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Underwater Mortgage: CNBC Explains

Jeffrey Coolidge | Photodisc | Getty Images

An underwater mortgage may sound like you're dealing with beach front property gone bad, but it's actually a term of art in the world of real estate. You probably heard this term in the aftermath of the Financial Crisis of 2008 and its accompanying real estate bubble. So what is an underwater mortgage? CNBC explains.

What is an underwater mortgage?

A mortgage is considered 'underwater' when the amount of the mortgage is greater than the current value of the home. Another term for this is "negative equity."

For example, a person decides to buy a home for $200,000. They put 20 percent down, or $40,000, and then get a mortgage for the remaining $160,000. Usually home prices rise, but let's say prices begin to fall and the home is now valued at $150,000.

The mortgage is 'underwater' by $10,000.

Why use the term underwater?

Because the value of the home, which the mortgage funds, is below or under the mortgage amount, which could be considered the water line.

It is just a metaphor that likely grew out of another metaphor: "drowning in debt."

Why is the term underwater so popular in housing today?

During the housing boom home prices rose dramatically. Much of that was because mortgage lenders held borrowers to very low standards, offering them mortgages for no money down.

Anyone could buy a home, and so many people -- who really couldn't afford what they were buying -- did. That pushed prices higher and higher. Many of these mortgages, however, had adjustable rates, which meant that a borrower's monthly payment could suddenly spike after a certain amount of time, usually three to five years.

That is just what happened, causing many people to default on their loans; in other words, they missed payments and couldn't keep up. As more and more people were unable to pay their mortgages, and banks began foreclosing on them, home prices crashed.

Since so many borrowers in this period had put no money down when they applied for a mortgage, any drop in home prices caused them to be underwater on their mortgages.

Why is the "underwater" mortgage issue such a drag on the housing recovery?

If a borrower can still make the monthly payment, being underwater doesn't really matter, other than making you feel like you are renting the house (since you don't have any equity in the house).

But for many people it makes moving impossible, because if a person owes more on their mortgage than their home is worth, then in order to move or sell, they would have to pay the bank back the difference.

They would have to pay in to their mortgage to get out of their home. Being underwater has also prompted many homeowners to walk away from or abandon their homes because they don't think the home will ever be worth more than the mortgage. They consider the home a bad investment and let it go to foreclosure.

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