eli5 What does it mean to be “upside down” on your home loan and how does it happen?
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I think there are two answers that make sense here:
1. The perceived state of being “upside down” where the estimated sale price is less than the remaining balance of the loan. Since different people will have different opinions on the sale price (or different interpretations of loan data), this is largely a game of interpretation. End of the day it just means “I don’t feel like I can get enough for my house to pay off the loan”.
2. When a house is actually being sold, the buyer will extend an offer and the seller will accept it. The lender will then be notified that the lien will need to be removed and the escrow agent will need to pay off the loan as part of the transaction. The seller is ‘under-water’ when there is a shortfall requiring additional funds from the *seller* to close the transaction.
Option 2 is perilous for the seller – it could potentially lead to the buyer backing out of the transaction, which in a falling market could leave the seller forced to accept a worse offer owing the bank more money! Ultimately the seller would need to negotiate with the bank or declare bankruptcy to liquidate the property and the debt.
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