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Underwater Mortgage: Owing More than Your Home’s Worth

Facing an underwater mortgage is manageable. Mortgage expert Sean Cooper walks our reader, Keith, through what to do.

The question

Hi Experts,
I’m in a bind. We have to sell our home because an opportunity came up in another city. We bought our house just a year and a half ago, pretty much at the height of the housing boom. Now, prices have dropped and we can’t sell the house at a price that will cover what’s left of the mortgage. We don’t have access to enough money to cover the difference. What are our options?

Keith L., Toronto, ON

The answer

Dear Keith,

What you are referring to is an underwater mortgage.

Home prices have come down a lot in the last year. The Canadian Real Estate Association (CREA) reported that the average price of a home in Canada dropped by 12 percent in 2022. Home sales were also down by a whopping 39 percent compared to December 2021.

This is in large part due to higher interest rates. The Bank of Canada raised interest rates by four percent last year alone. Our central bank did that to fight near 40-year high inflation.

An underwater mortgage is when the mortgage on your home is for more than you can sell your home for. Homeowners who bought their homes before COVID are likely okay. Homeowners who bought at or near the peak, are finding themselves in a similar position.

How to escape an underwater mortgage

Here’s what you can do when you’re facing an underwater mortgage.

Turn your home into a rental property

Who says you need to sell your home? Just because you’re moving to a new city, it doesn’t mean that you need to buy a home there. You don’t even know if the opportunity will work out. My suggestion would be to rent a home instead of buying a home. Renting is often cheaper than buying.

Many people assume that they need to buy a home when that’s not the case. There’s nothing wrong with renting. In fact, renting can be a smart financial move. When you rent, the transactional costs are a lot lower than buying. All you need is the first and last months’ rent. When you buy a home it’s a lot more costly. You need money for the deposit, down payment and closing costs. Not everyone is able to come up with that amount of money easily.

With your current house, you can rent it out to tenants. By doing that, you’ll bring in extra money to help cover the expenses of your home (mortgage payments, property taxes, utilities, etc.). You might even be able to turn a profit if you’re able to rent out your home for more than it’s worth.

Sell your home through a short sale

A lesser-known way to sell your home is through a short sale. A short sale is when you accept an offer on your home that’s for less than the balance you owe on your mortgage. To sell your home through a short sale, your mortgage lender must be willing to forgive the balance owing on your mortgage. Some lenders may be willing to do that, while others won’t be.

When doing a short sale, it’s a good idea to work with a real estate agent with plenty of experience with short sales. That way you’ll improve your chances of having it approved by the lender and finding a home buyer.

Selling your home through a short sale does have its disadvantages though. Mainly, that it can hurt your credit score.

A short sale will almost always show up on your credit report. Other lenders will be able to see that you settled your mortgage for less than you owed. I’m sure you can understand why the chances a lender wouldn’t necessarily be inclined to offer you a mortgage at their best rate.

A short sale is almost always better than filing for bankruptcy or a consumer proposal. That being said, it can hurt your chances of obtaining mortgage financing and other credit in the future. Credit blemishes like this can show up on your credit report for seven years. It could show that your mortgage was “not paid as agreed,” which doesn’t send a good message to other lenders.

During this time, you might not be able to qualify for a mortgage with a prime lender. As such, you’ll need to go with an alternative or private lender. With these lenders, you’ll be required to put down at least 20 percent on the property, maybe more. You won’t be able to buy a home with just five percent down like you could if you had good credit. Not to mention the mortgage rates tend to be much higher and there can be lender fees.

You also must be able to sell your home. Sometimes the market can be so tough that you’re not able to sell your home for weeks or months. A short sale only works if and when you’re able to sell your home.

Deed-in-lieu of a foreclosure

A variation of a short sale is a deed-in-lieu of foreclosure. Depending on where you live, this might be an option. When you do this, as the homeowner you sign away your home’s deed to your mortgage lender. By doing that, your lender will relieve you of the balance you owe on your mortgage.

This can be a win-win for you and the lender. If the alternative is a foreclosure, this can be a lot less costly for both parties involved.

Pay down your mortgage

If you haven’t paid down your mortgage enough and you owe more than your home is worth, you can keep paying down your mortgage. By paying down your mortgage, you’ll build up more equity in your home. Hopefully, you’ll then be able to sell your home and cover the rest of the mortgage balance owed.

Speak with at least a couple of real estate agents you know and trust They’ll tell you how much your home might be able to sell for. Knowing that you can figure out how close you are to building up equity in your home and plan accordingly.

Don’t sell your home

You said that an opportunity came up in another city. While it may seem like a good opportunity, it could cost you a lot when it comes to your home. As such, as difficult as it is, you might choose to stay put in your home and turn down the opportunity. By doing that, you can bide your time and wait until your home’s value hopefully rebounds now that mortgage rates have seemed to stabilize.

If you know that you’re going to get a pay raise at work, you can wait until that happens. When you get the pay raise, you can use the extra money to pay down your mortgage even faster.

How do you avoid having your mortgage underwater?

Hindsight is 20/20 as the saying goes. Hopefully, you found our suggestions helpful. To avoid this situation on your next property, it’s best to always aim to put more than the minimum down payment on a property.

Putting just five percent down leaves you vulnerable to an underwater mortgage if home prices drop after you purchase your home. Having an underwater mortgage isn’t the end of the world. However, if you need to sell your home, that’s when you can run into difficulties, as you’re experiencing now.

As such, always aim to put down more. Instead of five percent, aim to put down 10 percent, or whatever you can afford. By doing that, you’ll have a lot more options if something unexpected happens and you need to sell your home sooner.

This is also a good example of why it’s important to aim to keep emergency savings. That way if a situation like this happens, you can use your emergency savings to get out of the bind.

I hope that helps. Best of luck!

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