When you take out an auto loan, negative equity typically doesn't affect you unless you trade in your current car. It doesn't always stop you from doing it, but it does take a few more steps to accomplish.
Why Do I Have Negative Equity?
Negative equity is common on new cars, and even some used vehicles, depending on how well they hold their value and a few other factors. When you have negative equity, it means that you owe more on your auto loan than your car is worth. This happens for many people when they finance, and is more common on long-term loans or if you don't make a big enough down payment.
Negative equity happens because vehicles are depreciating assets. This means they lose value over time, especially in the first years of ownership. Depreciation can't be stopped, but you can ensure the gap between what you owe and the value of your car stays smaller. There are a few ways to do this:
- Make a large down payment – A large down payment helps reduce negative equity by allowing you to borrow less. In order for this to help, you should make a down payment that’s at least 20% of a vehicle's selling price.
- Take out a short-term loan – The longer you stretch your auto loan, the smaller your monthly payment becomes, and the easier it is to owe more than your car's value for a longer period of time. To fight this, balance the biggest monthly payment you can comfortably afford with the shortest loan term possible.
- Pay off your loan early – If you can't take out a short-term loan, you can make additional payments to combat negative equity. Paying extra whenever you can to knock down your loan balance faster helps, and there are many ways you can pay off your auto loan early.
- Get a car that holds its value – Certain makes and models are known to depreciate more slowly than others. To narrow the gap between vehicle value and amount owed, try to finance a car that holds its value better than others, such as a Toyota, Honda, or Subaru.
These tips can help you reduce negative equity, but it's not always possible to eliminate it. If you find you need to trade in your vehicle, but you’re not in an equity position, don't lose hope. You may be able to trade in your car with negative equity, but it might not be a good idea if you have poor credit.
Trading In with Negative Equity
If you have negative equity, trading in your car won't cover your existing loan balance, which you have to pay off. This means you need to either come up with the difference between what you owe and what you get for the vehicle in cash. If this isn't doable, you may be able to roll over the negative equity into your next loan.
Rolling over the negative equity isn't always possible, or wise – especially with bad credit. When you roll over an auto loan, your new lender pays off your existing balance, then adds the amount not covered by your trade-in to your new loan. This means a higher loan amount, higher monthly payment, and starting off with even more negative equity.
If you're able to roll over, it's going to take you longer to recover from negative equity than it did the first time. If you end up having to trade in or sell this new car with negative equity, you're liable to end up stuck in this same cycle of negative equity trading – commonly referred to as the trade-in treadmill – and it's not where you want to be.
In order to shut this cycle down, you typically have to wait until there's equity in your vehicle or until there's a small enough amount of negative equity that you can pay it easily. You can also wait until you pay off your loan, then the value of your car can be used as you see fit.
The Bottom Line
If you find you’re unable to wait until there's equity in your car before trading it in for another one, don't worry. Negative equity doesn't always have to stop you from getting the vehicle you need. When it's time to find your next auto loan, The Car Connection wants to help.
We work with a large network of special finance dealers that have lenders available to assist people with poor credit and unique credit situations. To get started on the path toward your next car loan, simply fill out our fast and free auto loan request form. After you do, we'll get to work connecting you to a dealership in your area.