What happens if I need to sell my property for less than the mortgage?

If the value of your property falls below the amount of money left on your mortgage, then you’re in negative equity. You have several options to move forward, but they all have consequences.

What is negative equity?

Negative equity, or an underwater mortgage, is when you owe more on a home than it’s worth.

For example, let’s say you took out a mortgage for $450,000. A year later, the market value of the property has fallen to $400,000. If you still owe $430,000 on your mortgage, you have negative equity. If you elect to sell the property now, you’ll still have $30,000 remaining on the mortgage that you’ll need to pay off.

How to sell a house with negative equity

If you have negative equity in your home but you need to sell it, you still need to repay the full mortgage. This leaves you with four main options:

1. Do a short sale. A short sale is a sale in which the lender agrees to a lower price than what the home is worth. To do a short sale, you’ll need to find a buyer and then approach your lender and ask them to agree. Your lender isn’t obligated to agree to a short sale though, and it will hurt your credit — but not as badly as a foreclosure.
2. Pay the difference. You can sell your house and pay anything remaining directly to your lender, either out of pocket or using a personal loan. For example, if you owe $150,000 and you sell the home for $140,000, you’d need to pay the lender a lump sum of $10,000 before the sale was final.
3. Foreclose. If you’re completely out of options, you can walk away from the home and let the bank foreclose on it. A foreclosure will damage your credit for seven years. And you likely won’t be able to get another mortgage during that time.
4. Offer a deed in lieu of foreclosure. If it looks like foreclosure is your only option, you might be able to get your lender to agree to a deed in lieu of foreclosure instead. You voluntarily give the deed to the lender and move out of the home. It can damage your credit just as much as a foreclosure, but you may be able to negotiate for a longer period of time to move out or a small lump sum of cash to help you get an apartment.

• Before making any decisions about getting rid of an underwater mortgage, talk to a professional. A real estate agent can help you determine how much you’ll be able to sell your home for. A certified personal accountant (CPA) can go over the tax implications of all four options.

Is it better to keep the property?

In most cases, you’ll be better off keeping the property and waiting to sell until you’ve broken even or built up equity. You can keep paying the mortgage down, work with a lender to find out if you’re eligible to refinance to a lower interest rate or rent the property out and use the rental income to pay down the mortgage.

But in some cases, keeping the property might not be worth it. If the home needs a lot of work or repairs that you can’t afford, you may be better off taking the loss — especially if the home’s condition is gradually getting worse.

Explore all of your options and talk to your lender, a real estate agent and/or a CPA before deciding what to do about your underwater mortgage.

What causes negative equity?

Negative equity can be caused by a number of factors, including:

• Falling house prices. If you buy when the market is at its high point and median house prices then drop, negative equity is sometimes the result.
• Overpaying for a property. If you pay more for a property than it’s worth, you’ll likely face negative equity if you sell too soon.
• Property damage. A property may decline in value if it is damaged or destroyed, for example if a house fire occurs in an uninsured property.
• High loan-to-value ratios. If you borrow most of the money for the home, even a small drop in the home’s value could lead to negative equity. For example, if you put 3.5% down and borrow 96.5%, even a 4% drop in the home’s value could lead to negative equity.

How can I get out of negative equity?

You may be able to turn things around if you:

• Make extra payments. Paying more than required each month on your mortgage can help you quickly pay down your principal.
• Refinance or negotiate. Consider refinancing with another lender or negotiating a better interest rate with your current lender. But keep in mind that it can be difficult to refinance with negative equity, and you may not get approved.
• Consider renovating. In some situations, you may be able to increase the value of your property by doing renovations to improve it. But this can also backfire and leave you in more debt, so it’s a risky move.

How can I prevent ending up with negative equity again?

• Avoid borrowing too much. Taking out a loan with a loan-to-value ratio of 90% or higher can be risky. It’s much safer to save a large down payment before you start looking for a home.
• Get an accurate valuation. Before you buy a home, get an independent appraisal to find out whether you’re paying too much. And resist the urge to pay above market value for a home you’ve fallen in love with.
• Avoid interest-only payments. Some mortgages let you just pay the interest for the first few years without paying down the principal balance. While this temporarily lowers your payments, it also prevents you from building any equity in the home.

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Bottom line

If you have negative equity in your home, start by considering whether you might be better off waiting to sell. If you need to move out, talk with a financial professional to help you make the best decision.

If your credit is damaged in the process, you may need to wait to buy another home. And when you’re ready, you’ll likely need to compare mortgage lenders to find one willing to work with you.