Negative Equity - in An Asset

In An Asset

In owner-occupied housing market, a 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 sometimes occurs when the owner obtains second-mortgage home-equity loans, causing the combined loans to exceed the home value. 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 both have lost the property and 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 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 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.

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 and residential. 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.

Since 2007, those most exposed to negative equity are borrowers who obtained high value mortgages that were commonplace before the credit crunch, as they are most at risk from declines in property price.

It is widely understood in business that certain 'infrastructure' businesses are inevitably negative equity. For example, passenger rail, world-wide, is unprofitable.