Definition
Negative equity is a situation in which more is owed on property than it is actually worth.
Analysis
Negative equity usually results from depreciation of an asset. This is a very common situation on vehicle loans with low down payments and long terms of repayment. Depreciation on the asset exceeds the rate that principal payments are applied on the loan.
Negative equity also can result from some mortgage loan products, such as interest-only loans or others that amortize negatively (fail to fully pay interest each month). In some depressed housing markets, property values have depreciated rapidly, leaving some recent purchasers of real property in a negative equity situation.
Negative equity severely limits the options that a financially distressed owner may have to get out of a loan. For property that is partially claimed by a lien, the lienholder must grant permission for the owner to sell the property. A lienholder may be reluctant to remove their claim to the property if they feel they may not be fully compensated.
Some financially distressed borrowers with negative equity may resort to insurance fraud in order to repay a vehicle loan. Perhaps the car is in poor shape, in which the market value is lower than the book value. They may destroy the car in order to file an insurance claim to repay the loan.
Some homeowners have resorted to arson to try to cure a negative equity situation. Other homeowners have simply walked away from a mortgage when faced with negative equity and predatory loan terms.
Factors that can reduce the likelihood of negative equity include making large down payments, getting lower interest loans and avoiding the purchase of property that may experience rapid depreciation.
