270,000 Recent Homeowners Are Already Underwater on Their Mortgages. Should You Be Worried?

Negative equity is a problem for a large number of 2022 buyers. Don't let it be a problem for you.

Home buyers faced a big challenge going into 2022. Low inventory meant that home prices were apt to be elevated on a national scale. And sure enough, many buyers paid more for a home this year than they would've had to pay in the past.

But higher home prices can make it difficult to come up with a sizable down payment. Many buyers took advantage of loan programs that make it possible to purchase a home with little or even no money down, like FHA loans and VA loans.

The problem, though, is that many people in that position are now already underwater on their mortgages. And that's a fate prospective buyers should make every effort to avoid.

A really big problem

Being underwater on your mortgage means your home loan balance is greater than your home's market value. Or, to put it another way, if you need to sell your home and get out, your home wouldn't command a high enough price to pay off your mortgage in full.

Many people grew familiar with the term "underwater" during the 2008 housing crisis. Back then, mortgage lenders weren't as strict as they are today, so a lot of people who couldn't afford to purchase homes did so anyway, fell behind on their payments, and then couldn't sell their homes for a high enough price to make their lenders whole.

Meanwhile, an estimated 270,000 homeowners who purchased a home in 2022 are already underwater on their mortgages, reports data firm Black Knight. That represents roughly 8% of home purchases financed with a mortgage this year.

Not surprisingly, borrowers with FHA and VA loans are those most likely to be underwater on their mortgages already. FHA loans make it possible to purchase a home with 3.5% down. And VA loans don't require a down payment at all, though they're available to a more limited pool of borrowers -- military members, veterans, and their spouses.

Should recent homeowners be worried?

Home prices peaked in June this year, so those who purchased a home around then may now be looking at lower property values than they were at the time their mortgages were signed. That's not necessarily problematic for those who took out a conventional mortgage and made a 20% down payment, because homeowners in that boat still have a long way to go before they're looking at negative equity.

Rather, it's buyers who didn't put a lot of money down at closing who need to be more concerned. If their financial situations change, these buyers might struggle to get out of their current housing situations.

New buyers should proceed with caution

It can be tempting to take out a mortgage with just a minimum down payment. But the danger in doing so is starting off with very little equity so that if home prices fall soon after, the risk of ending up underwater on a mortgage arises.

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In today's market, coming up with a 20% down payment can be tricky given how expensive homes have gotten. But if you're a prospective buyer, you should at least make an effort to put 10% down to avoid winding up in a bad situation.