What Happens When You’re Underwater on Your Mortgage?

These days, many U.S. property owners are sitting on their fair share of home equity. In fact, U.S. homeowners with mortgage loans -- roughly 63% of property owners -- saw their equity increase by $1 trillion between the fourth quarter of 2021 and the fourth quarter of 2022, according to CoreLogic.

But what if you're in the opposite boat? What if you have negative equity in your home because its value has dropped since you bought it?

If you have negative equity in your home, you might hear that you're underwater on your mortgage. And that's not an ideal situation to land in. But it really only becomes problematic if you have to sell your home.

It's not a problem if you're staying put

When you're underwater on a mortgage, it means that you owe more money on your home loan than what your home is likely to sell for. That could be a problem if you're struggling to keep up with your mortgage payments, or if you need to sell your home for another reason, such as to take a job in a different city or move to be closer to family.

Let's say you owe your lender $300,000 on your mortgage, but the market value of your home has dropped to $275,000. In that case, if you can only sell your home for $275,000, you're $25,000 short. You'd risk having to write a check out for that amount to your lender, which clearly isn't good. And you may not have that kind of money to begin with.

But while being underwater on a mortgage is a dangerous thing when you need to sell your home, if you're planning to stay put, it may not be such a problem. Let's say your home is only worth $275,000 now, but it holds steady at that value for a number of years. Meanwhile, let's say you keep paying your mortgage all those years, eventually whittling your balance down to $250,000. If, at that point, you need to sell your home and can only get $275,000 for it, it's not a problem, since that would be enough to satisfy your outstanding mortgage balance in full.

How to avoid being underwater on a mortgage

In some cases, people end up underwater on a mortgage because they make small down payments and the value of their properties drops shortly after they buy their homes. You can't necessarily control the latter -- that's a matter of demand and market conditions. But you can make an effort to come up with a larger down payment on a home, or to hold off on buying one until you've saved more money to put down.

Being underwater on a mortgage could put you in a tough spot if you suddenly need to sell your home and don't have time to wait for its value to come up. So it's best to do what you can to lower your chances of ending up with negative home equity in the first place.