Negative Equity

Posted in Finance, Accounting and Economics Terms, Total Reads: 622

Definition: Negative Equity

Negative Equity is defined as the condition when the value of an asset used to obtain a loan falls below the balance on the loan. Simply stated, it means that the net liabilities exceed the net assets.

It can be calculated using the following expression:

Amount of negative equity = Value of the asset - Balance on the outstanding loan

Negative equity can occur under two conditions- one when the value of the asset falls and two when the value of asset remains same but the value of the loan increases (when the interest amount exceeds the loan payment). Negative asset is quite frequently evident in automobile loans wherein the value of the automobile falls sharply once it is taken out of the showroom. A large number of negative equity cases were observed during the sub-prime crisis when there was a huge decline in the property prices.

Example: Suppose a person buys a house using a mortgage and immediately after the purchase, property prices begin to drop due to an economic slowdown. This would result in the value of the house falling below the amount due on the mortgage and the person will be said to be having a negative equity.



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