If the current value of your car is less than the amount you owe, you have negative equity. This is also known as a reverse on your car loan. When it comes time to buy a new car, having negative equity in your existing car loan can make it challenging. Regardless of whether you want to trade in your vehicle or sell your vehicle to a private party, owing more on the car than it’s worth will make things difficult.
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A car loses about 20% of its value in the first few years of ownership. This means you may owe more money than your car is worth before you pay off your loan. For example, if you borrowed $30,000 from the bank and you still owe $15,000 on your car, but it’s only worth $10,000, you have a total of negative equity of $5,000.
Knowing the value of the car you own and how much negative equity you have can help you combat the negative impact it can have on your finances. Let’s explore more about negative equity on a car loan so you can avoid it when you apply for a new loan for your next car.
Does Your Car Have Negative Equity?
To find out if your current car loan has negative equity, you can contact your lender to find out your current loan balance. Once you have that number, research the current value of the model you have. There are several websites that you can use to learn the value of your vehicle, such as Kelley’s Blue Book. You need to have some information about your car to get an estimate of its value, including:
- The mileage of the car
- The year, make and model of the car
- Car condition
Answer questions about your car on an appraisal website and once you know the car’s fair market value, you can determine the equity. You will simply subtract the amount you owe on your current vehicle from the amount it is worth. So, if you still owe $20,000 on your vehicle, but its appraised value is only $18,000, you have negative equity of $2,000.
These car appraisal websites will probably give you the trade-in value of the vehicle and its value if you decide to sell it to a third party. Usually, you’ll get more in a third-party sale, but they’re unlikely to pay you more than the car’s market value.
How Does Negative Equity on a Car Loan Work?
Even if you make all of your monthly payments on time, you can still have negative equity on your current car loan. This can happen for a number of reasons, such as:
You Make a Low Down Payment
Borrowing money to buy a new vehicle often requires you to make a downpayment. The amount you put down will affect your monthly payment amount as well as the interest rate and term of your loan. It will also affect the equity in your car loan. Making a higher down payment can help you avoid negative equity because it often leads to lower payments and better loan terms.
If you made a low down payment on your previous loan, you may be at risk of having negative equity in your car loan. The reason is that you will likely have higher monthly payments and a higher interest rate.
You Put a Lot of Mileage on Your Vehicle
The more miles a vehicle has, the less value it has. So if you put more miles than average on your vehicle, you may have more negative equity than you think. For example, let’s say you’re driving a 2017 Chevrolet Equinox that’s in good condition with 70,000 miles on it. The vehicle’s trade-in value will be around $25,000, according to Kelley Blue Book.
However, if the same year, make and model has 150,000 miles on it, that amount drops to $14,774. So, if you still owe $20,000 on the car, in the first example, you’ll have a positive amount of equity. But if you have higher mileage, you will be upside down in your car loan.
You Have Excess Wear and Tear on Your Vehicle
The wear and tear on your car will affect whether you have positive or negative equity on your loan. The more damage a used car has, the less value it has to potential buyers. If you want to avoid negative equity, take good care of your vehicle. This includes getting routine maintenance and keeping the car clean and free of body damage.
You Have Bad Credit Period
If your original loan is unsuitable, you could end up with negative equity. Many car loans today are extended for six, seven, or even eight years. When you have a longer loan term, you may pay less each month. Unfortunately, car values decrease every year. Therefore, the longer you pay off the loan amount, the more risk you have of being turned upside down when it comes to your car equity.
The Problem With Negative Equity on Car Loans
The way negative equity works can cause problems if you want to trade in or sell your car, but there are other problems you may run into. When you owe more on a car than it’s worth, you may run into these problems:
Your Car is Difficult to Trade or Sell
Trade-ins will not earn as much money sell your used car to private parties will. But no matter the condition, mileage or other details that make your vehicle great, you’ll have a hard time selling it if you have a loan that’s more than it’s worth. If you need to sell your car quickly, you may have to pay the balance of the loan out of your own pocket.
Your Next Car Loan Will Be Expensive
If you need to take out a new car loan for your next vehicle, it may cost more if you have negative equity in your current car loan. A dealer may offer to pay a lump sum on the remaining balance when you trade in your old car. This can help you get your next loan, but the dealer will likely charge you the full cost of the lump sum by rolling it into the cost of your next car loan.
Your Insurance Won’t Cover Negative Equity
Insurance providers will not cover any amount of negative equity you owe. If your car is totaled, your loan provider will only pay you enough money to cover its fair market value. If the loan amount has a balance left after the insurance claim is paid, the balance of the loan payment has to come from your own pocket.
Trade in Cars With Negative Equity
You can trade in a car with negative equity for a more expensive car, but it may not be the best option financially. This is because you will likely have more negative equity or continue the cycle of negative equity in your new loan. A new vehicle can be expensive, and if you’re behind on your loan payments, you may need to make larger payments or extend the term of your loan to make sure you can make your monthly payments.
Turning Negative Equity into New Car Loans
If you can’t wait to get a new loan because you need a new car now, here are a few things you should know about moving negative equity to a new car loan:
Know Your Car’s Value
Before you move toward getting a new loan, find out what your car is worth. It’s possible that you have enough cash to pay the difference between the loan balance and the value of the car, so you can switch from a negative equity loan to a positive equity loan. If the amount of negative equity is minimal, you may be able to negotiate a private sale in your favor.
In some cases, you can get out early when rolling negative equity into your next loan. Buying a cheaper new car or a used model means your monthly payments will be lower. If you can get a better term and pay off the loan faster, you can get more equity in your new vehicle after making your last loan payment.
Shop for a New Car Loan
Shop around before you settle on a loan to make sure you get the best deal. Lenders may offer to pay negative equity for you, but beware of additional fees or increases in the price of the car.
Get Pre-Approved for a Vehicle Loan
A pre-approval letter from a lending institution can give you leverage when negotiating a new car deal. It also tells you how much you can afford to spend on a new vehicle so you can avoid defaulting on your loan.
Understand Your New Loan
Make sure you read and understand the terms of your new loan before signing the agreement. Ask if there are prepayment penalties or any other fees that may be associated with paying off the loan. You can also ask about late fees and penalties.
Tips for Fixing Negative Equity in a Car Loan
If you have negative equity in your car loan, here are some things you can do to fix it:
Make Additional Payments
Making extra payments on your current car loan is one way to eliminate negative equity. Depending on how much negative equity you have, you can close the gap between your total debt and the value of your trip by paying less money each month or making extra payments when you can.
Refinancing Your Old Loan
You can refinance to get a better loan if you want to keep your current car. You can get terms that improve your financial situation, helping you pay off your debt sooner.
Use Other Resources
Other sources, such as borrowing money from a friend or relative, can help you pay off the loan early. If you know someone who can lend you the money you need, you will be able to repay the loan. Once you own it outright, you can sell or trade the car for something cheaper. This can give you extra money each month, which you can then use to pay back whoever helped you with the original loan.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. He has extensive knowledge of various lines of insurance, including auto insurance and property insurance. His byline has appeared in dozens of online financial publications, such as The Balance, Investopedia, Reviews.com, Forbes and Bankrate.