home-equity-explained): When You Owe More Than Your Home Is Worth

Nobody buys a home expecting it to lose value. But it happens. And when your mortgage balance exceeds your home's current market value, you're in what's called negative equity—also known as being "underwater" or "upside down" on your mortgage.

It's a stressful situation, but it's not hopeless. This guide explains how it happens, what it means for your finances, and what you can do about it.

What Is Negative Equity?

Negative equity occurs when you owe more on your mortgage than your home is currently worth.

Example:

Home's current market value: $320,000
Outstanding mortgage balance: $365,000
Equity: −$45,000

This homeowner is $45,000 underwater. If they sold the home today, the sale price wouldn't cover the remaining mortgage, leaving them responsible for the $45,000 gap (plus selling costs).

How Common Is Negative Equity?

It's more common than you might think, though it fluctuates with market conditions:

2012 (post-crisis peak): About 12.8 million homes—roughly 25% of all mortgaged properties—were underwater, according to CoreLogic.
2019 (pre-pandemic): Around 2.2 million homes (4% of mortgaged properties).
2022 (post-pandemic boom): Record low—fewer than 1 million homes (under 2%).
2025: Roughly 2-3% of mortgaged homes, concentrated in markets that saw the steepest pandemic-era price spikes followed by corrections.

Even in strong markets, there are always some homeowners in negative equity—typically those who bought recently with small down payments in areas that dipped.

What Causes Negative Equity?

Several factors can push a homeowner underwater:

1. Declining Home Values

This is the most common cause. When local or national housing markets drop, home values fall, but your mortgage balance doesn't budge. You still owe what you borrowed.

Major historical declines:

2006-2012: National home prices fell approximately 27% peak-to-trough. Some markets (Las Vegas, Phoenix, parts of Florida) dropped 50-60%.
1990-1995 ([California](/blog/california-heloc-guide)): Prices fell 20-30% in some areas.
Various local downturns: Factory closures, military base closings, natural disasters, and oil price crashes have caused localized declines of 15-40%.

2. Small or No Down Payment

The less equity you start with, the less buffer you have. A buyer who puts 3% down is one bad year away from negative equity:

Down Payment	Starting Equity on $400,000 Home	Price Drop to Go Underwater
20% ($80,000)	$80,000	-20%
10% ($40,000)	$40,000	-10%
5% ($20,000)	$20,000	-5%
3% ($12,000)	$12,000	-3%
0% (VA loan)	$0	Any decline

A homeowner who put 3% down on a $400,000 home goes underwater if the value drops just $12,000—a 3% decline that could happen in a single year in a cooling market.

3. Buying at Market Peak

Purchasing when prices are at their highest means you're most vulnerable to the correction that often follows. The buyers who purchased in 2006-2007 at peak prices were hit hardest by the subsequent crash.

4. Interest-Only or Negative Amortization Loans

Some mortgage products don't reduce the principal balance with regular payments—and some actually increase it. Interest-only loans keep the balance flat, so you're entirely dependent on appreciation for equity. Negative amortization loans (now rare post-2008 regulations) can increase the balance beyond what you originally borrowed.

5. Cash-Out Refinancing

Pulling equity out of your home through cash-out refinancing increases your mortgage balance. If you refinanced aggressively during a rising market and then prices fell, you could end up owing more than the home is worth.

6. Property Damage or Neighborhood Decline

Physical damage to your home (fire, flood, structural issues) or negative neighborhood changes (rising crime, nearby industrial development, school closures) can reduce your home's value below your mortgage balance.

What Negative Equity Means for You

What You Can't Do (Easily)

Sell without bringing cash to closing. If you owe $365,000 and your home sells for $320,000, you need to cover the $45,000 gap plus roughly $20,000-$30,000 in selling costs. That's $65,000-$75,000 out of pocket to sell your own home.

Refinance. Most conventional refinance programs require at least some positive equity. A few exceptions exist (like FHA Streamline for existing FHA loans), but options are limited.

Get a [HELOC or [[home equity](/blog/equity-vs-appreciation) loan](/blog/best-heloc-lenders-2026)](/blog/home-equity-loan-vs-heloc-2026). Lenders won't lend against equity that doesn't exist.

Move without financial pain. Even if your job relocates or your family outgrows the house, selling at a loss makes moving expensive and complicated.

What You Can Still Do

Stay and keep paying. Your mortgage terms don't change just because your home's value dropped. As long as you make payments, nothing bad happens. Over time, your balance goes down and (usually) the market recovers.

Live in your home normally. Negative equity doesn't affect your daily life. You still own the home. You can still make improvements, have guests, live your life.

Deduct mortgage interest. Your tax benefits don't change based on equity position.

What It Doesn't Mean

It doesn't mean you have to sell. Most underwater homeowners simply wait it out.

It doesn't mean you'll be foreclosed on. Foreclosure happens because of missed payments, not negative equity. As long as you make your payments, the lender won't foreclose.

It doesn't mean you made a bad decision. Buying a home is a long-term commitment. Short-term value fluctuations are normal. Most homeowners who bought at previous peaks eventually saw their values recover and exceed what they paid.

Your Options When You're Underwater

Option 1: Stay and Wait

Best for: Homeowners who can afford their payments and plan to stay in the home for several more years.

This is the most common and often the wisest approach. Markets recover. Your payments continue reducing the balance. Time works in your favor from both directions.

Historical recovery timelines:

2008 crash: National prices took about 6-7 years to return to 2006 peak levels. Some hot markets recovered faster; some harder-hit areas took 10+ years.
1990s California downturn: Prices recovered within 5-7 years.
Post-pandemic corrections (2022-2023): Minor dips of 5-10% in some markets recovered within 1-2 years.

If you can afford your monthly payment and don't need to move, waiting is usually the right call.

Option 2: Pay Down the Balance Faster

Best for: Homeowners with extra cash flow who want to accelerate their return to positive equity.

Any extra payments go directly to principal, closing the gap faster. Even $200-$300 extra per month can make a meaningful difference:

On a $365,000 balance when the home is worth $320,000 (underwater by $45,000):

Extra Monthly Payment	Months to Reach Positive Equity*
$0 (regular payments only)	~48 months
$200	~36 months
$500	~24 months
$1,000	~15 months

*Assumes no change in [home value](/blog/appraisal-process-explained). With even modest appreciation, timelines shorten.

Option 3: Refinance Through Government Programs

Best for: Homeowners with FHA loans who want a better rate.

While options are more limited than they were during the housing crisis (when HARP existed), some programs still help:

FHA Streamline Refinance: If you have an existing FHA loan, you can refinance with limited documentation and no appraisal required—meaning negative equity isn't a barrier.
VA Interest Rate Reduction Refinance Loan (IRRRL): Similar streamline option for existing VA loans.
USDA Streamline Refinance: For existing USDA loan holders.

These programs don't eliminate negative equity, but they can lower your interest rate and monthly payment, freeing up cash for extra principal payments.

Option 4: Short Sale

Best for: Homeowners who need to move and can't afford to cover the gap.

In a short sale, the lender agrees to accept less than the full mortgage balance when you sell. The home sells at market value, and the lender forgives the remaining balance (or sometimes pursues a deficiency judgment for the difference).

Pros:

Lets you move without paying the full gap
Less damaging to credit than foreclosure (typically 100-150 points vs. 200-300+)
Faster recovery time for credit (2-4 years vs. 7+ for foreclosure)

Cons:

Requires lender approval (can take months)
May result in a deficiency judgment (varies by state)
Forgiven debt may be taxable as income
Still damages credit significantly
You lose the home

Option 5: Deed in Lieu of Foreclosure

Best for: Homeowners who've exhausted other options and want to avoid the foreclosure process.

You voluntarily transfer ownership of the home to the lender in exchange for release from the mortgage debt. It's essentially "giving back" the home.

Pros:

Avoids the lengthy foreclosure process
Slightly less credit damage than foreclosure
May include relocation assistance from the lender

Cons:

You lose the home
Significant credit impact (though less than foreclosure)
Lender may not agree
May have tax consequences

Option 6: [Loan Modification](/blog/what-happens-when-you-miss-mortgage-payment)

Best for: Homeowners struggling to make payments who want to keep their home.

Contact your lender to discuss modifying the terms of your loan. Modifications can include:

Reducing the interest rate
Extending the loan term (lowering monthly payments)
Adding missed payments to the end of the loan
In rare cases, reducing the principal balance

Lenders often prefer modification to foreclosure because foreclosure is expensive and time-consuming for them too. You don't get a modification by asking nicely—you get it by demonstrating genuine financial hardship and showing that modification is in the lender's best interest.

Option 7: Strategic Default (Walk Away)

Best for: Extremely rare situations where the financial math heavily favors it.

Some homeowners choose to stop making payments and let the home go to foreclosure. This is controversial and comes with severe consequences:

Credit score drops 200-300+ points
Foreclosure stays on credit report for 7 years
May face deficiency judgment (lender sues for the gap, depending on state law)
Tax consequences on forgiven debt
Difficulty buying another home for 3-7 years

Strategic default might make mathematical sense if you're deeply underwater (owing $200,000+ more than the home's worth) with no prospect of recovery, but the personal and financial costs are substantial. Consult an attorney before considering this path.

State Laws That Affect Your Options

Important: state laws significantly impact what happens when you're underwater.

Recourse vs. Non-Recourse States

In non-recourse states (including Alaska, Arizona, California, Minnesota, Montana, North Carolina, North Dakota, Oregon, Washington), the lender generally cannot pursue you for the deficiency after foreclosure on a purchase money mortgage. The home is their only remedy.

In recourse states (most other states), the lender can seek a deficiency judgment—meaning they can come after your other assets for the gap between the sale price and the mortgage balance.

This distinction matters enormously for short sales, foreclosures, and strategic defaults. Know your state's laws or consult a local attorney.

Anti-Deficiency Protections

Even in recourse states, some protections may apply:

Some states limit the timeframe for pursuing deficiencies
Some states limit the amount based on fair market value
Some states offer protection for owner-occupied primary residences

How to Avoid Negative Equity

Prevention is always easier than recovery:

Before Buying

Put at least 10-20% down. More equity at the start means a bigger buffer against value declines.
Buy below your budget. A smaller mortgage relative to the home's value provides protection.
Research the local market carefully. Are prices at historic highs? Is the local economy diversified? What happened during the last downturn?
Get a fixed-rate mortgage. Adjustable rates can increase your payment and make it harder to pay down principal.
Avoid overpriced markets. If price-to-income ratios in your area are stretched, you're buying closer to the peak.

After Buying

Make consistent payments. Every payment reduces your balance.
Avoid cash-out refinancing unless the funds are used for high-ROI improvements.
Maintain your home. Deferred maintenance silently erodes value.
Build an emergency fund. Having cash reserves means you won't be forced to sell during a downturn.
Don't panic in dips. Short-term value declines are normal. Time heals most housing downturns.

Real-World Recovery Stories

The 2008 Buyer Who Waited

Maria bought a home in Phoenix for $285,000 in 2007 with 5% down. By 2011, the home was worth $155,000—she was $115,000 underwater. Her mortgage payment was manageable, so she stayed and kept paying. By 2018, the home was worth $310,000. By 2024, it was worth $430,000. She went from −$115,000 to over $200,000 in equity by simply staying the course.

The 2020 Buyer Who Got Caught

James bought a condo in Austin for $380,000 in 2021 with 3% down during the pandemic buying frenzy. By 2023, similar condos were selling for $340,000 as the local market cooled and inventory surged. He was about $50,000 underwater. Rather than selling at a loss, he made an extra $300/month toward principal and watched as the market stabilized. By 2025, his condo was worth $365,000 and his paydown had brought the mortgage to $350,000—back in positive territory.

Neither story is unusual. The pattern is consistent: buying at a peak hurts in the short term, but homeowners who can afford their payments and ride it out almost always recover.

Frequently Asked Questions

Am I underwater if my home value drops but I still have equity?

No. Negative equity specifically means your mortgage balance exceeds your home's value. If your home drops from $400,000 to $370,000 and you owe $350,000, you still have $20,000 in positive equity—even though you lost value.

Does the bank notify me if I'm underwater?

No. Lenders track their portfolio's equity positions, but they don't notify individual borrowers. You'd need to estimate your home's value and compare it to your mortgage balance yourself.

Can I still make improvements if I'm underwater?

Yes. In fact, strategic improvements can help restore value. Focus on maintenance and repairs that protect value rather than luxury upgrades. Fix the leaking roof before remodeling the bathroom.

Will being underwater affect my property taxes?

Potentially yes. Most jurisdictions base property taxes on assessed value. If your home's value has genuinely declined, you may be able to appeal your property tax assessment and get a reduction. This saves you money but doesn't affect your mortgage balance.

Can I negotiate with my lender if I'm underwater?

Yes, but timing matters. Lenders are most willing to work with you when you're current on payments but can demonstrate hardship. Options include loan modification, forbearance, or refinancing through streamline programs. Don't wait until you've missed multiple payments—reach out early.

How does negative equity affect my credit score?

Being underwater doesn't directly affect your credit score—only your payment behavior does. If you make all payments on time, your credit is unaffected by your equity position. Missed payments, short sales, and foreclosures all damage credit significantly.

Should I stop paying my mortgage if I'm underwater?

Almost never. Stopping payments triggers late fees, credit damage, and eventually foreclosure. The exceptions are extremely rare and should only be considered with professional legal and financial advice. For the vast majority of underwater homeowners, continuing to make payments is the right strategy.

The Bottom Line

Negative equity is stressful, but it's usually temporary. The vast majority of underwater homeowners who keep making their payments eventually return to positive equity through a combination of mortgage paydown and market recovery.

If you're underwater right now, take a breath. Assess your ability to make payments. Think about your timeline—how long you plan to stay in the home. If you can afford to stay and wait, history strongly suggests you'll come out the other side with equity intact or better.

If you can't afford payments or need to move, explore your options: loan modification, short sale, or government programs. And whatever your situation, consider consulting a HUD-approved housing counselor (free) or a [real estate attorney](/blog/how-to-build-real-estate-team) for guidance specific to your state and circumstances.

[Home Equity Explained: What It Is and How to Build It](/blog/home-equity-explained)
Property Taxes Explained: How They Work and How to Reduce Them
USDA Loan Guide 2026: Zero Down Payment in Rural Areas

Negative Equity Explained

Key Takeaways