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Negative Equity

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In real estate, negative equity describes a situation where the debt on real property exceeds the assumed value of the property. With negative equity, the proceeds of a sale may not satisfy the mortgage. Negative equity thus increases the probability of borrower default. Historically, the most common cause of negative equity was a decline in property values. Excessive borrowing is another independent cause of negative equity. Some loan products are dangerous for the borrower by potentially facilitating negative equity. For example, a negative amortization mortgage may allow for monthly payments that do not even cover the interest on the principal, with the difference being capitalized, or added to the principal balance. If equity is already zero, the increase in principal creates negative equity. In practice, many banks will notify the borrower once the loan balance exceeds 110% of the original appraised value of the property, but by then negative equity may or may not exist.



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