Do you know what equity is? We can say that the definition of Equity is, the value of ownership one has in a property or business. If we talk about property that is mortgaged, we can say that equity means the difference between the current market value and the outstanding mortgage amount on that property.
Now what do we mean by Negative Equity? Technically this term means that the unpaid mortgage balance on your property is more than its actual value in the market. We can calculate Negative Equity by subtracting the balance on the outstanding loan from the actual market value of the asset.
There are many cases in the past when negative equity has occurred. There were cases in the 80s when even house owners experienced Negative Equity as the market of real estate crashed. The value of real estate crashed very badly and the house owners had outstanding loan amounts much more than the real value of their houses. Thus, selling of houses became very difficult.
A negative equity situation occurs when an owner purchases an asset by taking a loan from the market by mortgaging the asset and the economy crashes. The asset value decreases below the value of the mortgaged loan amount.
This is not the case anymore. Real estate market is just shooting up every day now.
Who is affected by Negative Equity?
It's seen that mostly car owners are affected by this issue of negative equity, since automobiles depreciate in value very quickly.
It is said that vehicles lose almost 30% of their value as soon as they are driven off from the dealer's place. Sometimes people buy new cars and trade in their existing car in the process. Here they suffer from negative equity especially within the first few years of their loan. As in the beginning years, the payments are applied mostly to the interest and not to the principle amount of theloan.
We can also refer Negative Equity as an upside down to the assets value. In America, assets with negative equity are referred as 'underwater' and borrowers with that are said to be 'upside down'.
If one wants to buy a new car in exchange of an old one then, the negative value of the old car would be applied towards the new loan. In such a case one would be signing a new loan with negative equity built into it. Hence one should think carefully before doing so. It is always better to pay off the existing loan to a point where the value of the car is more than the loan balance, so that the negative equity is eliminated.
There is one more situation when a negative equity occurs. If the value of asset stays fixed and the loan balance increases then also negative equity occurs. This happens when the loan payments are less than the interest. Such situation is called 'negative amortization'. This happens when the borrowers fail to repay the loan. In such cases lenders only look to the security i.e., the asset itself that has been mortgaged.
Negative equity sometimes occurs when an owner takes a second mortgage loan. The new one combines with the old one and the combined loan exceeds the value of the house. In such case if the borrower defaults repossession the lenders sell the property but the sale also doesn't raises as much amount as needed to repay the loan and the owner loses the property while still being in debt.
It is seen that those people usually experience negative equity who obtain high value mortgage loans. As the loan amount so high that it becomes difficult for them to pay off their loan early and by the time they pay off, their asset values decline.
Solution to Negative Equity
Now I am sure you must be wondering what the solution to this is. The only solution to save yourself from a loss like this is you should make as much down payment as you can when you purchase an asset. It is advisable to take as less of loan as possible. You can also put some extra money to the monthly EMIs. If you would put extra money with your EMI, that money would reduce the principle amount of your loan, and would save you from landing up in negative equity.
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