Can I Refinance My Upside Down Mortgage Loan?

Reader Question: “I have heard a lot of conflicting information about this, so I thought I’d ask. Is it possible to refinance your upside down mortgage loan, and if so how would I do it?”

This subject has been in the news a lot lately. A staggering number of homeowners in the U.S are upside down in their mortgages. The last figure I heard or read was 12 million homeowners in this exact situation. Depending on how much you are upside down in the loan, you may not have any options. I’ll expand on that in a moment, but first I want to provide some background information for other readers.

What Does Upside Down Mean?

It means you owe more on your mortgage loan than the current value of the home. If I owe $300,000 on the balance of my loan, but my home is currently valued at $255,000, then I am upside down by owing more than the property is worth. You may also hear the term “under water” in the mortgage — they mean the same thing. This can happen with any type of loan, but is most common with auto loans and mortgages.

How Does It Happen?

Homeowners can end up in this situation in several ways. But the most common cause in the current economy is a drop in home value. Nationally, we’ve been sitting on a huge real estate bubble for the last few years. In many cities, property prices were ridiculously inflated — i.e., average median home prices were much higher than median incomes. I don’t need to tell you how hard that bubble burst over 2008 and 2009.

As a result of this housing crash, home prices dropped in most cities across America. In places like California, Nevada and Florida, they dropped significantly. For example, a San Diego home that was worth $500,000 in 2006 might only be worth $350,000 today — perhaps even less. So if I bought a house at that price point and at that particular time, I would most likely be upside down in my mortgage loan today. I would owe more on the home than it was worth in the current market.

How Can I Refinance in This Situation?

You might not be able to refinance if you are upside down in your home. I know that’s not what you want to hear. But it’s the cold, hard reality of the situation. Millions of people are in this situation right now, and some worse than others. Some homeowners have lost a lot of value / equity in their homes over the last few years, so their chances of refinancing are slim to none. Others are only slightly upside down, with a lesser degree of negative equity, and these people might have a few options for refinancing.

To find out where you stand in terms of your equity, you’ll need to do the following:

1. Find out what your current outstanding loan balance is. Your lender can tell you this.
2. Find out what your home is currently worth. Not what it was worth last year or five years ago — but what it’s worth today. A professional home appraisal is the best way to determine the value.
3. If your balance is less than the market value (determine by the appraisal), you are in a positive equity situation. But if your balance is more than the current value, you are upside down in the mortgage loan.

If you are only slightly underwater in the loan, you might still qualify for refinancing under the federal government’s housing plan. Visit MakingHomeAffordable.gov to learn more about it.

If you are upside down by more than five percent or so, you are probably “stuck” where you are for now. This is the situation with millions of homeowners in the U.S. A negative-equity situation like this will typically prevent you from selling the home as well (because you can’t pay off the loan balance with the sale price). People in this situation simply have to stay put and hope they recover enough equity to refinance or sell later on. Many people are also choosing to walk away from their homes. It all comes down to soul searching, careful research, and weighing your options.

So, if I had to sum up all of this information in one sentence, it would be this:

If you are only slightly underwater, you may be able to refinance your upside down mortgage under the Making Home Affordable program; but if you are upside down by more than 5 percent, you’re probably stuck with the loan for now.