Underwater Mortgage: Meaning, Overview, History

What Is an Underwater Mortgage?

An underwater mortgage is a home purchase loan with a higher principal than the home’s market value. This can occur when property values decline, leaving the homeowner with no equity for credit. An underwater mortgage can prevent refinancing or selling the home without paying the loss out of pocket.

Breaking Down an Underwater Mortgage

Underwater mortgages were a problem during the 2008 financial crisis, which involved a substantial decline in housing prices. While the market has recovered due to monetary policy and interest rate stabilization, underwater mortgages remain a concern for property owners.

A mortgage is considered underwater when the home’s value is less than the original principal. Depending on the decrease in value, the borrower may have negative equity. For example, a borrower with a $250,000 mortgage and a home value of $225,000 is underwater. However, if the borrower has paid $125,000 of the principal, they still have positive equity of $100,000.

The 2008 Financial Crisis

The 2008 financial crisis had numerous effects on the U.S. economy, including a housing bubble burst and a decline in property values. Loose lending standards and subprime borrowers contributed to the deflation, leading to defaults and foreclosures. The Federal Reserve’s monetary policy and lower interest rates helped the economy recover and housing prices rebound.

Assessing Home Value

The Dodd-Frank legislation improved mortgage lending standards, reducing the likelihood of significant price drops like in 2008. However, homeowners still need to monitor home values and mitigate underwater mortgage risks. Appraisals and regular renovations can help maintain a high home value. In the event of an underwater mortgage, working with reputable mortgage refinancing companies is a potential solution.