Underwater mortgages are mortgages that currently have a balance that is higher than the current market value of the real estate used as collateral for the loan. A mortgage situation of this type may develop due to sudden changes in the neighborhood that drive down property values, or even be a result of some sort of general economic crisis such as a recession. Regardless of the factors that led to the underwater mortgage, the situation can be distressing for homeowners, especially if there is a strong indication that those property values will not recover in the near future. When faced with an underwater mortgage, homeowners may choose to wait it out and keep making payments, attempt to refinance or renegotiate the debt, or even take a loss and default on the mortgage.
One approach to dealing with an underwater mortgage is to simply continue making the payments as if nothing has changed. Homeowners who are having no trouble making those payments and who have reason to believe that property values will gradually increase over time may choose to go this route. While the potential for loss remains strong, shifts in the economy could correct the situation over time, effectively putting the mortgage debt back on track.
A second strategy would be attempting to renegotiate the underwater mortgage with the current lender. While not all lenders will be open to this idea, there is the chance of making changes in the existing contract that would adjust the interest rate or other provisions of the contract, including the possibility of some adjustment on the principal due. Should this option not be available, the homeowner may seek to refinance the mortgage, hopefully locking in a better interest rate. When refinancing a mortgage that is underwater, the need to supply a new down payment that brings the mortgage amount in line with the current market value of the property may be necessary.
In severe cases, homeowners may determine that the downward trend with property values will continue, resulting in an ever-increasing loss. When this is the case, the homeowner may choose to either default on the mortgage or at least work with lenders to arrange the sale of the property a the best possible price, settle at least the major portion of the debt, and work out some other arrangements to pay off any remaining balance. This approach can have serious consequences for credit ratings, making it the least desirable approach for dealing with an underwater mortgage.