When your home is worth less than what you owe, your options depend on your income, your lender's willingness to negotiate, and whether you plan to stay
An underwater mortgage — also called being "upside down" — means your home's current market value is lower than the balance on your loan. If your home is worth $150,000 but you owe $180,000, you are underwater by $30,000. This situation became common after the 2008 housing crisis and can happen again when home values drop or when you bought at a market peak.
For lower-income households, an underwater mortgage creates a real trap: you cannot sell without bringing cash to closing, you cannot refinance to a better rate because lenders won't lend more than the home is worth, and you are locked into a payment you may struggle to afford. The strategies that work depend on whether you want to keep the home, whether you can afford the payment, and what your lender will accept.
Key Takeaways
- Loan modification through your lender can lower your monthly payment by extending the loan term, reducing the interest rate, or in rare cases forgiving part of the principal.
- A short sale lets you sell the home for less than you owe, though it damages your credit and the lender must approve the sale price.
- Deed in lieu of foreclosure transfers the home to the lender to avoid foreclosure, but has similar credit damage and tax consequences as a short sale.
- If you can afford the payment and plan to stay, waiting for the market to recover may be the lowest-cost option, though it requires years of patience.
- The Home Affordable Modification Program (HAMP) ended in 2016, but many lenders still offer modifications under their own programs with similar terms.
Loan modification: lowering your payment without selling
A loan modification is a written agreement with your lender to change the terms of your mortgage — usually by lowering the interest rate, extending the loan term to 40 years, or in some cases reducing the principal balance. The goal is to make your monthly payment affordable. This keeps you in the home and avoids the credit damage of a short sale or foreclosure.
To request a modification, contact your lender's loss mitigation or loan workout department — not the regular customer service line. Ask specifically for a loan modification program. You will need to provide recent pay stubs, tax returns, a bank statement, and a letter explaining your financial hardship. The lender will calculate your debt-to-income ratio (your total monthly debt payments divided by your gross monthly income) to decide whether to approve.
Most lenders want your debt-to-income ratio below 43 percent after modification. If you earn $2,000 per month, they want your total debt payments to be no more than $860. If your current mortgage payment alone is $1,200, a modification might extend your loan from 30 years to 40 years, dropping the payment to $950 and bringing you within range. The catch: you pay interest for 10 extra years, so you pay more total interest over the life of the loan.
Principal reduction — where the lender forgives part of what you owe — is rare and usually only happens if you are already in default or if the lender has a specific program for it. Ask directly whether your lender offers principal reduction. Some do; most do not.
Short sale: selling for less than you owe
A short sale means selling your home for less than the mortgage balance, with the lender's written permission to accept the lower price. If you owe $180,000 and the home sells for $150,000, the lender absorbs the $30,000 loss. This works only if the lender agrees — they are not required to.
A short sale makes sense if you cannot afford the payment, do not want to stay in the home, or need to move for work. It stops foreclosure and lets you walk away without owing the difference. However, it damages your credit score for three to seven years, and some lenders report the forgiven debt to the IRS as taxable income (though federal law has sometimes suspended this tax consequence during economic downturns — check current rules with a tax professional).
To pursue a short sale, list the home with a real estate agent experienced in short sales — this is important, because the agent must negotiate with the lender and the process takes longer than a normal sale. You will need to provide the lender with a hardship letter, financial documents, and a purchase offer. The lender will order an appraisal to confirm the home's value, then decide whether to approve the sale price. This process typically takes two to four months.
During the short sale, you continue paying your mortgage. If the sale falls through, you are still responsible for the full loan balance. Some lenders will agree to forgive the difference (called a "deficiency waiver"), but this is negotiable and not may provide.
Deed in lieu of foreclosure: transferring the home to the lender
A deed in lieu of foreclosure is a legal document that transfers ownership of your home directly to the lender, bypassing the foreclosure process. You stop paying the mortgage, the lender takes the home, and you walk away. This avoids the public auction and court costs of foreclosure.
The credit damage is similar to a short sale — your score drops significantly and the record stays for seven years. Like a short sale, the forgiven debt may be reported to the IRS as taxable income. The lender must agree to accept the deed; they are not required to, and they may prefer to foreclose instead because it gives them more legal control.
A deed in lieu works if you are already in default, cannot catch up, and want to exit quickly without the months-long short sale process. It is faster than foreclosure and avoids the legal fees. However, it is harder to negotiate than a short sale because the lender has less incentive — they get the home either way, so they may straightforward foreclose and let the court handle it.
Waiting for the market to recover: the long-term hold
If you can afford your monthly payment and plan to stay in the home for many years, doing nothing may be the cheapest option. Home values fluctuate. Markets that fell can recover, especially over a decade or longer. If you wait long enough, your home may no longer be underwater.
This strategy works only if three conditions are true: you can afford the payment without hardship, you do not need to move, and you can tolerate the uncertainty. It requires patience — recovery can take five to ten years or longer depending on your local market. During that time, you are paying full interest on the full loan balance, which costs more than a modification would.
However, if you have already modified your loan or refinanced at a low rate, waiting may make sense. You are building equity through your payments, and you avoid the credit damage and tax consequences of a short sale or deed in lieu. Once the home is no longer underwater, you can refinance to a better rate or sell without bringing cash to closing.
Refinancing: when it is and is not possible
Refinancing means taking out a new loan to pay off the old one, usually at a better interest rate. However, most lenders will not refinance a loan for more than 80 percent of the home's current value. If your home is worth $150,000 and you owe $180,000, no lender will refinance you because you are asking them to lend $180,000 on a $150,000 home.
The exception is the Home Affordable Refinance Program (HARP), which ended in 2018 but served borrowers with loans owned or may provide by Fannie Mae or Freddie Mac. If you have a Fannie Mae or Freddie Mac loan, contact your lender to ask whether you still may have access to for any remaining HARP-like programs. Some lenders have extended similar programs under their own names.
If you cannot refinance through a standard lender, a loan modification is usually your better option because it does not require the home to be above water.
Avoiding scams and predatory offers
When you are underwater and struggling with payments, you will receive calls and letters from companies promising to "save your home" or "eliminate your debt." Many of these are scams. Legitimate help comes from your lender directly, from HUD-approved housing counselors, or from legal aid organizations — not from third-party companies charging upfront fees.
Red flags include: demands for payment before any work is done, promises that you will not have to pay your mortgage while they "negotiate," claims that they have special access to lender programs, and pressure to sign documents you do not understand. Your lender will not require you to pay a third party to modify your loan. They will work with you directly.
Contact a HUD-approved housing counselor for free information. You can find one through the National Foundation for Credit Counseling or by calling 1-800-569-4287. These counselors can review your specific situation, explain your options, and help you understand what your lender is offering.
Tax consequences of forgiven debt
If your lender forgives part of your debt through a modification, short sale, or deed in lieu, the IRS may treat the forgiven amount as taxable income. If $30,000 of your mortgage is forgiven, you might owe income tax on $30,000 in "phantom income" — money you never received but the IRS counts as income.
However, federal law has sometimes suspended this tax consequence for mortgage debt forgiveness during economic downturns. The rules change, so before you pursue a short sale or deed in lieu, ask a tax professional or your lender whether the forgiven amount will be reported to the IRS and whether you will owe tax on it. This can significantly change whether a short sale makes financial sense.
Frequently Asked Questions
Will a loan modification hurt my credit score?
A modification itself does not damage your credit if you are current on payments when you request it. However, if you are already behind on payments, the late payments are already on your credit report. A modification can help you catch up and stop further damage. A short sale or deed in lieu will damage your score significantly for three to seven years.
Can my lender force me to accept a modification I do not want?
No. A modification is a voluntary agreement between you and the lender. You can refuse and keep your current loan terms. However, if you are in default and cannot catch up, refusing a modification may lead to foreclosure.
What happens if I stop paying my mortgage while negotiating a modification?
Stopping payments will damage your credit and may trigger foreclosure. Most lenders want you to keep paying while you negotiate. If you cannot afford the payment, tell your lender when ready — they may allow you to make reduced payments during the modification process, though this varies by lender.
How long does a loan modification take?
The process typically takes 30 to 90 days from the time you submit a complete process. During this time, keep paying your mortgage on time. Some lenders offer a trial modification period where you make a lower payment for three months before the permanent modification is approved.
If I do a short sale, will I owe the difference between the sale price and what I owe?
Not if the lender agrees to a deficiency waiver, which forgives the difference. However, this is negotiable — some lenders will not agree. Ask your lender in writing whether they will waive the deficiency before you list the home for sale.