In early 2010, one quarter of all U.S. homes were underwater. No, there was not massive flooding across the entire country. The term underwater means that homeowners owed more on their mortgages than their home was worth. How did this happen?
Consider someone who purchased a $600,000 home in 2007 and borrowed $540,000 to make this purchase. Although the homeowner had invested $60,000, it was still a highly levered investment. If the price of the home fell by 20 percent to $480,000, the homeowner would still owe the bank the original $540,000 and be $60,000 underwater.
In states where the housing boom was strongest Nevada, Florida, Arizona, and parts of California this phenomenon was most pronounced. In the Las Vegas area, for example, approximately 70 percent of all homeowners were underwater! This is a striking example of the down-side from leverage.