An “underwater” mortgage is when the balance of the mortgage loan is higher than the fair market value of the property. This type of situation became common following the housing market crash that occurred in the late 2000s when many homeowners saw their homes lose a considerable portion of their value.
Let's say your mortgage is $500,000 but the market value of your home is only $475,000. Your mortgage is $25,000 more than the value of your home. In this case, your mortgage is underwater.
Underwater mortgages can pose problems in several situations.
An underwater mortgage makes it difficult for homeowners to sell their house. Buyers generally will only pay market value for a home, but if the property is underwater, the sale price won’t be enough to pay off the mortgage debt. This makes it difficult, if not impossible, to sell a property that is underwater. Even if the lender agrees to a short sale, the homeowner may get saddled with a deficiency judgment. (Learn more about short sales and deficiency judgments following short sales.)
An underwater mortgage also often prevents a homeowner from being able to refinance the debt. Underwater homeowners are unable to get a new loan with more favorable terms (like a lower interest rate) if the current value of the property is not enough to act as security for a new loan that is sufficient to pay off the existing mortgage.
If the homeowner needs to sell the home or refinance because the monthly payments are too high, but cannot do so, there is a high risk that the home will go into foreclosure.
(To learn more about foreclosure and ways to prevent it, or alleviate its downsides, see Nolo's Foreclosure area.)
Because of the large number of underwater mortgages nationwide, some advocates and even governments are trying to come up with ways to help homeowners. To read about one proposed solution in California, see The Underwater Mortgage Problem: A Solution in California?