Negative equity occurs when the value of a property (asset) falls below the outstanding balance of the mortgage tied to it.
Industry jargon also refer to these situations as being underwater or an upside down mortgage.
While sounding ridiculous, these situations can arise when there is a sudden and drastic drop in real estate prices.
When property price depreciation outpaces the speed of mortgage repayments, a house can easily run into negative equity.
Should home prices continue to fall, it implies that homeowners are losing money the longer they stay in their homes!
Yet they would be too scared to sell their homes as that would realize those losses!
When lenders become aware of such events, they might choose to:
- Ignore it and do nothing
- Request the borrower to make a cash top up to the mortgage so that equity rises to a healthier level
- Recall the loan
Recalling the loan due to negative equity can seem like an extreme act, lenders with demand clauses in their mortgage contract can exercise this right at any time.
And as we have all observed in the past, a panicking bank can do a host of stuff that are unimaginable to the general public.