Negative Equity, Upside Down, Under-water… no matter what you call it as of 2014 27% of car owners had negative equity in their vehicle.
How is negative equity acquired and how can you try to avoid slipping “under water” farther? First let’s forget the idea that a car is any type of investment. It isn’t. Unless you are a collector of antique vehicles, there is no investment that you will drive off a lot and build equity on. When you drive a car off the lot you have what is called the initial drop. This is the depreciation that automatically happens when you purchase a car. This happens in the first 1/3 of your cars life.
What is negative equity and why do I have negative equity in my car? Negative equity occurs when you roll the remaining balance of a loan of the previous car into the next car. Negative equity happens because of many different reasons. The first is the initial drop of value. A car may have been purchased for $20k, but in the first 1/3 of the vehicles life it is now only work $16k, you are still owing on the initial value and don’t forget to keep in mind NO car holds its value. Other reasons there is negative equity are that a buyer may have picked a car that doesn’t fit their needs any longer, they purchased a car that was out of their price range, the buyer added extra options to the vehicle, they have a long loan payment, or most of the time the buyer just gets bored and wants a newer vehicle. The average life of cycle of a car buyer is between 3-5 years. It does fluctuate.
Can I NOT have negative equity in my car? Well, the answer is of course you can, but what are you willing to do to make sure that happens? Having negative equity means carrying out the entire term of your car loan/lease. There is not a magic formula to do this. You can also purchase a car within your means and even at a lower price/value. Even putting a bigger down payment may help, but remember it only may, nothing is definite.
I am upside-down and over my current vehicle… what can I do? First thing you can do is try selling it yourself. You may get more than it is worth through that venue. You can also just hold onto it longer. I know, I know you want the new, more fancy technology or the leather seats, even better gas mileage but waiting might be worth it. You can keep a shorter loan term. You can also look into purchasing new. The reason this is an option is because incentives from the dealer may reduce the balance of the negative equity in your old vehicle. Leasing is also a great option. It keeps you in the lower terms, you get a warranty, you get gap (which will cover the whole car if something were to happen to it and the value is less than what it is worth, yes gap actually is worth having.), and it will get you in a newer car! The only part of this is that you cannot turn it in early or you will just acquire more negative equity and circle back to where you were before.
- When the lease is over, you walk away and get to start over. Given your current budget/predicament, you are (probably) not going to want the car you buy now in the long run.
- A lease will basically hide your negative equity with the incentives the dealership offers and the way a lease works, as far as principle and interest payments.
- Gap insurance – basically every lease requires/rolls this in. This means if you drive off and total the car 3 minutes later, you walk away with the entire debt repaid. No more negative equity, no more car payment, nothing. Back to zero. Side note – gap insurance is almost always worth buying on any new car loan (even if the dealer doesn’t offer it – credit unions will if you finance through them and it’s CHEAP – think $1 per $100 in monthly payment). It saved a new car loan where it would have been drastically underwater (45k car, totaled 1.5 months in; still owed 50k including TTL etc…, and the value was ~$40,000 or so meaning I would have been 10k out of pocket for 30 days of driving).
Buyer Beware! What to know about negative equity:
Find out what your car is worth. Visit sites like KBB and NADA as a guide. This doesn’t mean your car is exactly worth what they are saying, it is JUST a guide. These numbers don’t factor in wear and tear and most people are not honest with themselves about the condition of their vehicle. Underestimate instead of overestimate!
READ THE CONTRACTS. Can’t emphasize this enough. Ask how the negative equity is being applied. Don’t be a blind customer.
Don’t lie to yourself or the dealership. This could be the condition of your car you are trading in, your credit, any financial information etc. It will come back and bite you in the rear. Have faith in the dealership and they will have faith in you.
In the end, some buyers hate the idea of negative equity and will never be comfortable with it and maintain their car purchase for years. However, there is a large group that know it will be a continuous cycle and continue to roll their negative equity because they love having newer cars.
If you have questions regarding negative equity you can contact your financial institution or you can speak to a finance director at a dealership and they can answer your questions. Or feel free to post your questions here and we will answer them!
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