Underwater or Upside down Mortgage: How it Happens
What does an Underwater (Upside down) Mortgage Mean?
A mortgage is underwater when the loan balance is greater than the market value of your home. In other words, you owe more on the house than it is worth. You may also hear this situation referred to as an upside-down loan or negative equity. When you have equity in your home, that means the current market value of your house exceeds what you owe on your mortgage. Negative equity indicates the opposite of that. This may result when the house you buy with debt loses value faster than you can pay off the loan.
Having an underwater or upside-down mortgage is an overwhelming and stressful situation for homeowners. But before you learn about your options on what you can do about it, you must know how it happens.
How does an Underwater Mortgage Happen?
An underwater mortgage may occur for several reasons, but it's often tied to declines in the economy. Some of the main reasons are explained below:
One of the most common causes of negative equity is market decline. Most people assume that the property value would increase with time but that’s not necessarily the reality. Homeowners may buy a property or borrow against their home but then the market plummets and the property value decreases leaving them with a mortgage greater than the property’s worth.
Yes, the property market is subject to change which means it can go up or down at any time and is not entirely under your control.
Loans made to high-risk borrowers have a higher interest rate than loans made to low-risk borrowers. Borrowers with high-interest loans have a majority of their monthly payments go toward paying the interest instead of paying down the loan.
High-risk borrowers are categorized as such due to their low credit score, high LVR, lots of red flags in their credit report, or unstable job status. If you are facing any of these situations, then consider taking time to improve your finances and credit score, save for a substantial deposit or pay off debts. This way you could save money by securing a loan with a lower interest rate.
Poor Home Condition
The condition of your home affects its value. Even a property in a strong market can lose value if it has structural problems or other issues specific to that property. If your property’s value decreases and you owe more on your home loan than the property’s worth, you’ll be upside down on that mortgage. So maintenance is key. You should fix any issues as soon as it arises, and make upgrades to add value to your home when you are able.
Small Down Payment
A larger down payment means you’ll have more equity in the home from the start which can safeguard you from market declines. If you get a loan with little or no money down and the market plummets shortly after you purchase, you’ll almost immediately have negative equity because you didn’t have much in the first place. Make sure you have enough money saved up for a higher down payment or consider less expensive properties.
A lender cannot exceed the appraised value of a home when lending money. So if the appraisal is lower than the agreed-upon price, you may have to pay the difference out of your pocket. If you agree to that, you’re already in a negative equity situation since you’re paying more than the property is worth. Rather, negotiate with the seller to see if they will decrease the price to the appraised value. If not, you may want to consider backing out of the deal and finding another.
Underwater mortgages can also occur when you skip on your mortgage payments. In the beginning, most of your loan payments go towards paying down interest. As you steadily pay down your principal loan balance, you spend less and less on interest. This process is referred to as amortization.
If you fail to pay your interest for one month, that interest will accumulate more interest due to a phenomenon known as compound interest. This makes it tough for you to pay back your debt and may put you underwater. You’ll find yourself further underwater if you don’t pay an amount equal to two monthly payments the following month. That’s why it is crucial to buy a home that you can afford.
If you owe more on your home than it’s currently worth, you’re upside down on your mortgage. This can happen due to several reasons discussed above. While it’s not an ideal situation to be in, there are things you can do like talking to a mortgage broker about your chances of being underwater. You can contact our experienced mortgage brokers at Capkon and get more such financial advice.