Buying real estate is not necessarily a sure thing. The market moves, often unexpectedly. What appears to be a great price for a home one year may not look nearly so strong just a few years later.
An underwater mortgage is one that has been negatively impacted by the market, as the value of the home drops — perhaps dramatically, perhaps not — and falls under what is still owed on that mortgage. It’s not just less than the price paid when the home was purchased, but under the amount that is left.
For instance, someone in New York could buy a home for $500,000 and then pay off $70,000. They still owe $430,000. At the same time, though, the market in the area drops so far that the house is worth a mere $350,000. They owe more than the actual value of the house by $80,000 — meaning that a traditional sale would leave them with no home and outstanding debt.
There are a few options: renting the home, keeping it until the market rebounds, etc. Sometimes, owners consider a short sale, which means that they are allowed to sell it for under what they owe. They have to clear it with the lender, which stands to lose money in that deal, but lenders will sometimes do it if they would lose more through foreclosure or if the homeowner just walked away.
Sellers and buyers alike need to make sure they understand the options and limitations of a short sale, as it can be a more complex transaction process than a normal sale.