What 'Underwater' Means, and How to Avoid It

Sometimes a home is worth less than what you still owe on it. When that happens, people say the mortgage is 'underwater,' or that the owner has negative equity. It's an uncomfortable spot, but it's not a moral failing, and understanding how it happens is the first step to avoiding it.

Imagine you buy a home for $250,000 and borrow $240,000 after a small down payment. If home prices in your area later fall and your home is now worth $220,000, you still owe around $238,000. You owe more than the home would sell for, so you're underwater by roughly $18,000.

Two things make this more likely: putting very little down at the start, so you own only a sliver of the home, and a drop in local home values. Combine the two and even a steady, on-time borrower can end up here through no fault of their own.

Being underwater mostly becomes a problem when you need to move or sell. If you sell for less than you owe, you have to cover the gap out of pocket. It can also make refinancing harder. As long as you can keep making payments and stay put, though, it's often a paper problem that time can heal as you pay down the loan.

Your equity is the home's value minus what you owe. The faster you build equity, through your down payment and your monthly principal, the more cushion you have if values dip.

1. 1Put down a meaningful down payment so you start with real equity, not almost none.
2. 2Borrow less than the most you're approved for, leaving room if values slip.
3. 3Avoid stretching into a home right at the top of your budget in a hot market.
4. 4Add a little extra to principal over time to build equity faster.

No one can promise that home values only go up, and pretending otherwise is how people get hurt. But a healthy down payment, a loan you can comfortably afford, and a plan to stay a while make being underwater both less likely and less painful if it ever happens. Buy with a margin of safety, and you give yourself room to ride out the dips.