German YusufovSeptember 15, 2025

Mortgage stress can creep in fast, especially if you suspect the home is worth less than what you owe. At Yusufov Law Firm, PLLC, we focus on debt relief and bankruptcy options that help people in Mesa, Phoenix, and Tucson steady their finances and keep a roof over their heads.

If you are wrestling with an underwater mortgage, you are not alone, and you do have paths forward. In this article, we cover what an underwater mortgage is, common causes, the risks, and practical routes Arizona homeowners can use to move ahead.

What is an Underwater Mortgage?

An underwater mortgage happens when the principal balance on your home loan exceeds the current market value of the property. In short, the value has fallen or the debt has not dropped enough, creating negative equity. This gap can block a sale or a refinance without bringing cash to the closing table.

Negative equity can feel like quicksand, yet it is a math problem that can change with time and smart moves. Many homeowners check the value once a year with recent sales data, then compare it to their payoff balance to see where they stand. A professional appraisal gives the most precise number if you plan to sell or refinance soon.

Common Causes of Underwater Mortgages

Several factors can push a loan underwater. Some are market-driven, others relate to how the home was financed in the first place.

Declining Property Values

When home prices fall in a neighborhood, mortgages that once looked safe can slip underwater. The 2008 housing crisis is the clearest example, as large price drops left many owners owing more than their homes could sell for. Price declines still happen in pockets after job losses, interest rate shifts, or local oversupply.

Low Down Payments

Small down payments mean you start with little equity. If prices dip, even a few percent, you can cross into negative territory, especially after accounting for the costs of a potential sale. This does not mean low down payments are wrong; it just means the margin for error is thin early on.

Economic Downturns

Recessions bring job losses and strained budgets, which can trigger more missed payments and foreclosures in a community. More distressed sales tend to pull comparable values down. This cycle puts pressure on owners who have already started with slim equity.

Taking Out a Second Mortgage

Home equity loans and lines of credit stack debt on top of your first mortgage. If that extra borrowing soaks up most of your ownership stake, a small price decline can put the total debt above market value. Add rising rates or income changes, and the problem can snowball.

Risks Associated with Underwater Mortgages

Negative equity does not always mean disaster. If you can afford the payment and plan to stay put, time often helps. Still, there are real risks to watch for.

Difficulty Refinancing

Lenders prefer the loan amount to sit at or below what the home is worth. An underwater balance often blocks standard refinancing since there is no collateral cushion. Some government-backed loans allow limited streamline refinances, yet qualifications can be tight.

Hardship can make a refi even tougher unless you qualify for a program tied to your current loan type. Without a refi, you can get stuck with a higher rate or a term that no longer fits your budget, which can strain your monthly cash flow.

Complications When Selling

If sale proceeds cannot cover the payoff, you would need cash to close or your lender’s approval to accept less than owed. That is where a short sale comes in with lender sign-off. It can work, but it hits your credit.

Short sales involve extra paperwork, a hardship review, and tight timelines. Lender policies differ, so getting expectations in writing helps you avoid surprises.

Increased Risk of Foreclosure

Without refinance access, you can miss chances to lower your payment when rates or terms improve. If income falls or costs rise, a high payment can become unsustainable. That raises the risk of foreclosure if arrears build up.

Arizona uses deeds of trust for many home loans, so foreclosures often proceed through a trustee’s sale. Timeframes can move quickly. Acting early gives you more tools to work with.

Solutions for Arizona Homeowners with Underwater Mortgages

There is no one-size plan. Your best move depends on income, loan type, credit, and goals for the home. Bankruptcy is one option, yet there are several non-bankruptcy tools worth a look.

  • Confirm your payoff balance, current value, and any second liens.
  • Check whether your mortgage is FHA, VA, or USDA, since some streamline options exist.
  • Talk with your servicer about forbearance, modification, or loss mitigation programs.

With those basics in hand, here are common paths homeowners use in Arizona:

Stay Put and Build Equity

Continuing regular payments lowers the principal over time, which narrows the gap. If budget allows, add small extra principal payments, even $50 to $100 a month. Modest gains add up across years and speed up the turnaround in your loan-to-equity ratio.

Many markets move in cycles. A steady payment record, plus a value rebound, can pull you back to even, then positive equity.

Explore New Financing Options

Refinance options are limited with negative equity, yet some borrowers with FHA loans can use an FHA Streamline Refinance to reduce their rate or change the term. VA and USDA have similar streamlined paths with their own rules. Cash-out is not possible without equity, and payment history standards apply.

If you have a conventional loan, talk with your servicer about a loan modification. A modification can lower the interest rate, extend the term, or capitalize arrears, all aimed at a payment you can handle.

Arizona Homeowner Options At a Glance

Option What It Does Credit Impact Do You Keep the Home? Arizona Notes
Stay and Pay Reduce principal with regular and extra payments Positive with on-time history Yes Works best if job and income are stable
Refinance or Modify Lower rate or adjust term, or change loan terms with servicer Neutral to mild dip, depends on terms Yes Streamline options for FHA, VA, USDA; servicer rules apply
Short Sale Lender accepts less than payoff at sale Negative, yet often less than foreclosure No Get deficiency policy in writing, as Arizona can allow deficiency in some cases
Deed in Lieu Voluntarily transfer title to servicer Similar to foreclosure No Confirm deficiency treatment and any move-out funds
Chapter 13 Repayment plan, cure arrears, potential lien strip of a wholly unsecured second Negative at filing, improves with time and regular payments Yes Automatic stay stops trustee’s sale while the case is active
Mortgage Modification through Bankruptcy Court Allows mortgage modification with bankruptcy court oversight Negative at filing, improves with time and regular payments Yes Automatic stay stops trustee’s sale while the case is active, trustee sale cannot take place while modification is ongoing

 

This table is a quick snapshot. The best next step is to match the option to your budget and goals.

Consider a Short Sale

A short sale is a sale approved by the lender for less than the payoff. You submit hardship documents, list the home, and the lender decides on offers. It takes patience and organized paperwork.

FHA guidelines can allow you to get another FHA mortgage quickly after a successful short sale if you had no late payments on your mortgage or other installment loans in the 12 months before the sale. Always ask the servicer about deficiency rights and get written confirmation. That written piece matters later.

Deed in Lieu of Foreclosure

With a deed in lieu, you agree to transfer the property to the servicer in exchange for releasing the mortgage. The servicer must consent, and the home typically needs to be listed first. Some servicers offer move-out funds if you keep the property in good shape.

Ask in writing how any deficiency will be handled. Arizona has anti-deficiency protections in limited situations, yet not every loan or property qualifies. Clear answers help you plan your next move.

Bankruptcy as a Solution

Bankruptcy is a powerful tool when debt and missed payments are piling up. Filing puts the automatic stay in place, which stops foreclosure and collection. That pause can create room to reorganize and save the home.

Understanding Bankruptcy Options in Arizona

Most individuals file either Chapter 7 or Chapter 13. Each path serves a different purpose, and the right fit turns on income, assets, and how far behind you are on the mortgage.

Chapter 7 Bankruptcy

Chapter 7 clears most unsecured debt, such as credit cards and medical bills. A trustee reviews your assets, and Arizona law exempts many basics, including a protected amount of home equity. If the mortgage is current and equity is within the exemption, many homeowners keep living in the home and keep paying.

Owners who cannot afford the home can choose to surrender the property and wipe out personal liability on the mortgage. Clearing other debts first can also free up cash for critical housing costs. It is a fast process compared to Chapter 13. Chapter 7 also allows the use of the Mortgage Modification Mediation program.

Chapter 13 Bankruptcy

Chapter 13 sets up a three- to five-year plan that lets you catch up on missed mortgage payments. You make a monthly plan payment to the trustee, and ongoing mortgage payments continue. If a second mortgage is completely unsecured by the home’s value, you may be able to strip that lien and treat it like unsecured debt.

Chapter 13 works best when you have a steady income. The plan can also address car arrears, taxes, and other debts in one consistent payment. Many homeowners choose this to stop a trustee’s sale and stabilize their budget.  Like Chapter 7, Chapter 13 allows you to utilize the Mortgage Modification Mediation.

Mortgage Modification Mediation

The Mortgage Modification Mediation program is unique to Arizona and a few other states.  Although it was initially available only in Chapter 13 bankruptcy, it is now available in a bankruptcy filed under any chapter.  The purpose of this program is to provide a more structured approach to mortgage modification as compared to the conventional modification process.  There are several unique features of the program that help accomplish this:

  • A trained mediator assists the homeowner and the mortgage company through the process.
  • There is no paper forms to fill out—everything is done online.
  • All communications between the homeowner and the mortgage company are tracked, which prevents disputes about what was said by whom or what information was or was not provided.

More information on the Mortgage Modification Mediation program can be found here.

Facing Foreclosure or Overwhelming Debt? Contact Us Today

We help Arizona families and small businesses stop the spiral and protect what matters. If foreclosure or relentless debt is on your mind, a quick conversation can bring options into focus. Call us at 520-745-4429 (Tucson) or 480-788-0098 (Phoenix), or reach us through our Contact Us page to schedule a consultation and talk through your situation.

We welcome your questions, and we work hard to get strong results with clear communication at every step. The sooner you act, the more tools we can put to work for you. If you are in Mesa, Phoenix, or Tucson, let’s talk about a plan that fits your life and your goals.