Negative equity

Real estate is the preferred choice of investment for many investors, young or old, men or women. The possibility of using the concept of leveraging make the real estate investment so much more attrative. With a certain amount of money to be used as down payment or deposit, investor can borrow an amount nine time the amount of deposit. Say if an investor has RM50,000-00 to part with, he can use it to purchase a house of value RM500,000-00 as the financial institution at this moment offer end financing up to a maximum of 90% of the purchase price. There are even cases where the financing went up to 95%.

Experienced investors will normally look for property where rental income can cover the monthly installment of the loan or at least the interest charges of the overdraft taken to finance the purchase. Thus by paying 10% of purchase price as down payment and the rest by bank borrowing and if the price of property increase by 10%, effectively the investor make a profit of 100% based on the investment of his own money.

However the opposite is also true, if the price of property dropped by 10% and if the investor sell the property, then he lose 100% of all his investment assuming that he is only serving the interest payment during the period he hold the property. In essence, even if the rental income can cover the monthly installment, the part of installment that is being actually used to pay the principal amount is also very little in the initial years of repayment.

Therefore if the price of property dropped by 10%, then effectively when the investor want to sell the property, the proceed from the sale may not be enough to settle the bank borrowing. That is when the investor has negative equity.

In short the definition of negative equity is as below:-

The difference between the value of an asset and the outstanding portion of the loan taken out to pay for the asset, when the latter exceeds the former. Negative equity can result from a decline in the value of an asset after it is purchased.