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Having negative equity in your car could leave you in a tough place if you sell or trade it in, and make it difficult and expensive to get a new ride.
Negative equity simply means that you owe more on your car loan than the vehicle is worth — also referred to as being “upside down” on your car loan. For example, if your vehicle is valued at $10,000 but you still owe $15,000 on your loan, you have negative equity of $5,000.
Let’s take a look at the factors that can lead to negative equity and its potential effect on your finances.
Why do I have negative equity on my car loan?
You can get yourself upside down on your car loan in a few different ways.
You don’t put enough money down
New cars can lose up to 20% or more of their value in their first year on the road — so if you only make a small down payment, or no down payment at all, you could find yourself upside down on your loan. Depending on the amount of your down payment, you could have negative equity as early as the first year of your loan.
You put a lot of wear and tear on your vehicle
If you put a lot of miles on your car or its condition really deteriorates, its value may drop lower than similar cars on the road, due to depreciation. This is another factor that can contribute to becoming upside down on your loan.
You have a long car-loan term
In recent years, six- and seven-year car loan terms have become more common. In fact, more than 40% of car loans that originated in 2017 have terms that are six years or longer, according to the Consumer Financial Protection Bureau.
While a longer loan term may give you more time to pay off your car, stretching out your vehicle financing can increase your risk for negative equity. If you take longer to pay back your car loan, you could find yourself in a situation where your car has significantly depreciated in value, but you still owe thousands on it.
How can negative equity affect me?
Being upside down on your auto loan could leave you in a financial jam.
Your next car loan could be more expensive
When it’s time to get your next car, you might want to trade in your existing vehicle and use the proceeds to help with your down payment. But if you’re upside down on your loan, it can add to the cost of your new loan.
If you decide to roll over the balance of your current auto loan into your new car loan, you’ll end up borrowing more than the price of your new vehicle. This increase in the cost of your loan could immediately put you in a negative equity situation again.
Selling your car could be difficult
You might be able to find a buyer for your car, but they’ll likely only pay a price within your car’s fair market value range. If you have negative equity on your loan, this amount probably won’t be enough to cover your total loan balance — making it impossible to break even.
You could end up making payments on a totaled car
If your car is totaled or stolen, standard comprehensive or collision coverage will most likely cover only your car’s actual cash value — its market value at the time of the incident — minus any deductible. If you owe more than your car’s value, you’ll be on the hook for the balance. That means you’ll still need to make loan payments on a car you can no longer use.
Having negative equity on your auto loan could end up costing you. Making a big enough down payment, keeping your mileage down and avoiding a long loan term can all help lower your risk of becoming upside down on your loan.
If you do end up owing more on your car than it’s worth, don’t panic. You might have a few options, like refinancing your car loan or selling your car privately, to help you get your finances back on track.