Negative Equity

Roman Danaev

25 May 2023

Meaning and Definition

Negative equity, also known as an upside-down loan or underwater loan, occurs when the value of an asset, such as a vehicle, is less than the outstanding balance of the loan used to finance that asset. In the context of car finance, negative equity arises when the value of a financed vehicle depreciates faster than the loan balance decreases due to loan interest and repayment. It means the borrower owes more on the car loan than the car is worth.

Why it is important to know

Understanding the concept of negative equity is crucial for individuals who are financing a vehicle, especially if they plan to sell or trade-in the vehicle before the loan is fully repaid. Negative equity can have financial implications as it may result in a shortfall between the proceeds from selling or trading in the vehicle and the outstanding loan balance. It is important for borrowers to consider the potential risk ofnegative equity when choosing a car finance option and to manage their finances accordingly.

Example in car finance

Suppose a borrower purchases a car for £20,000 and finances it with a loan of £18,000. After a few years, the borrower decides to sell the car. However, due to depreciation and market conditions, the car's value has decreased to £15,000. In this case, the borrower has negative equity of £3,000 (£18,000 loan balance - £15,000 car value). If the borrower sells the car, they will still owe £3,000 to the lender to fully settle the loan, as the car's value is insufficient to cover the loan balance.

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