Certainty seems farthest on the horizon for the U.S. housing market. With rising interest rates, inflationary pressures, and limited for-sale home inventories, the market is not only volatile but also quite uncommon nowadays. Experts fear the unknown while homeowners already grapple with challenges, such as underwater mortgages.
When a homeowner’s outstanding mortgage balance surpasses the property’s current market value, they have an underwater mortgage. While refinancing is an option, traditional methods may lead to unfavorable terms or higher interest rates.
The good news is there are lesser-known options available. If you find yourself in this predicament, exploring possibilities can give you valuable insights to help you build financial stability and relieve you of the burden of negative equity.
The Problem With Underwater Mortgage
An underwater mortgage simply means owing more on the mortgage than the property is worth. This situation can arise due to a decline in property values, economic downturns, or high loan-to-value ratios at the time of purchase.
The problem with an underwater mortgage lies in its financial implications for homeowners. When the value of a property falls below the mortgage balance, several challenges arise, including:
Limited refinancing options
Traditional lenders often require a certain amount of equity in the property. Hence, homeowners with negative equity may struggle to refinance their mortgage to secure lower mortgage refinance rates or better terms.
Obstacles to selling or moving
Selling the property becomes difficult when the homeowner can’t recover the full mortgage amount from the sale. This can hinder relocation for job opportunities or other personal reasons.
Reduced financial flexibility
Homeowners in negative equity are at a higher risk of financial stress. They may find it challenging to tap into home equity for emergency funds or other investments.
Increased risk of foreclosure
When financial difficulties arise, homeowners with negative equity may face a higher risk of foreclosure as they lack the equity cushion to sell the property and settle the debt.
Stifled housing market
A high number of underwater mortgages can contribute to stagnation in the housing market, as sellers are less motivated to list their homes, leading to decreased housing inventory and limited buyer options.
As of early 2023, U.S. homes with negative equity remained at 2.1 percent of all mortgaged properties — about 1.2 million homes compared to last year. This statistic highlights the prevalence of underwater mortgages and the importance of exploring viable solutions for homeowners, such as refinancing.
How To Refinance an Underwater Mortgage
Navigating today’s real estate market can be overwhelming. But for any challenge, there are solutions to explore. If you’re looking for a way out of an underwater mortgage, here are refinancing options tailored to help you find solid financial footing:
Freddie Mac Enhanced Relief Refinance Mortgage (FMERR)
The Freddie Mac Enhanced Relief Refinance Mortgage (FMERR) is a refinancing option designed to help homeowners with high loan-to-value (LTV) ratios, including those facing negative equity. FMERR allows borrowers to refinance their existing mortgages into more manageable loans, potentially leading to lower monthly payments and improved financial stability.
To qualify for FMERR, homeowners must have a Freddie Mac-owned loan and meet specific eligibility requirements. These requirements include being current on mortgage payments and having a solid payment history for the past 12 months.
Additionally, the new loan must reduce the monthly mortgage payment or convert an adjustable-rate mortgage (ARM) into a fixed-rate mortgage. FMERR offers a practical option for underwater homeowners with Freddie Mac loans to find relief and regain control over their financial situation.
FHA Streamline
The FHA Streamline refinance program is specifically designed for homeowners with existing FHA-insured mortgages. One significant advantage of this program is that it does not require a new appraisal or extensive documentation, making the refinancing process faster and more straightforward.
For homeowners with underwater FHA mortgages, the FHA Streamline offers an opportunity to refinance without needing a significant amount of equity in the property. Additionally, the program may allow borrowers to reduce their monthly mortgage insurance premium (MIP) or shift from an adjustable rate to a fixed-rate mortgage.
However, to qualify for the FHA Streamline, borrowers must have a history of timely mortgage payments and demonstrate that the refinancing will be beneficial. By taking advantage of the streamlined process and favorable terms, eligible homeowners can find relief from the challenges of an underwater FHA mortgage.
Fannie High LTV Refinance Option (HIRO)
This option has been temporarily paused due to the Revised QM Rule, but it is worth considering once the suspension is lifted. The Fannie High LTV Refinance Option is similar to FMERR, and its most significant advantage is the absence of a maximum LTV limit. This makes HIRO more accessible for homeowners with severely underwater properties.
However, to qualify for HIRO, borrowers must have a solid payment history with no late payments in the past six months and no more than one late payment in the previous year. The new loan must also provide a tangible benefit, such as reduced monthly payments or a more favorable interest rate. Homeowners who meet these criteria can benefit from the Fannie HIRO program and find relief from the challenges of an underwater mortgage.
VA IRRRL (Interest Rate Reduction Refinance Loan)
The VA IRRRL, also known as the “Streamline Refinance,” is an option available exclusively to veterans and active-duty service members with existing VA-guaranteed mortgages. This program is designed to help them secure more favorable interest rates and terms, regardless of whether their home is underwater.
One of the significant benefits of the VA IRRRL is that it typically does not require an appraisal or credit underwriting, simplifying the refinancing process. Additionally, the program may allow borrowers to include closing costs in the new loan or choose a shorter loan term to build equity faster. However, to be eligible for the VA IRRRL, borrowers must have a history of on-time mortgage payments and certify that they currently or previously occupied the property.
For a funding fee of 0.5 percent of the refinancing loan, eligible military personnel can find financial relief and potentially reduce the burden of an underwater mortgage.
USDA Streamline Direct
The USDA Streamline Direct program is specifically designed for homeowners with existing USDA Direct Loans, typically for low-income borrowers in rural areas. The program aims to help these homeowners reduce their monthly mortgage payments and find financial stability.
One significant advantage of the USDA Streamline Direct program is that it does not require a new appraisal, credit check, or income verification. This streamlines the refinancing process and makes it more accessible for those with underwater USDA Direct Loans. Additionally, the program may offer lower interest rates and reduced monthly payments.
To qualify for USDA Streamline Direct, borrowers should be up-to-date with their mortgage payments and meet specific income requirements. By utilizing this program, eligible homeowners with USDA Direct Loans can potentially find relief from the challenges of an underwater mortgage and secure more favorable loan terms.
What To Do if Refinancing Is Not an Option
Several options can be explored for homeowners unable to refinance an underwater mortgage. One approach is paying down the loan balance through extra principal payments. Another option is seeking forbearance under the CARES Act, which provides temporary relief by suspending or reducing mortgage payments.
A mortgage modification from the lender may lead to adjusted terms and more manageable payments, and selling the house and covering the difference between the sale price and mortgage balance could eliminate negative equity. Alternatively, conducting a short sale, where the lender agrees to accept a lower sale price, could be an option.
If none of these options work, foreclosure might be the only route. A total of 35,196 properties had been filed for foreclosure as of May 2023. Note that foreclosure severely impacts a person’s credit and future housing opportunities, so it should only be a last resort to resolve an underwater mortgage.
Remember, staying informed is critical to making the best decision for your financial future. New opportunities may arise as the real estate market evolves and opens up more refinancing opportunities.
Be proactive and consult financial experts to determine which refinancing path aligns best with your circumstances. By taking charge of your financial situation, you can move toward achieving stability and financial relief despite the initial challenge of an underwater mortgage.
