When you purchase a car, you hope that it will hold its value so that when it comes time to sell it or trade it in, you can get a positive return on your investment.
However, sometimes the value of a vehicle decreases faster than expected, leaving the owner owing more on the loan than the car is worth.
This is called negative equity, and it can put the borrower in a difficult financial situation.
Negative Equity Defined
A vehicle has “negative equity” when the outstanding balance of the current lien (auto loan) exceeds the estimated value of the vehicle.
How Does Negative Equity Work on an Auto Loan?
If the borrower decides to sell or trade in the car before the loan is paid off, they will have to account for the negative equity that their current vehicle holds during this process.
This can make it difficult to qualify for a new loan or lease because lenders are typically
reluctant to finance a vehicle with negative equity, due to the risk that comes with it. This is especially true if the borrower has bad credit.
How Does a Vehicle Come to Have Negative Equity?
A car can become “negative” in terms of equity for several potential reasons:
- The value of the car depreciates more quickly than expected, outpacing the payment schedule for the loan.
- The loan was started by financing a significant amount, potentially even more than the purchase price to cover tax, title, & license fees.
- The borrower put little or no money towards a down payment and keeps minimal payments, which may not keep up with depreciation.
- The borrower rolled over previous negative equity with a trade in, starting off the new loan immediately negative.
Your Options with Negative Equity
There is no one right answer when it comes to having a negative equity vehicle. Each situation is unique, so know your options and consider each route before making your decision.
- Privately Sell your vehicle to maximize the amount you are able to pay off towards the deficit.
- Refinance your negative equity car loan before getting a new one if you can qualify for better rates and terms.
- Trade in your upside down car and take on the additional cost with the new loan.
- Pay off your negative equity with a larger down payment when taking on the new loan.