Negative equity is a deficit of owner's equity, occurring 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 Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more general ...

, whose loans are

mortgages A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any pu ...

) 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 sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...

History

The term negative equity was widely used in the

United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the continental mainland. It comprises England, Scotland, Wales and North ...

during the economic recession between 1991 and 1996, and in

Hong Kong Hong Kong ( (US) or (UK); , ), officially the Hong Kong Special Administrative Region of the People's Republic of China ( abbr. Hong Kong SAR or HKSAR), is a city and special administrative region of China on the eastern Pearl River Delt ...

between 1998 and 2003. These recessions led to increased unemployment and a decline in property prices, which in turn led to an increase in

repossession Repossession, colloquially repo, is a "self-help" type of action, mainly in the United States, in which the party having right of ownership of the property in question takes the property back from the party having right of possession without in ...

s by banks and

building societies A building society is a financial institution owned by its members as a mutual organization. Building societies offer banking and related financial services, especially savings and mortgage lending. Building societies exist in the United Kingdo ...

of properties worth less than the outstanding debt. Since 2007, those most exposed to negative equity are borrowers who obtained loans of a high percentage of the property value (such as 90% or even 100%). These were commonly available before the

credit crunch A credit crunch (also known as a credit squeeze, credit tightening or credit crisis) is a sudden reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from banks. A credit cr ...

In an asset

In the owner-occupied housing market, a fall in the

market value Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or ''fair market value'', although the ...

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 loan A home equity loan is a type of loan in which the borrowers use the equity of their home as collateral. The loan amount is determined by the value of the property, and the value of the property is determined by an appraiser from the lending inst ...

s, causing the combined loans to exceed the home value, or simply because the original mortgage was too generous. If the borrower defaults,

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 Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...

as well as having lost the property. Some US states like

California California is a U.S. state, state in the Western United States, located along the West Coast of the United States, Pacific Coast. With nearly 39.2million residents across a total area of approximately , it is the List of states and territori ...

require lenders to choose between legal actions (such as wage garnishment) against the borrower or taking repossession, but not both. It is also common for negative equity to occur when the value of a good 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 In finance, negative amortization (also known as NegAm, deferred interest or graduated payment mortgage) occurs whenever the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan ...

. The typical assets securing such loans are

real property In English common law, real property, real estate, immovable property or, solely in the US and Canada, realty, is land which is the property of some person and all structures (also called improvements or fixtures) integrated with or affixe ...

– 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.

Negative net worth

A person who has negative equity can be said to have "negative net worth", where the person's liabilities exceed their assets. One might come to have negative equity as a result of taking out a substantial, unsecured loan. For example, one might use a

student loan A student loan is a type of loan designed to help students pay for post-secondary education and the associated fees, such as tuition, books and supplies, and living expenses. It may differ from other types of loans in the fact that the interest r ...

to pursue higher education. Although education increases the likelihood of higher future earnings, potential alone is not a financial asset. In the United States,

student loans A student loan is a type of loan designed to help students pay for post-secondary education and the associated fees, such as tuition, books and supplies, and living expenses. It may differ from other types of loans in the fact that the interest r ...

are rarely dischargeable in

bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor ...

, and typically lenders provide student loans without requiring security. This stands in contrast to lenders requiring borrowers to have an equity stake in a comparably-sized real estate loan, as described above, secured by both a down payment and a mortgage. An explanation for the willingness of creditors to provide unsecured student loans is that, in a practical sense, American student loans are secured by the borrower's future earnings. This is so since creditors may legally garnish wages when a borrower defaults.

Effects

A homeowner who is under water might be financially incapable of selling their current house and buying another one.

History

In an asset

Negative net worth

Effects

See also

References

Further reading