Negative Equity Definition

Negative equity indicates that an asset used to secure a loan has a fair market value of less than the outstanding balance on the loan. For example, imagine you buy a new car valued at $50,000, using a $45,000 loan; as new cars depreciate very quickly, within a few months the car’s resale value on the open market is perhaps only $43,000 but you still owe $44,200 on the loan.

Another term used to describe this situation is when someone says they are "upside down" in a loan. Negative equity may occur for a variety of reasons including a negatively amortizing mortgage, sinking market prices, or asset depreciation. Most situations of negative equity increase the risk to the lender, as the borrower is more apt to "walk away" from the asset and the loan.