DEFINITION of 'Debt Deflation'

A situation in which the collateral used to secure a loan (or another form of debt) decreases in value. This can be detrimental because it may lead to a restructuring of the loan agreement or the loan itself.

Also known as "worst deflation" and "collateral deflation".

BREAKING DOWN 'Debt Deflation'

A mortgage, which is a form of secured debt, presents a good example. Let's say you purchased a home by taking out a mortgage. That same home would be secured as collateral for the loan, meaning that if you defaulted on payments to the bank, the home would be repossessed by the bank. If the potential selling price of the home decreased in value while you were still making payments to the bank, you would be in the middle of a debt deflation scenario.

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