Negative equity

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Negative equity occurs when the value of an asset used to secure a loan is less than the outstanding balance on the loan^[1]. In the United States, assets (particularly real estate) with negative equity are often referred to as being "underwater", and loans and borrowers with negative equity are said to be "upside down".

Overview

This can occur when the value of the asset stays fixed but 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 and residential. The typical loan is one secured when the property owner mortgages the property to secure the loan. When the loan is nonrecourse the lender can only look to the security, that is, the real property when the borrower fails to repay the loan.

Applied to the owner-occupied housing market, a general fall in the market value of a mortgaged house or condo is the usual cause of negative equity. Negative equity in the owner-occupied market has sometimes occurred when the owner obtains second-mortgage home-equity loans so that the total loans exceed the home value when the loans are first made. This means that if the borrower immediately defaults on the loan, repossession and sale of the property by the lender will not raise enough cash to repay the amount outstanding, and the borrower will both have lost the property and may still be in debt. Some states like California require lenders to choose between going after the borrower or taking repossession, but not both.

The term was widely used in the United Kingdom during the economic recession between 1991 and 1996, and in Hong Kong between 1998 and 2003, which 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 on a loan. This occurs regularly in automobile loans, where the market value of a car might drop 20-30% "as soon as the car is driven off the lot."

Since 2007, those most exposed to negative equity are borrowers who obtained high value mortgages that were commonplace prior to the credit crunch, as they are most at risk from property price falls.^[2]

American cities in 2007

Low mortgage rates throughout the 2000s and loose lending standards encouraged a housing bubble to form in the US from 2002 onwards. Speculation pricing increased throughout the United States. As property prices peaked in the United States in 2006/2007, so too did the demand made by evacuees as they started to move back to their home states. The subprime crisis made banks tighten lending, causing the housing bubble to deflate further. People who bought at the time of the highest prices are now left with property that is impossible to sell at the inflated purchase price.

See also

• Mortgages
• Negative amortization
• Loss mitigation

References

1. ^ America's foreclosure plan: Can’t pay or won’t pay?, Paragraph 5, The Economist (February 19, 2009).
2. ^ Ruth Jackson, The return of negative equity, MoneyWeek (April 18, 2008).

• Irwin, Robert. Home Seller's Checklist: Everything You Need to Know to Get the Highest Price for Your House. McGraw-Hill Professional. p. 180. 
• Nerad, Jack (1996). The Complete Idiot's Guide to Buying or Leasing a Car. p. 129. 
• http://www.edmunds.com/advice/strategies/articles/104952/article.html
• http://money.cnn.com/2005/08/04/real_estate/buying_selling/home_equity_falling/index.htm

External links

• House Price Crash