An underwater mortgage, sometimes called an upside-down mortgage, is a home loan with a higher principal than the home is worth. Consider these factors before you do.. Image Credit: Shutterstock

Dubai: Have you been making your home loan payments for years only to realise you now owe more money on your home than your property is worth? If so, you have an ‘underwater mortgage’. Such a predicament can be a headache for homeowners like you.

This is particularly true if you want to sell your property or refinance it, meaning you replace the mortgage you have with a new mortgage that has more favourable terms, which allows you to get a better interest rate on your mortgage.

What is an ‘underwater mortgage’?
An underwater mortgage, sometimes called an upside-down mortgage, is a home loan with a higher principal than the home is worth. This happens when property values fall but you still need to repay the original balance of your loan.

“Mortgages aren’t the only loans that can go underwater as any loan can end up the same way even when you miss your payments,” said Stephanie Myrtle, vice president of a Dubai-based real estate research firm. “But it’s riskier for home loans to go belly up as the dues at stake are way higher.

“Being forced to sell your home when you're ‘underwater’ on your mortgage is a difficult predicament. There are often times when homeowners have no choice. Your employer might transfer you to a new job across the country, or your home might be too small for a growing family.”

What do you do when your home loan is underwater?

If you're in this situation, the odds are high that you'll have to write a cheque to your lender once your home sale closes. But you might be able to reduce the amount you owe by setting the right asking price.

“Why it is hard to sell a mortgaged house or you’re still paying payments on? Selling a home with ‘negative equity’ is often a massive financial hit primarily because instead of making money on your home sale, you'll lose it,” said Prakash Bhat, a mortgage consultant based out of Abu Dhabi.

Glossary: ‘Home equity’, ‘Negative equity’
Home equity or a homeowner's financial stake in a home can increase over time if the property value increases or as you pay down the mortgage loan balance, particularly the principal amount. It increases the amount of money you have in your home that you may be able to use now or later.

‘Negative equity’ is a deficit of owner's equity, which happens when the value of a property used to secure a loan is less than the balance on the loan. It is potential debts arising when the market value of a property falls below the outstanding amount of a mortgage secured on it.

Here’s an illustration to understand this: Assuming you owe Dh200,000 on your mortgage, but your home is worth only Dh180,000. You'll struggle to sell your home for more than the Dh180,000 value. Even if you do sell at that figure, you'll still owe your lender Dh20,000 after you close your sale.

This means you'll have to write your lender a cheque for Dh20,000 at closing. That's not the outcome any home seller wants. So, here are some factors you should weigh before you sell your home when you're underwater on your mortgage.

Steps to selling your home when underwater on mortgage

Step #1: Wait as much as you can to sell your mortgaged property

What if you are underwater on your mortgage? A popular advice property and loan consultants often give their clients is to look for possible ways to hold off on selling your home. That way, you can hope that your home gains value — hopefully enough so you no longer have negative equity.

“You can also wait until you make enough monthly mortgage payments so you no longer owe more on your home loan than it's worth. If you can send extra money to your lender to be applied directly to reducing your loan's balance, you might be able to build equity at a faster pace,” added Bhat.

“However, the good news is the number of homeowners who are underwater on their mortgages is falling, compared to what it was a few years ago, as banks find alternatives for you before that happens. So it’s important to warn the bank of any sign you will continue to default on your loans.”

Selling a home with ‘negative equity’ is often a massive financial hit primarily because instead of making money on your home sale, you'll lose it

- Prakash Bhat, a mortgage consultant based out of Abu Dhabi

Step # 2: Set the right asking price on a mortgaged home

If you have no choice but to sell, the key is to set the right asking price for your property. “If you're underwater on your mortgage, set an asking price that's more competitive than what the market says your home is worth,” added Myrtle. “But practice caution as buyers know your home’s worth.

“If you set your asking price too high, most will pass your home by, looking at other properties instead. You can't force buyers to pay more for your home because you're underwater, because buyers do not take into consideration what you paid for your home – contrary to popular myth.”

You need to set an asking price that's fair, but also the highest possible amount you can sell it for. “The best way to find this price is to work with a real estate agent who is familiar with your neighbourhood,” added Bhat.

“Real estate agents that are familiar with the area your house is located can help you set an asking price that draws the biggest number of potential buyers, increasing your odds of selling your home for the highest price.”

What to do if you don’t use a real estate agent?
If you’ve decided not to hire an agent, you’ll need to do your research first, on recently sold properties in your area and properties currently on the market, to determine an attractive selling price, advised both Bhat and Myrtle.

“Most home prices have an agent’s commission factored in, so you may have to discount your price as a result. You’ll be responsible for your own marketing, so ensure to get your home on the multiple listing services in your area to reach the widest number of buyers,” said Myrtle.

“As you have no agent, you’ll be the one showing the house and negotiating the sale with the buyer’s agent, which can be time-consuming. Since you’re forgoing an agent, hire a real estate lawyer who can help you with the finer points of the transaction and for drawing up a contract.

“Even with a lawyer’s fees, selling a home yourself can save you thousands. If the buyer has an agent, however, they’ll expect to be compensated. This cost is typically covered by the seller, so you’ll still need to pay 1 per cent to 3 per cent of the home’s sale price to the buyer’s agent.”

Step # 3: Staging your home and make all necessary repairs

If you're underwater and plan to sell, you'll want to spend the least amount of money possible to sell your home, advised Bhat, and “investing in a home staging service providers or furnishing renters (those who provide furnishings and home décor on rent) can pay off.

“With the cost of such staging services starting at Dh10,000, the home you put on the market can be well presented. A stager will rearrange your furniture and home décor so that your home looks more spacious, bright, and roomy. This way your home makes a strong first impression on buyers.”

However, in order to sell your home, Bhat added that you'll have to repair any broken appliances, torn carpets, dinged walls, or stuck windows. The reasoning behind this is that “you can't list your home with any defects if you expect buyers to pay more money for it”.

Step #4: Look for ways to sweeten the deal or offer incentives

Another way to make the home and deal more attractive is to “sweeten” your selling offer, added Myrtle. “You could offer, for example, to pay some or all of the closing costs. Buyers are looking for a deal, particularly in a down market, so do your best to make them feel that they get one.

“Another tip is to offer a transferable home warranty, which provides discounted repair and replacement services for household goods. A potential buyer may feel more at ease knowing that the home is protected, which could make your home more attractive than a competing home.”

Key takeaways?

Selling a home can be stressful, even more so if you’re on a tight deadline. Fortunately, whether you need to sell fast because of a new job, an urgent need for cash, or financial reasons, there are ways to speed up the process.

If you don’t have a big budget to get your home sell-ready, then focus on making a great buyer impression. Additionally, whether you’re working with an agent or going it alone, setting the right asking price is key.

Remember the comparative market analysis you or your agent did when you bought your home to determine a fair offering price? Buyers will do this for your home, too, so as a seller you should be one step ahead of them.

The house may sit on the market for far longer than you expect, especially in a declining market. If you can’t find a buyer in time, you may end up trying to pay two mortgages, having to rent your home out until you can find a buyer, or, in dire situations, in foreclosure.