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What is an Underwater Mortgage?

29 November 2011

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Thankfully, even with the recession that hit in 2008, the Canadian housing market never really suffered all that badly, and we didn’t have thousands of underwater mortgages on the market. But the U.S. did, and lots of people lost their homes because of it. Now, the housing market in the United States is the best it’s been in 5 months, and people are rejoicing at the number of underwater mortgages going down. While this is obviously great news, it has a lot of people (in Canada and the U.S.) asking the same thing: just what the heck is an underwater mortgage?
A mortgage may become underwater when there is negative home equity. Or in other words, when you owe more on your home than what the property is worth; and there are actually many circumstances that can lead to an underwater mortgage. If you only have one mortgage on your property, you probably don’t need to worry about having an underwater mortgage. But if you’ve refinanced your home or have taken out a second mortgage loan, you might want to watch the equity in your home a little more carefully.
The reason for this is because that is the time when your home equity is going to dwindle slightly, and the amount you owe on the property will rise. While second mortgage loans can be extremely helpful to people who need cash fast, if you don’t have enough home equity, they could actually do a great deal of damage. It’s for this reason that most lenders generally don’t like to loan more than a certain percentage anyway when you’re applying for a second mortgage loan. But different lenders do work differently and if you find one that will let you borrow more, even with little home equity and a lot of debt, they likely won’t tell you the risk of doing so.
But borrowing against your home equity when the equity just isn’t there isn’t the only way that people can find themselves in an underwater mortgage situation. Another way is when the housing market booms, and prices start rising. In these cases, a person might be a property at a very high price, and have a very high mortgage to pay off because of it. When the housing market stabilizes though, and prices start to go down again, the value on that property is going to drop. This causes a great imbalance – the home equity isn’t there yet, yet the homeowner still has this massive mortgage to pay off because the home was overpriced and over-valued at the time of purchase. This same thing could happen anytime there’s a shift in property prices. For example, should the property become rezoned, it could lower the property value and that could also set up a scenario for an underwater mortgage.
There are many scenarios that could set up an underwater mortgage situation and sadly, more often than not it’s the market conditions, and not bad borrowing on the part of the homeowner, that cause them to happen. This can be even more infuriating because homeowners who have played by the rules, paid their mortgage on time every month, and didn’t buy more house than they could afford, are often the ones who end up in an underwater mortgage situation. But, don’t despair. You do still have some options and if you’re not currently having any trouble making payments, you could just continue doing so until your home starts to float above the surface once again. Speak to your lender or your mortgage broker if you think you’re headed for an underwater mortgage situation, or if you’re already in one. Just because you’re sinking doesn’t mean that there’s not a rescue boat somewhere nearby.

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