Financing a vehicle purchase has numerous benefits. A finance agreement allows vehicle buyers to get into a new or newer car without having the pay the full purchase amount upfront. Additionally, making regular payments can improve credit scores, and driving a newer, more dependable vehicle can save plenty of money on repairs and maintenance. However, financing a vehicle oftentimes puts you in a position of negative equity, and it's important to know what that means before entering into a finance agreement.
What is Negative Equity?
Put simply, negative equity occurs when a vehicle depreciates faster than it is paid for. When you hear about being "upside-down" or "underwater" on a car loan, what's being talked about is negative equity. When someone has negative equity on an auto loan, they owe more than the vehicle is worth. You see, the amount you pay on an auto loan is greater than the cost of the vehicle itself. A portion of your loan payment includes things like interest expenses. It's not uncommon to experience negative equity for a period of time after you finance a vehicle, but it is in your best interest to make that period of time as short as possible.
What Causes Negative Equity?
Vehicle owners can end up with negative equity for a variety of reasons. Some of the common situations that lead to prolonged negative equity include:
- Making a down payment that's too low
- Falling behind on monthly payments
- Setting up a lengthy loan term
- Needing to trade in a vehicle before you've paid off your current loan
- Accumulating excessive miles on your vehicle
Remember, experiencing negative equity isn't unique. In 2015, approximately 30 percent of car sales that included a trade-in were situations where the owner still owed some money on the vehicle. Getting out of a negative equity situation isn't particularly fun, but it is necessary. Making larger payments or refinancing are common strategies to help vehicle owners eliminate their negative equity.
Buying a Car Without Negative Equity
One of the most practical ways to get yourself out of a negative equity situation is to continue making payments on your current vehicle until you are no longer underwater. You can also think of this as getting to a point where the value of your vehicle is greater than the amount owed. This will also give you an opportunity to improve your credit score, which can result in a better interest rate on your next vehicle purchase. In situations where keeping your current vehicle is unrealistic, like if the vehicle is involved in an accident or unable to accommodate your growing family, you may need to consider other options.
New car leases are another strategy for vehicle owners to eliminate their negative equity. In this scenario, the amount of money still owed on your current vehicle loan can be rolled into your monthly lease payments. You'll still end up paying a higher amount in monthly payments, but at the end of your lease term, you'll break even. While it's true you won't have a vehicle's trade-in value when you go to make your next vehicle purchase, you also won't bring existing debt into a new lease or finance agreement. It's an opportunity to start fresh.