Which of the following accurately describes an upside-down or underwater mortgage?

And as a result of being upside down, it may not be possible to sell your house.

Assume that you have $0 in the bank.

Your mortgage has a clause that says you must pay the entire $75 which you owe on the house before you sell it.

If you could find someone to pay $75 for the house, you could use that to pay off your mortgage and escape.

But in this example, the most anyone will pay is $70. So, you’re stuck.

Your only options are:

• Stay in the house until you get $5 cash somewhere. It could be your pay from work or something similar.

• Wait until house prices go back up, and someone is willing to pay $75.

• Declare bankruptcy.

Buying a home often seems like a promising strategy to build wealth since your monthly mortgage payments can help you build equity, and home values typically appreciate over time. However, sometimes due to housing market conditions, your home's value might actually depreciate — and the value of the home can fall below the amount of money you borrowed to pay for it.

This phenomenon is actually known as an "underwater mortgage," which can also be called an upside down mortgage.

"An upside down mortgage is when the principal exceeds the value; in other words, you owe more than the home is actually worth," says Christopher Rotio, the Executive Vice President of Town Title Agency.

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How do you end up with an upside down mortgage?

An upside down mortgage is typically the result of short-term fluctuations in the housing market. So in a market where home values are on the higher end due, for instance, a homebuyer is likely to need a larger loan to cover the cost of the house.

But if the home's value crashes for whatever reason, the loan amount you borrowed doesn't crash with it; you'll still owe what you borrowed even though the home is worth less.

"As the economy changes, you find yourself in a situation where home values normalize and come back down to earth," Rotio explains. "So it's not worth the same as it was when it was purchased."

Is an upside down mortgage a bad thing?

Market volatility can always feel uncomfortable and many individuals tend to feel inclined to take action during this time. But much like dealing with volatility in the stock market, the best way to deal with volatility in the housing market is to do nothing since the tides will turn again and the value of your home will likely be recovered over time.

However, you can run into real trouble if you have an upside down mortgage and are trying to sell your home. According to Rotio, if someone in this situation sells their home for an offer that's still less than what they owe on their mortgage, the home seller will need to pay the difference to their lender out of pocket. Depending on the situation, this could wind up costing the home seller tens of thousands — or sometimes even hundreds of thousands — of dollars.

"I don't recommend selling if you have an upside down mortgage, but due to extenuating circumstances, some people have to sell anyway," Rotio says. "They'd have to be prepared to pay the difference in this situation."

What should you do if you have an upside down mortgage?

"Sometimes, the best action is inaction," Rotio says. That sentiment certainly applies here.

Simply avoiding a drastic action like selling your home when the value has tanked will allow your home's value to rebound over time until you no longer have an upside down mortgage. Rotio also recommends being strategic during this time and making additional mortgage payments so you can pay down the principal faster.

"The point in doing this is so once the market levels off and values go back up, you will have built up much more equity in your home," he says. Making additional payments even while you have an upside down mortgage can also ensure you pay less out of pocket to your lender if you needed to sell the home before values have had the chance to rebound completely.

Is there any way to avoid an upside down mortgage in the first place?

Before purchasing your home, you should be sure to get an appraisal that makes sense, Rotio says. An appraisal is an evaluation of a home's fair market value. They can be based on a variety of factors, including the condition of the property, any upgrades that have been made to the home, square footage, the number of bedrooms and other elements.

"Typically, an appraisal is in line with the purchase price but you don't want to overpay," Rotio explains. "So, negotiating on the frontend is more important than ever."

Home appraisals do cost extra but some mortgage lenders might waive the fee, so it's always worth asking if this is something your lender can do. And if you can't get the fee waived, you can try finding other ways to save on upfront costs. Some lenders, like Ally Bank, don't charge certain lender fees. Other lenders, like SoFi, offer significant savings and cash back offers to eligible homebuyers.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.

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