eli5 What does it mean to be “upside down” on your home loan and how does it happen?
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In Dutch this is called your house under water and that sounds much more impactful than upside down.
But that is beside the point. Let us know what this is called in other languages.
One way it happens is when people take out second mortgages, or borrow against their equity during a booming market. Then when the market corrects itself they owe more than the house is worth.
Being upside down on a loan means you owe more money on the loan than the thing is actually worth. It’s more common in the car loan world because people take out 8 year loans on vehicles they can’t actually afford.
By year 5 you probably still owe $30,000 on a vehicle you could only sell for $10,000.
You’re ‘upside down’ because you can’t just sell the asset to pay down the rest of the loan. In my example above, even if you sold your car for $10,000 and put all that money towards the loan, you still owe the bank $20,000.
True story:
I bought a cheap condo right at the height of the real estate bubble, I paid 110,000K for the condo. My down payment was 20K, mortage 90K.
The stock market crashed and my property value dropped to 30K, which left me with a loan to value ratio of 300%, meaning I owed 3X what the condo was worth. I was under water or upside down by 70,000
The easiest way to explain this: your house is worth less than what you’re paying for it (upside down).
Sell said home you purchased for 500k and sell it for 700k (equity/profit)
It means you owe more on your mortgage than the house is worth… happens when a house goes down in value, you made a small down payment and haven’t lived there long enough to make much of a dent in paying down the mortgage.
If you bought a house last year with a 3% down payment and it has gone down in value 5%, you’d be upside down.
Right now this is happening more. The reason is during covid people wanted to have more space whether that be one or inside square footage. People outgrew their homes once they were stuck at home all day with their families. This created a housing shortage because a higher than average percentage of people especially renters decided to buy. At the same time people didn’t want to sell mid pandemic and the amount of new listings going on the market dropped drastically. When this happened people began offering over asking price on homes because competition was so fierce. They paid the amounts over appraised value in cash and took a mortgage for the appraised value as you typically cannot get a mortgage for over the appraised value of a home. These people started out “upside down” on their homes. This also is semi occurring now because of refinances and equity draws. Equity raised so quickly a lot of people withdrew some of the equity they had in their homes (paid 200 now valued at 300 means 100 in equity). Now that prices are leveling out in many areas, some areas are seeing cause drop and they may now be upside down on their homes.
It means the amount you owe on the loan secured by the home is more than the value of the home
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.
It’s about to happen to A LOT of people, but basically you decide to buy a home. That house costs $500K. You cannot pay that much, so you put down 25K. Then as soon as you close on the deal, the market DROPs. Now if you wanted to sell your house, which you now owe $475K on, you couldnt find a single buyer willing to pay more than 300K. This is when you see a lot of people ‘walk away’ from their home. Because why bother paying for something so over priced? Of course if this home is your ‘forever home’ it matters less. But can still be frustrating knowing you owe far more than it is worth.
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