Underwater

Underwater summary:

• Underwater describes a situation where the amount you owe on a loan is more than the value of the asset it's tied to.

• You could be underwater on a mortgage or an auto loan if you owe more on your house or car than it's worth.

• Being underwater on a loan is also referred to as having negative equity or being upside down. 

Underwater definition and meaning

Underwater means you owe more on an asset than it's worth. You could be underwater on any loan that's secured by something of value, like a home or a car. 

When you're underwater, you have negative equity. Equity is the difference between what you owe on an asset and what it's worth on the open market.

Being underwater or upside down on a loan could happen if the underlying asset loses value after you borrow. For example, if the housing market declines after you buy your home and its value goes down, you could end up underwater on the mortgage loan. 

Refinancing, selling the asset, or negotiating with your lender are some of the ways to potentially get out of an upside-down loan. 

Key concept: Owing more on an asset than it's worth.

More on underwater

Secured loans could help you hit some big financial milestones, like buying a house or a car. You get the money you need to make the purchase, and whatever you buy secures the loan. As long as you make your payments on time, you'll eventually clear the debt and own your home or car outright. 

You could end up underwater if the value of your home or car drops after you take out the loan. For example, home values could go down if the market takes a hit, and some cars could depreciate or lose value faster than others. 

Being upside down on a loan stings a little, since you still have to repay what you borrowed as agreed. It's not ideal, but it's not the end of the world either. There are always ways to get your head above water again. 

Underwater: a comprehensive breakdown

To understand underwater, you also have to understand equity. Equity is the difference between what you owe on an asset and what it's worth. 

When you talk about home equity, you're typically talking about an increase in value rather than a decline in value. Homes, for the most part, tend to appreciate or grow in value over time. If the value rises and your mortgage balance decreases, you gain more equity. 

Negative equity happens when your home's value dips below what you owe on the mortgage. This could happen with a car loan, too. You could end up underwater if:

• Your home value drops because of market fluctuations

• Your vehicle rapidly depreciates after you buy it

• You made a smaller down payment or chose a longer loan term

• You take out additional loans on the same asset, like a home equity loan or HELOC, which shrinks your equity

Being underwater could be an issue if you want to sell your home or car. Even though the value has dropped, you'll still need to pay off the original loan. That could put you in a situation where you need to come up with a sizable chunk of cash to clear the debt. 

Real-life example of underwater 

Here's a simple example of what it means to be underwater on a loan. 

Let's say you bought your home five years ago. You paid $350,000 and put down 10%, leaving you with a $315,000 mortgage. For the first couple of years, your home's value rose and you started to build a little equity. Then a recession came along, and the housing market suffered. Home values in your neighborhood dropped—not just yours.

Over a matter of months, your home's value drops from $360,000 to $280,000. You still owe $305,000 on the mortgage, which means you have $25,000 in negative equity. 

What do you do in this situation? 

You could talk to your lender to find out if a loan modification or refinance is an option. Either one could help pull you out of the hole. If you want to escape mortgage debt altogether, you might have to consider a short sale or a deed-in-lieu of foreclosure. 

With a car loan, you could try to make extra payments to shrink the equity gap. If you don't want to keep the car, you could try to sell it or have someone else take over the loan.