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 can stay in the house

An underwater mortgage — also called being "upside down" — means the market value of your home has dropped below the amount you still owe the lender. If you bought at $200,000 and owe $180,000 but your home is now worth $150,000, you are underwater by $30,000. For lower-income homeowners, this creates real constraints: you cannot sell without bringing cash to closing, refinancing becomes harder, and walking away has serious consequences.

Your actual options narrow based on three things: whether you can afford to keep paying, whether your lender will work with you, and what your state's laws allow. This guide covers the paths that exist and what each one costs you.

Key Takeaways

  • Staying and paying is often the cheapest long-term choice if you can afford the monthly payment, because your home may regain value and you keep building equity.
  • Loan modification — where your lender rewrites the terms — can lower your payment but requires proof of financial hardship and takes two to four months to process.
  • Short sales let you sell for less than you owe, but require lender approval and may trigger a tax bill on the forgiven amount.
  • Foreclosure destroys your credit for seven years and may leave you liable for a deficiency judgment in some states, so it should be a last resort.
  • Your state's laws determine whether a lender can pursue you for money after foreclosure, which changes whether walking away is financially survivable.

Staying in the home and continuing to pay

If you can afford your monthly payment and do not need to move, staying put is often the simplest path. Being underwater does not change what you owe each month, and over time — sometimes years — home values can recover. You continue building equity with every payment, even if the home is currently worth less than the mortgage balance.

The risk is that you are locked in place. You cannot sell without a short sale (see below), you cannot refinance to a better rate without significant equity, and if your income drops and you cannot pay, you have fewer escape routes than someone with equity. For lower-income households, this means a job loss or medical emergency becomes a foreclosure threat rather than a manageable problem.

This strategy works only if your income is stable enough that you can absorb a financial shock. If you are already stretched thin, explore the options below before committing to stay.

Loan modification: rewriting your mortgage terms

A loan modification is a formal agreement with your lender to change the terms of your mortgage — usually by extending the loan period, lowering the interest rate, or temporarily reducing the payment. The goal is to make the monthly payment affordable. This is different from refinancing, which replaces the old loan with a new one; modification keeps the same loan but changes its terms.

To request a modification, contact your lender's loss mitigation department (not the regular customer service line) and ask for a modification application. You will need to provide recent pay stubs, tax returns, a bank statement, and a written explanation of your hardship. The lender will review your income and expenses to decide whether a modified payment is sustainable.

The process typically takes two to four months. During that time, keep making your regular payment if you can, because missing payments while your request is pending can trigger foreclosure. Some lenders will put you in a trial modification — a lower payment for three months — before committing to a permanent change. If the trial works, they convert it to a permanent modification.

Modifications do not erase the underwater status, but they can make it manageable. The downside is that extending the loan period means you pay interest longer, so you may pay more total interest even though the monthly payment drops. Ask your lender for a comparison of total interest paid under the old and new terms before you agree.

Short sale: selling for less than you owe

A short sale means selling your home for less than the mortgage balance and asking the lender to forgive the difference. If you owe $180,000 and sell for $150,000, the lender forgives $30,000 (minus selling costs). This requires the lender's written approval before you list the home.

To pursue a short sale, contact your lender and request a short sale package. You will need to show financial hardship — job loss, medical bills, divorce, or reduced income. The lender will order an appraisal to confirm the home's value, then review your offer once you have a buyer. Approval typically takes four to eight weeks after you have a signed purchase agreement.

The major catch is the tax bill. The IRS treats forgiven debt as income. If your lender forgives $30,000, the IRS may consider that $30,000 taxable income in the year of the sale. For lower-income households, this can mean a surprise tax bill of several thousand dollars. However, some forgiven mortgage debt is excluded from income under the Mortgage Forgiveness Debt Relief Act, though this exclusion has expired and been reinstated multiple times — check current rules with a tax professional before proceeding.

A short sale also damages your credit, though usually less severely than a foreclosure. It signals to future lenders that you did not pay the full debt, but it shows you worked with the lender rather than abandoning the home.

Deed in lieu of foreclosure: transferring the home to the lender

A deed in lieu of foreclosure is an agreement where you sign the home over to the lender instead of going through a foreclosure. The lender takes the property, you move out, and the foreclosure process is avoided.

This is faster than foreclosure — usually completed in six to eight weeks — and it avoids the public court process. However, the lender still reports it to credit bureaus as a default, and you may still face a tax bill on forgiven debt. The main advantage is speed and avoiding the legal costs and court appearance of a formal foreclosure.

Lenders are often willing to accept a deed in lieu if the home is worth significantly less than the mortgage, because it saves them the cost of foreclosure proceedings. Ask your lender's loss mitigation department whether this is an option in your situation.

Foreclosure and deficiency judgments: understanding the worst-case scenario

If you stop paying and do not negotiate with your lender, foreclosure is the likely outcome. The lender takes back the home, sells it (usually at auction for less than market value), and applies the proceeds to your debt. If the sale does not cover what you owe, you may be liable for the difference — called a deficiency.

Whether you can be sued for a deficiency depends entirely on your state. Some states are non-recourse states, meaning the lender's only remedy is to take the home; they cannot pursue you for additional money. Other states are recourse states, where the lender can sue you for the deficiency and garnish your wages or bank account. A few states are mixed, with different rules depending on the type of loan or whether the home is your primary residence.

Foreclosure also destroys your credit for seven years, making it nearly impossible to borrow money, rent an apartment, or sometimes even get a job. For lower-income households, this can mean homelessness or years of paying premium rates for housing.

Before foreclosure happens, you will receive notice — usually 30 to 120 days depending on your state — giving you time to explore the options above. Use that time. Foreclosure should be a last resort only if every other option has been exhausted.

State laws that change your options

Your state's laws determine which strategies are actually available to you. Some states require lenders to offer loan modifications before they can foreclose. Some states have anti-deficiency laws that protect you from owing money after the home is sold. Some states require a judicial foreclosure (through a court) rather than a non-judicial one (handled by the lender), which gives you more time and more legal options to fight back.

Before you decide on a strategy, research your state's foreclosure laws. Your state's attorney general's office, your local legal aid society, or a HUD-approved housing counselor can tell you what protections exist in your state and which options are realistic for your situation. This information is free and can change which path makes sense for you.

Getting help from a housing counselor

A HUD-approved housing counselor can review your situation, explain your options, and help you communicate with your lender. These counselors work for nonprofits and are free to lower-income homeowners. They understand loan modifications, short sales, and state-specific rules, and they can often negotiate with lenders on your behalf.

To find a counselor, call 211 or visit HUD's counselor locator at hud.gov. You can also contact your local legal aid society, which often has housing attorneys who work with underwater mortgages. If you are behind on payments or facing foreclosure, getting professional help early — before the lender files papers — gives you the most options.

Frequently Asked Questions

Can I just walk away from an underwater mortgage?

Legally, yes, but the consequences depend on your state. In non-recourse states, the lender can take the home but cannot sue you for the difference. In recourse states, you can be sued for the deficiency and have wages or bank accounts garnished. Either way, foreclosure destroys your credit for seven years. Before walking away, talk to a housing counselor about your state's laws and whether you have other options.

Will a loan modification hurt my credit?

A modification will show on your credit report as a change to your loan terms, which may cause a small dip in your score. However, it is far less damaging than a late payment, short sale, or foreclosure. If you are current on payments and modify before you fall behind, the credit impact is usually minimal.

What if I cannot afford any option — not even a modified payment?

If your income is too low to sustain any mortgage payment, your realistic options are short sale or foreclosure. A housing counselor can help you understand which is less damaging in your state and whether you may have access to for any emergency assistance. Some nonprofits also offer down-payment help or relocation assistance for people facing foreclosure.

Can I refinance out of an underwater mortgage?

Standard refinancing requires at least 20% equity, which you do not have. However, some government-backed programs like FHA Streamline or HARP (Home Affordable Refinance Program) allow refinancing with little or no equity if you meet other requirements. Ask your lender whether you may have access to, or discuss this with a housing counselor.

How long does it take to recover from a short sale or foreclosure?

Both remain on your credit report for seven years, but their impact weakens over time. After two to three years of on-time payments on other debts, you may be able to borrow again, though at higher rates. Foreclosure is typically more damaging than a short sale because it signals abandonment rather than negotiation with the lender.