Negative equity usually only causes problems for you if you need to sell your vehicle, or it’s totaled in an accident. However, negative equity doesn't typically last forever, so you may not need to take action right away, or at all.
What is Negative Equity?
When you owe more on your car's loan than what the vehicle is worth, you’ve got negative equity. You may hear people refer to this situation as being underwater or upside-down on your car loan. Negative equity can only happen when you’re financing, so if you own your vehicle outright, the entire value of the car is equity. Equity is when you owe less on your loan than your vehicle’s actual cash value (ACV).
To find your equity position, check your vehicle’s estimated value, and then compare it to your loan balance. If you find that you’re in a negative equity position, don't panic – you may not need to do anything about it.
Negative equity typically only causes problems for borrowers in a few situations. Namely, when you need to sell the car or if the vehicle is totaled or stolen and your auto insurance doesn’t cover your entire loan balance.
Selling a Car With Negative Equity
To officially sell a car, you must pay off the entire balance before ownership can be transferred to the new owner.
If you need to sell a vehicle when it has negative equity, you must first pay off the entire balance of the loan. This can be hard to do when your car can’t sell for what you owe to the lender. If you were to trade in the vehicle at a dealership, you may not get a large enough offer to pay off your loan and remove the lien from the title.
There are two main ways you can sell a vehicle with negative equity:
- Pay the negative equity out of pocket – Once you find out how much an offer you can get for your car, subtract that amount from your loan balance. You can pay off the remaining balance with your own funds and remove the lien. If the balance is too much to pay out of pocket, then option two may work for you.
- Roll over negative equity – Rolling over negative equity means adding it to your next auto loan balance. You could trade in your vehicle, apply the trade-in amount to your loan balance, and anything leftover can be added to your next auto loan. However, this usually puts you in a negative equity position again, so consider this option wisely.
Refinancing with negative equity isn’t an option either, since this involves replacing your current auto loan with another one.
While there are ways to sell a car with negative equity, perhaps the wisest decision is to wait to sell your car until you’ve caught up to your loan balance. Paying on your auto loan like normal usually eventually leads to an equity position. You can also pay extra if you can, since most auto loans don’t come with prepayment penalties (although it wouldn’t hurt to check with your lender).
Auto Insurance and Negative Equity Snags
When you’re financing a vehicle, you’re required to have a full coverage auto insurance policy on it. While full coverage can help with many claims, if the car is stolen or totaled, the insurance provider only pays out the value of the vehicle at the time of the claim. If you have negative equity when your car is totaled or stolen, you're left to pay for it out of pocket in order to get out of the loan.
Once a vehicle is deemed a total loss (meaning repairs cost more than its value), the insurance company determines the car’s ACV. They pay the lender that amount and any leftover balance is up to you to pay. The same goes for a vehicle that is stolen and never recovered. If you owe hundreds or thousands of dollars after insurance has paid, it means you could be paying for a car that you no longer have or isn’t drivable.
However, this doesn't have to be your fate; guaranteed asset protection (GAP) insurance can help borrowers with negative equity. It covers the “gap” between what you owe and the vehicle’s value. GAP promises to pay for the entire balance of your auto loan, regardless of the car’s value. For borrowers who take on large loans or finance new vehicles that lose their value quickly, GAP insurance is a great way to avoid paying for negative equity out of pocket if something happens.
GAP insurance is relatively inexpensive, averaging around $20 to $40 annually, although the price depends on the car’s value and other factors. You’re likely to be offered this optional insurance coverage at the dealership, though, you can typically get it through your insurance company as well.
Ready for Another Auto Loan?
If you find that you’re in a negative equity position with your auto loan, it’s not all bad. Like we said, negative equity typically only causes problems if you need to sell your vehicle, are in an accident where it’s totaled, or the car is stolen and never recovered.
With some patience, time, and continued payments, you can catch up to your loan balance. However, if you want out of your negative equity auto loan and need another vehicle, we want to help you find resources.
Here at The Car Connection, we’ve gathered a nationwide network of dealerships that assist borrowers in tough credit situations. If you’re ready for an auto loan but you’re worried about your less than perfect credit getting in the way, then start with us! Fill out our free auto loan request form from the comfort of your home, and we’ll look for a dealer in your local area that’s signed up with bad credit lenders – with no obligation. Don’t delay, get started today!