As we continue along on this downward spiral of home foreclosures, vehicle repossessions, adjustable rate mortgages and the crisis that is today’s global economy, the news reports are using more and more industry jargon that is not always understood by the general public. When talking about the foreclosure process, negative equity is often a huge concern, not just for the homeowners but the banks as well.
Well what exactly is negative equity? According to the dictionary definition, negative equity is a situation when the market value of a property falls below the outstanding amount of its mortgage, sometimes forcing foreclosure.(Source:http://dictionary.reference.com) This also applies to vehicle loans, equipment loans and most every loan that is secured by collateral. Negative equity is when you are upside down on your loan.
Let’s use a vehicle loan as an example. You buy the huge SUV of your dreams, brand-new and all customized just for you for $40,000.00 and now only two years later you realize you can’t afford the gas to put in it! When you visit your nearest dealership you are surprised to find the current value of your beloved SUV is much less than you paid for it.
Vehicles worth today: $28,000.00
Loan Payoff Amount: $32,000.00
Difference: -$4,000.00
Negative equity is simple math. What do you owe in order to payoff the existing loan in full? And what is the vehicle, home, boat etc. value today. If the payoff is less than what the value is, you have equity. If the payoff is more, you have negative equity.
Now that we know what negative equity is, why is it a bad thing? If you are trading in your car, you need to payoff the loan in full in order to trade it and get the title for the dealership. So where does the difference come from? Most of the times it is wrapped into your new loan. Negative equity is horrible because you are still paying for something that you no longer have. In the case of a mortgage, if you have negative equity in your home and you sell it, you will not be able to sell it for what you owe and you will lose money. Where does that money come from? You either wrap it into your new mortgage, you take out a personal loan or you pay for it out of your pocket.
I think the biggest problem with negative equity is that people do not fully understand what it is and what it means to them. you will continue to pay for negative equity on your new loan. And by doing that, you are already starting you new loan off for more than the vehicle, home etc is worth.