An underwater mortgage deals a serious financial blow because the negative equity can turn one of your greatest assets into a liability. High risk prevents most lenders from refinancing underwater mortgage loans -- if you default and the lender forecloses, it won't earn enough on the sale of your home to offset its loss. However, you have several other options for getting out from underneath that upside-down loan.
Ride It Out
The simple fact that you're underwater doesn't mean you need to take action. If you can afford your mortgage payment and don't anticipate needing to move in the next few years, your best bet may be to do nothing. Your home's value likely will appreciate over time. In the meantime, every payment you make brings you closer to getting out of the negative equity situation.
A number of programs exist to help homeowners struggling to pay down upside-down mortgages. These loan modifications extend the amount of time you have to pay off the loan, lower the payments by reducing interest or, in fewer cases, lower your payments by reducing the principal balance on your loan. The government's Making Home Affordable Program also works with lenders to make available a number of special refinance options through its government-backed-loan programs for underwater homeowners. If you qualify and your lender cooperates, you may be able to reduce your principal balance and restructure the loan using one of these programs.
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If you're unable to pay your mortgage because of an ongoing hardship but you want to stay in your home, consider filing bankruptcy. The primary consequence of loan non-payment is foreclosure, which is a collection activity. Bankruptcy stops collection activities. Bankruptcy seriously damages your credit and it stays on your report for 10 years. However, your credit score will begin to recover after you've finished making your Chapter 13 repayments or within a couple of years after a Chapter 7 bankruptcy that eliminates your repayment obligations.
You can avoid foreclosure by selling short -- selling your home for less than you owe on the mortgage. You'll need your lender's permission, and you'll have to document the hardship that keeps you from continuing your payments. A short sale has about the same effect on your credit as a foreclosure, but it serves as proof that you worked toward meeting your obligation to the lender. Note, however, that a short sale is a type of loan forgiveness. You may have to pay tax on the amount forgiven.
Foreclosure or deed-in-lieu essentially gives a home back to the lender. In a foreclosure, the lender eventually issues an order for the homeowner to vacate the property, then repossesses the home and sells it to recoup some of its loss. A deed-in-lieu means the homeowner transfers ownership to the lender, which saves the lender from having to repossess the home. Although a deed-in-lieu is more palatable to many homeowners, it has the same impact on your credit score as a foreclosure.
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