases, the mortgage may be able to be refinanced to have a manageable loan balance.
Avoiding an Underwater Mortgage Situation
For new or potential homeowners, avoiding an underwater mortgage situation is key. Before taking out a loan, it is important to research the local market and ensure that the proposed purchase is within the financial means of the homeowner. It is also important to speak with a qualified financial advisor and ensure that all other factors, including debt risk, are accounted for.
In addition, homeowners should understand their rights when facing an underwater mortgage. There are several options available for homeowners, such as refinancing, restructuring, or deferment of payments. It is important to understand and evaluate all available options in order to select the best course of action.
The Bottom Line
An underwater mortgage is a situation in which a homeowner owes more on their mortgage loan than the current market value of the home. This can have significant financial and legal implications for the homeowner. To avoid the situation, it is important for potential and current homeowners to research the local market prior to taking on a mortgage loan and be aware of their rights and options if they do fall into an underwater mortgage situation.