The term “being underwater” is an apt image. As applied to personal finance, it is most commonly used to describe mortgage debt that exceeds the value of the underlying property. This is achieved by buying in an up market at a high price, and borrowing a large percentage of the investment, only to see the market go down and your asset being worth less than the debt it supports.

This means that if it is sold the resulting cash will not be sufficient to pay off the loan. How far underwater you are is measured by the difference between the outstanding debt and the potential or actual price the asset can be sold for. Two ways of dealing with this situation are to hold onto the property and continue to pay down the debt over time, thus holding the property until such time as the market price returns to above your debt level. Second is to walk away from an underwater debt, which means that all property rights and ownership go to the lender.

The underwater term can also refer to the value of stock options whose option price was at market when awarded, but whose market price has since gone down rather than up, and so the option has no value as the right to buy at a price above market is meaningless. The solution to underwater options is to wait for the market price to rise above the option price. This is easier to deal with than an underwater mortgage as there is no payment due or carrying cost in an underwater stock option.

In both cases the term describes a negative situation. The assumption that values always go up is not borne out by history. Residential real estate is not a low-risk investment. The tax incentives allowing for mortgage deductions cloud the issue. The reduction of barriers to entry can easily flood the market with buyers and cause prices to rise. The illusion of wealth in paper values can lead to underwater debt. It is best not to have firsthand underwater experience if possible.

Jack Falvey is a frequent contributor to the Union Leader, Barron’s and The Wall Street Journal. He can be contacted at