This means that the homeowner would be unable to sell the home and pay off the debt if they chose to do so. An example of this would be if someone purchased a home for $400,000 with a 20% downpayment, but then the market value of the home decreased to $350,000. In this case, the borrower would be underwater on their mortgage due to the decline in value.
The risk of an underwater mortgage increases in periods of declining real estate values, as seen during the 2008 financial crisis. Homeowners with underwater mortgages are at high risk of foreclosure, as they may find themselves unable to make their mortgage payments due to their reduced equity. As a result, lenders have tightened their lending criteria, making it more difficult for borrowers with poor credit or lower incomes to get loans.
In cases of severe economic downturns, many homeowners can take advantage of government-sponsored loan modification programs to avoid foreclosure. These loan modification programs can reduce monthly payments, extend the loan term, or provide principal reduction as a way to help homeowners stay in their homes.
Those who are underwater on their mortgages also have the option of a short sale. A short sale is when a lender agrees to accept the proceeds from a sale of the home for less than what is owed on the mortgage. The downside of this option is that it will affect the homeowner's credit score, as the sale will appear as a negative item on their credit report.
Underwater mortgages can be a risky proposition for both lenders and borrowers. Borrowers should consider all the options available to them before entering into an agreement. For lenders, it pays to exercise due diligence in evaluating the borrower's ability to repay the loan and making sure the loan-to-value ratio is appropriate for the current market conditions.
In summary, an underwater mortgage is when the outstanding balance owed to the lender exceeds the current market value of the property. This means that the homeowner would be unable to sell the home and pay off the debt if they chose to do so. The risk of an underwater mortgage increases in periods of declining real estate values, which can lead to foreclosure if the borrower is unable to repay their loan. Government loan modification programs and short sales are two options that borrowers can consider to help them avoid foreclosure and remain in their home. It is important for both borrowers and lenders to understand the risks associated with underwater mortgages, and to evaluate their options before entering into an agreement.
This article was contributed on Sep 21, 2023