Underwater on Your Mortgage? Understanding Negative Equity and Your VA Loan Options

For many active-duty service members, Veterans, and eligible surviving spouses, owning a home purchased with a VA loan is a source of pride and stability. The VA loan’s incredible benefits, like no down payment and no Private Mortgage Insurance (PMI), offer an accessible path to homeownership. However, even with the strongest foundation, economic shifts can sometimes lead to an unexpected challenge: being “underwater” on your mortgage.

At VeteransLoans.com, we understand that falling into a negative equity position can be stressful and confusing. It’s a situation no homeowner wants to face, but it’s important to know what it means, what causes it, and most importantly, what steps you can take to navigate it, especially with the unique advantages of your VA loan.

What Does “Underwater” on Your Mortgage Mean?

An “underwater mortgage,” also commonly referred to as an “upside-down mortgage” or “negative equity,” occurs when the amount you owe on your home loan is greater than the current market value of your home.

In simpler terms:

Your Home’s Current Market Value < Your Remaining Mortgage Balance

For example, if you owe $250,000 on your mortgage, but your home would only sell for $220,000 in today’s market, you are $30,000 “underwater.” This $30,000 represents your negative equity.

Equity vs. Negative Equity

• Equity: This is the portion of your home that you actually own outright. It’s calculated by subtracting your remaining mortgage balance from your home’s current market value. As you pay down your mortgage and as your home’s value appreciates, your equity increases.
• Negative Equity: When your mortgage balance exceeds your home’s value, you have negative equity. This means that if you were to sell your home today, you would not only get nothing from the sale but would actually owe money to your lender after the sale.

What Causes a Mortgage to Go Underwater?

Being underwater on a mortgage is primarily a result of market forces and, sometimes, personal financial decisions.

The most common causes include:

• Significant Decline in Property Values: This is the leading cause. Rapid or sustained downturns in the local or national housing market can cause home values to drop below the original purchase price or the outstanding loan balance. This happened significantly during the 2008 financial crisis. Localized issues like increased crime rates, failing schools, or the departure of major employers can also cause property values in specific areas to decline.
• Buying at the Peak of the Market: If you purchased your home when prices were at their highest, there’s less room for continued appreciation, and a higher risk of values falling.
• Low or No Down Payment: While a major benefit of the VA loan is no down payment, starting with zero equity means any depreciation in home value immediately puts you underwater. Even with a small down payment on a conventional loan, a slight dip in value can quickly erode that initial equity.
• Taking Out a Second Mortgage or Home Equity Line of Credit (HELOC): Borrowing against your home’s equity reduces the amount of equity you have, making you more vulnerable to market fluctuations.
• Rapid Depreciation of the Home’s Condition: While less common for the entire market, if your home falls into significant disrepair and its value declines due to neglect, it can contribute to negative equity.
• Foreclosures and Short Sales in Your Area: A high number of foreclosures or short sales in your immediate neighborhood can drive down property values, impacting your home’s value.

Why Is an Underwater Mortgage a Problem?

While being underwater on your mortgage isn’t ideal, it’s not necessarily an immediate crisis, especially if you plan to stay in your home long-term. However, it does present several significant challenges:

• Difficulty Selling Your Home: This is the most direct impact. If you need to sell your home, you’ll have to bring cash to the closing table to cover the difference between the sale price and what you owe the lender. This can be a substantial sum.
• Inability to Refinance (in most cases): Most traditional refinance options require you to have positive equity. Lenders are unwilling to lend more than a home is worth. This can prevent you from taking advantage of lower interest rates or better loan terms.
• Inability to Access Home Equity: If you’re underwater, you have no equity to tap into for home improvements, debt consolidation, or emergency funds.
• Risk of Foreclosure: If you experience financial hardship and stop making mortgage payments, being underwater exacerbates the problem. The lender has less incentive to work with you on a loan modification if they know they can’t recover their full loan amount through a sale.

What Can You Do About an Underwater Mortgage?

Facing an underwater mortgage can feel overwhelming, but there are several strategies and options available. The best course of action depends on your financial situation, whether you need to sell, and if your loan is a VA-guaranteed loan.

Option 1: Stay Put and Ride It Out (If Possible)

For many homeowners, if you can afford your monthly mortgage payments and don’t need to move in the near future, the simplest strategy is to continue making your payments and wait for the market to recover.

• Pros:
  • No additional costs (like closing costs for refinancing or selling).
  • Avoids further damage to your credit score (unlike short sales or foreclosures).
  • Over time, you will build equity by paying down your principal, and property values may eventually rise.
• Cons:
  • Market recovery is not guaranteed and can take many years.
  • You remain financially tied to a depreciating asset in the short term.

Tips:

Continue Making On-Time Payments: This is paramount. Missing payments will only compound the problem and could lead to foreclosure.

Make Extra Principal Payments (If You Can): Even small additional payments directly to your principal can help you build equity faster and get above water sooner. Always confirm with your lender how to ensure extra payments are applied directly to principal.

Monitor Local Market Trends: Stay informed about property values in your area. This will help you know when the market is turning around.

Option 2: Explore Refinancing Options (Especially for VA Loans)

Traditional refinancing usually requires equity. However, specific government-backed loan programs, like the VA IRRRL, are designed to help borrowers with little to no equity.

• VA Interest Rate Reduction Refinance Loan (IRRRL) – The “Streamline”:
  • Key Advantage for Underwater Mortgages: An IRRRL typically does not require an appraisal or credit underwriting. This is a huge benefit if your home value has dropped, as the VA does not need to verify the current value to approve the refinance.
  • Purpose: The IRRRL’s primary goal is to lower your interest rate, reduce your monthly payment, or convert an Adjustable-Rate Mortgage (ARM) to a stable Fixed-Rate Mortgage.
  • Eligibility: You must already have an existing VA loan on the property and meet seasoning requirements (generally 210 days and six on-time payments).
  • Funding Fee: A VA funding fee (usually 0.5% for an IRRRL) applies, but can often be rolled into the new loan. Veterans with service-connected disabilities are exempt.
  • Net Tangible Benefit: The VA requires that the refinance provides a “net tangible benefit” to you.

If you have a VA loan and are looking to lower your interest rate, the IRRRL is an excellent option, even if you’re underwater. Learn more about the VA IRRRL at veteransloans.com/va-irrrl-refinance.

VA Cash-Out Refinance (Not for Negative Equity):

While the VA offers a Cash-Out Refinance option, this does require equity in your home. It’s designed for borrowers who have positive equity and want to tap into it. If you’re underwater, this option will not be available to you.

Option 3: Loan Modification

A loan modification is an agreement between you and your lender to change the original terms of your mortgage. This can make your monthly payments more affordable and help you avoid foreclosure.

• How it Works: The lender might:
  • Reduce your interest rate.
  • Extend your loan term.
  • Add missed payments to the loan balance (recasting the loan).
  • In rare cases, reduce the principal balance (principal reduction).

Eligibility: You typically need to demonstrate a financial hardship that prevents you from making your current payments.

VA Assistance: If you have a VA-guaranteed loan and are struggling, the VA can directly intervene on your behalf. Contact the VA Loan Guaranty service at 1-877-827-3702 to speak with a VA loan technician. They can work with your loan servicer to explore options like special forbearance, repayment plans, or loan modifications.

Option 4: Short Sale (If You Must Sell)

A short sale is an option if you need to sell your home, are underwater, and cannot afford to bring cash to the closing table. In a short sale, your lender agrees to let you sell your home for less than the amount you owe on the mortgage.

• How it Works:
  • You list your home for sale at its current market value.
  • If you receive an offer, you submit it to your lender for approval.
  • The lender reviews your financial hardship and decides whether to accept the offer, knowing they will take a loss.
• Pros:
  • Avoids foreclosure.
  • Less damaging to your credit than a foreclosure.
• Cons:
  • Can take a long time to get lender approval.
  • Still damages your credit score (though less severely than foreclosure).
  • You might still owe the “deficiency” (the difference between the sale price and loan balance) depending on state laws and lender agreements.

Tips:

Consult a Real Estate Agent: Work with an agent experienced in short sales.

Communicate with Your Lender: Be open and honest about your financial situation.

Seek Legal/Financial Advice: Understand the tax implications and deficiency laws in your state.

Option 5: Deed-in-Lieu of Foreclosure

In a deed-in-lieu of foreclosure, you voluntarily transfer ownership of your home back to the lender to avoid the formal foreclosure process.

• Pros:
  • Avoids the public record and severe credit damage of a full foreclosure.
  • Often less stressful than foreclosure.
• Cons:
  • You lose your home.
  • Still impacts your credit significantly.
  • Requires lender approval, and they may require the property to be in good condition.

Option 6: Foreclosure (Last Resort)

Foreclosure is when the lender takes legal action to repossess your home due to missed payments. This is the most damaging outcome for your credit and should be avoided if possible.

Consequences: Severe damage to your credit score for many years, difficulty obtaining future credit, and potential deficiency judgments.

Important Tips and Information for VA Homeowners

If you find yourself underwater on your VA loan, here are some crucial tips:

Don’t Panic, But Don’t Ignore It: Market fluctuations are a normal part of real estate. While negative equity is concerning, panicking can lead to rash decisions. However, ignoring the problem will only make it worse. Address it proactively.

Understand Your Current Home Value: Get a realistic idea of what your home is worth today. You can consult local real estate agents for a comparative market analysis (CMA), or consider a professional appraisal.

Know Your Mortgage Balance: Keep track of how much you still owe on your loan. This information is typically on your monthly mortgage statement or available through your loan servicer’s online portal.

Calculate Your Equity/Negative Equity: Subtract your mortgage balance from your home’s estimated current value. This will show you exactly how much you are underwater (or above water).

Contact Your Lender/Loan Servicer IMMEDIATELY: This is the most critical first step. The sooner you communicate your situation, the more options you’ll have. Lenders prefer to work with borrowers to avoid foreclosure.

Leverage VA Resources: If you have a VA-guaranteed loan, you have an incredible advocate: the Department of Veterans Affairs.

• VA Loan Technicians: The VA has dedicated loan technicians who can assist Veterans who are struggling with their mortgage payments. They can provide advice, intervene with your loan servicer, and help explore all available options to avoid foreclosure. Call the VA at 1-877-827-3702 (TTY: 711).

Seek Housing Counseling: The Department of Housing and Urban Development (HUD) sponsors local housing counseling agencies that provide free or low-cost advice on avoiding foreclosure, budgeting, and understanding your options.

Beware of Scams: Be cautious of companies that promise guaranteed fixes for an upfront fee. Always work with reputable organizations and directly with your lender or the VA.

VeteransLoans.com: Your Partner in Homeownership

While facing an underwater mortgage can be challenging, having a VA loan provides you with specific advantages and resources not available to other homeowners. The key is to understand your options and act proactively.

At VeteransLoans.com, we are committed to supporting our military community throughout their homeownership journey, from the excitement of purchasing a home to navigating unforeseen challenges like negative equity. While we primarily assist with VA loan origination and refinancing, we also aim to provide comprehensive information and guidance for all aspects of VA homeownership.

If you have questions about your VA loan, eligibility, or potential refinance options to help with your current mortgage situation, don’t hesitate to reach out. Our experienced VA loan specialists are ready to provide expert, personalized advice.

• Get Pre-Qualified (or just talk to us!): Even if you’re not looking to buy or refinance immediately, understanding your options is the first step. Visit veteransloans.com/prequalify or
• Call a VA Loan Expert: For direct assistance and answers to your specific questions, call us at 1 (888) 232-1428.

Your service has earned you this benefit, and we’re here to help you protect it.