Negative equity

Negative equity occurs when the value of an asset used to secure a loan is less than the outstanding balance on the loan. In the United States, assets (particularly real estate, whose loans are mortgages) with negative equity are often referred to as being "underwater", and loans and borrowers with negative equity are said to be "upside down".

People and companies alike may have negative equity, as reflected on their balance sheets.

In the owner-occupied housing market, a fall in the market value of a mortgaged house or apartment/flat is the usual cause of negative equity. It may occur when the property owner obtains second-mortgage home-equity loans, causing the combined loans to exceed the home value, or simply because the original mortgage was too generous. If the borrower defaults, repossession and sale of the property by the lender will not raise enough cash to repay the amount outstanding, and the borrower will still be in debt as well as having lost the property. Some US states like California require lenders to choose between going after the borrower or taking repossession, but not both.

The term negative equity was widely used in the United Kingdom during the economic recession between 1991 and 1996, and in Hong Kong between 1998 and 2003. These recessions led to increased unemployment and a decline in property prices, which in turn led to an increase in repossessions by banks and building societies of properties worth less than the outstanding debt.

It is also common for negative equity to occur when the value of a property drops shortly after its purchase. This occurs frequently in automobile loans, where the market value of a car might drop by 20-30% as soon as the car is driven off the lot.

While typically a result of fluctuating asset prices, negative equity can occur when the value of the asset stays fixed and the loan balance increases because loan payments are less than the interest, a situation known as negative amortization. The typical assets securing such loans are real property – commercial, office or residential. When the loan is nonrecourse, the lender can only look to the security, that is, the value of the property, when the borrower fails to repay the loan.

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Wikipedia