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The figurative description of "drowning in debt" is particularly apt for people stuck with underwater mortgages -- loans with balances that exceed the value of the home. For example, if your home is worth only $230,000 but you owe $280,000 on your mortgage, your mortgage is underwater.
Loss of Equity
Underwater mortgages generally result from housing prices dropping after buying the home. For example, if you borrow $190,000 to buy a $200,000 home, you start with $10,000 in equity. However, if you bought at the peak of the housing market and in two years your home is worth only $160,000, even if you've paid your mortgage down to $185,000, you're still $25,000 underwater. You might also end up underwater if you take out a second mortgage or home equity loan, such that the total of your debt exceeds the value of your home.
If you're content making monthly payments on your mortgage, being underwater won't actually affect you. Eventually, as you pay down the loan, your mortgage will get back above water. However, being underwater does cause significant trouble if you're attempting to refinance or sell your home. When you go to refinance, a bank usually won't want to let you borrow more than your home is currently worth, even if the refinance will save you money. When you sell, your lender might not want to agree to a sale that results in less money than you owe on the home.
Special Refinancing Programs
During times of widespread mortgage trouble, the federal government may step in with various underwater loan refinance programs to help underwater homeowners. However, these typically require that you be current on your mortgage and have made one or no late payments in the past year. If you're not eligible, try talking to your lender to see if it is willing to modify your mortgage. In the face of a potential default, your lender might be willing to adjust either your interest rate or even forgive some of your principal.
Some homeowners have simply walked away from their underwater mortgages, which is not without consequences. If you walk away, it has the same impact on your credit score as a foreclosure. But, if you have a mortgage with Fannie Mae or Freddie Mac, you may qualify to walk away with a slightly less negative impact on your credit score, provided you are current on your payments. It's similar to a short sale or deed in lieu -- but the difference is that you don't have to be delinquent on your payments first, meaning that your credit takes less of a hit.
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