When you have equity in your car, it means the vehicle is worth more than what you owe on its loan. If the car is worth less than what you owe, you have negative equity, which is also referred to as being upside down. A lot of people have negative equity in their vehicle at one point or another, but it isn't necessarily a problem unless you decide to trade in or sell your car, or if it gets stolen or is totaled.
Why Negative Equity on a Car Can Be a Problem
As mentioned, negative equity typically happens at some point during your loan. If nothing happens during your loan term, you eventually pay enough so that you owe less than the vehicle’s worth.
However, if you’re looking to trade in or sell your car – or it gets totaled or stolen – before it’s worth more than you owe, being upside down can put you in a tough situation. If you trade in or sell your vehicle and don’t get enough to cover the remaining loan balance, you’re still responsible for paying it.
It is sometimes possible to trade in your car with negative equity by rolling the balance over into the new loan, but it’s something we don’t recommend. With the increased amount tacked on, your monthly payment increases, you're paying interest on it, and you end up being upside down for even longer in the new loan. Overall, it's not worth the trouble unless the amount of negative equity is negligible.
In addition, negative equity can become a problem if your car gets totaled or stolen. Your insurance company only pays the current market value of the vehicle if either of those two things happen. If you owe more than what the car’s worth at the time of the incident, you’re responsible for paying the difference. Luckily, you can avoid this by purchasing GAP insurance, which we cover below.
Avoiding or Minimizing Negative Equity
You can typically avoid negative equity right off the bat by making a sizable down payment – usually from 20% to 30% of the vehicle’s selling price. Although a down payment is usually required when taking out a bad credit auto loan, not everyone is able to make such a large one. That’s OK – there’s an alternative to avoiding many of the issues that come with being upside down.
If your down payment isn’t hefty enough to eliminate negative equity, it’s in your best interest to take out GAP insurance. This covers the difference between the loan balance and your car's value in the event your vehicle gets stolen or totaled. This prevents a nightmare situation where you owe thousands on a car that you no longer have or can't even drive.
Don’t Let Negative Equity Hold You Back
It’s extremely tough to eliminate negative equity right out the gate with an auto loan, but you don’t have to deal with the potential troubles that come along with it. You just need to do some planning and have a large down payment ready, or set money aside to purchase GAP coverage. You’re better off safe than sorry.
If you’re ready to purchase a vehicle but don’t have a dealer to work with, we can assist you. At The Car Connection, we can connect you to a local dealership that can help you get the financing you need.
All you need to do is complete our free, fast, and no-obligation car loan request form, and we’ll get right to work matching you with a dealer near you.