I Am Underwater on My Mortgage. Can I still Refinance?

Read Time: 7 minutes

Owe more on your mortgage loan than your home is currently valued at? If so, you are not alone. Many borrowers are underwater on their mortgages, a situation that can be challenging to navigate and reverse.

That begs a question: Can you refinance your mortgage loan when you are underwater? 

Fortunately, the answer is yes if you qualify for a special refinance program. Find out what it means to be underwater, if and when it’s possible to refinance an underwater loan, different refinance programs to consider, the steps involved with refinancing, and other options you can pursue if you cannot currently refinance.

What “Being Underwater” Means

Being “underwater” on a mortgage simply means that you owe more on the home loan than your property is worth right now. 

“This can occur due to a decline in your property’s value, an increase in your mortgage debt, or a combination of both,” explains Lauren Mendoza, founder of Bank Standard. “Being underwater is a critical issue, as it hampers your financial flexibility and may limit options like selling the property or refinancing.”

While fewer homeowners are underwater today than several years ago, the number of underwater borrowers is trending upward. Consider that more than one in 10 people who borrowed funds to purchase homes in 2022 owe more than the properties are worth, according to recent research by data firm Black Knight.

The best way to reverse an underwater status is to either increase your home’s value via making home improvements or by waiting until your local market improves on its own, or by decreasing the principal amount you owe by making larger payments. 

Is it Possible to Refi When You Are Underwater?

Although it is more challenging to refinance your primary mortgage loan when you are underwater, the good news is that you can attempt to refinance if you qualify for special conventional or government-backed loan programs.

“However, there are restrictions involved. For example, your current conventional mortgage must be backed by Fannie Mae or Freddie Mac, you must be current on your payments, and your loan must have originated after October 1, 2017,” says Dennis Shirshikov, head of growth for Awning.com and a finance and economics professor at the City University of New York.

Here are 5 popular options for refinancing your mortgage when you are underwater.

Option #1: FHA Streamline Refinance

If you want to refi your FHA loan, you can pursue an FHA streamline refinance with minimal red tape (here, “streamlined” means less documentation and underwriting is involved). To qualify, you must be current on your mortgage payments, the refinance must result in a net tangible benefit to you in the form of a lower interest rate and/or improved loan term, and you can’t cash out more than $500 at closing. Other restrictions apply, too.

“As with other refinance options, the benefits of an FHA streamline refi include potentially obtaining a lower interest rate and reducing monthly payments,” explains financial expert Jon Morgan, CEO/editor-in-chief of Venture Smarter.

Option #2: USDA Streamlined Assist Refinance

Got a USDA home loan? Think about applying for a USDA streamlined assist refinance, which can lower your monthly mortgage payments by at least $50. For most borrowers, no new appraisal, credit review, home inspection, or debt ratio calculation is required, although the USDA must verify that your mortgage was paid as agreed for 12 months prior to the refinance application.

Your income may not exceed the adjusted annual income limit for the county or metropolitan statistical area where your home is located. Other rules and stipulations apply. 

Option #3: VA IRRRL Loan

The VA streamline refinance — better known as the VA Interest Rate Reduction Refinance Loan (IRRRL) — can lower your interest rate without requiring documentation, possessing a minimum credit score, or needing an appraisal. That means you can qualify even if you are underwater.

But you must currently have a VA mortgage loan, be an active duty military member, veteran, or surviving spouse, and certify that you currently live in or used to reside in the home covered by the loan. 

“Enhanced relief programs like a streamlined assist refinance allow a borrower to refi without an appraisal, if the borrower can benefit financially by lowering their payment and improving their ability to pay their mortgage,” says Mason Whitehead, a Dallas-based branch manager for Churchill Mortgage. “It may be possible to end up with a loan-to-value ratio over the typically allowed ratio when an appraisal is not needed.”

Option #4: Fannie Mae High LTV Refinance

The Fannie Mae High LTV Refinance option allows borrowers to refinance if they have been paying their existing Fannie Mae mortgage on time but have a loan-to-value (LTV) ratio that surpasses the maximum allowed for a standard limited cash-out refi.

To qualify, however, borrowers must benefit from the refi via a reduced monthly principal and interest payment, lower interest rate, shorter amortization term, or a more stable mortgage product (like shifting from an adjustable-rate mortgage to a fixed-rate mortgage). 

“This program allows you to refinance your mortgage with a high LTV. The pros include potentially obtaining a lower interest rate and reducing monthly payments,” says Morgan. “To qualify, you must have a good payment history and meet specific LTV ratio limits.”

Unfortunately, Fannie Mae has temporarily paused this program until further notice.

Option #5: Freddie Mac Enhanced Relief Refinance Mortgage

The Freddie Mac Enhanced Relief Refinance Mortgage program is designed to benefit borrowers with existing Freddie Mac home loans who are making payments on time but cannot capitalize on a standard Freddie Mac “no cash-out” refinance offering because the new mortgage exceeds maximum LTV limits.

Mortgages with application received dates on or after November 1, 2018, are eligible. You can refi to a conventional 15-, 20-, or 30-year fixed-rate mortgage or a conventional 5-year, 5/1, 7/1, 10/1, 5/6-month, 7/6-month, or 10/6-month adjustable-rate mortgage (ARM), so long as the mortgage being refinanced is already an ARM.

“This program replaces the Home Affordable Refinance Program (HARP) and is designed to help homeowners with high LTV ratios refinance mortgages,” continues Morgan. “The advantages include potential interest rate reduction and improved affordability. To qualify, you must be current on mortgage payments and meet specific LTV and credit score criteria.”

The bad news? Freddie Mac has also put a temporary hold on this program until further notice.

Steps Involved With an Underwater Refinance

Eager to move forward with a refinance of your underwater mortgage, assuming you qualify? Here’s what you need to do:

  1. Examine your existing mortgage loan and property value. Calculate your current mortgage balance and evaluate the present value of your home to understand the extent to which you are underwater.
  2. Investigate available refi programs. Look closer at each of the refinance approaches listed above, and consult closely with a lending expert who can guide you through your best options.
  3. Gather required documentation. “Prepare the necessary documents, such as income statements, tax returns, bank statements, and property appraisals to support your refinance application,” advises Morgan.
  4. Submit a refinance application. Complete the application process, being sure to furnish accurate information and required documentation that the lender needs.
  5. Await approval and closing. “Allow the lender to review your application, perform necessary verifications, and make a decision. If approved, follow the lender’s instructions to close the loan, sign the necessary documents, and complete the refinancing process,” adds Morgan.

Alternative Options if You Cannot Refinance

Not eligible for any of the refi options listed above? Don’t panic. There are alternative strategies to consider that can help your underwater situation.

Pay Down Your Mortgage Balance

By making additional payments toward your mortgage principal, you can decrease your loan balance over time. This strategy will help you regain equity in your home. But it requires steady financial discipline and the flexibility to make extra payments.

Mortgage Modification

Contact your lender to request a modification of your loan terms. If they agree, you could lower your monthly payment and/or interest rate, making matters more affordable. 

“Qualification requirements often involve demonstrating financial hardship and providing documentation to support your request,” Morgan notes.

Short Sale

“If you need to sell your home but cannot pay off your mortgage and closing costs with the sale proceeds, consider a short sale. Here, the lender agrees to take less than the payoff,” says Whitehead.

“However, the amount of debt forgiven comes to you as taxable income, and a short sale will deliver a substantial negative hit to your credit score – limiting your ability to obtain a new mortgage for a period of time.”

Deed in Lieu of Foreclosure

This tactic involves voluntarily transferring your property to the lender to bypass foreclosure.

“It saves the lender money and time otherwise spent going through the foreclosure process, but it still has a major negative impact on your credit score and can prevent you from qualifying for a future mortgage for a period of time,” cautions Whitehead.

Strategically Default

If all else fails, a last resort is to possibly walk away from the home and stop paying your mortgage, although experts warn that this option is unethical and severely damaging to your credit. 

“Strategically defaulting means intentionally stopping mortgage payments and allowing the property to go into foreclosure. But this move can have severe consequences on your credit score and future borrowing abilities,” Morgan says.

Erik J. Martin

Erik J. Martin is a Chicago area-based freelance writer and public relations expert whose articles have been featured in AARP The Magazine, Reader’s Digest, The Costco Connection, Bankrate, Forbes Advisor, The Chicago Tribune, and other publications. He often writes on topics related to real estate, personal finance, technology, health care, insurance, and entertainment. He also publishes several blogs, including Martinspiration.com and Cineversegroup.com, and hosts the Cineversary podcast (Cineversary.com).

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