What Happens to my Negative Equity?
There comes a time when one grows sick of his or her current vehicle, regardless of its condition. Unfortunately, if money is still owed on the loan of the vehicle that you are looking to trade in, the loan won’t simply disappear. The remaining balance on the loan must be paid off, and it can present an issue if you owe more on the loan than what the car is worth. This imbalance in what is owed and what the car is worth is referred to as negative equity.
What is Negative Equity?
Negative equity, also known as being “upside down” or “under water” on a loan, occurs when the value of your vehicle is less than the outstanding balance on your vehicle’s loan. For example, if your outstanding balance on your vehicle’s loan is $20,000, but your vehicle is only valued at $18,000 on the market, you have a negative equity of $2,000 (Value of the Vehicle – Outstanding Loan Balance = +/- Equity).
As previously mentioned, if you decide to trade in your vehicle and it results in negative equity, you will responsible for paying the price of the new vehicle plus the outstanding balance on your previous loan. This, in turn, will result in much higher monthly payments, as the balance of the loan on your previous vehicle will “rollover”, or be added to the balance of the loan on your new vehicle.
Managing Negative Equity
It is crucial that you understand how negative equity works and how you can manage it effectively and successfully. We all know that life can be unpredictable. There may be circumstances in which trading in your current vehicle for another might be the right move for you. You may find that you need something roomier, or it turned out that your vehicle is more expensive than you thought you could afford. Regardless of your situation, you may find that taking on negative equity might be the best decision for you. Thankfully, there isn’t a “one-size-fits-all” approach to dealing with negative equity, you have a few options:
- Ask the Lender to Roll Over the Outstanding Balance
The most common method that people use to reduce or eliminate their negative vehicle equity is rolling over the outstanding balance on the previous loan into the new loan. This method does not cost anything out-of-pocket; however, you should expect higher monthly payments due to the higher total financed (this higher total will also result in more interest paid over time, since the loan will be for a higher amount). This strategy offers a convenient way for you to buy the new car that you have yourself set on, as long as you are confident, willing, and able to make these higher monthly payments.
Some dealers do offer incentives, which can be applied to your negative equity. For example, if you have a negative equity of $2,000, and a dealer was currently offering a $1,000 rebate to purchase, you could essentially apply this $1,000 to the outstanding balance on your loan, thus reducing your negative equity to $1,000.
- Keep Your Current Car:
The less favorable but best strategy to reduce negative equity is to keep your current car. Theoretically, if you decide to hold on to your vehicle you will reach a break-even point in the loan. You could potentially reach a point where the value of the car will outweigh the amount you owe; however, it is important to at least limit your losses. By delaying the purchase of a new car, you will have more time to reevaluate your situation and determine which car will be the best fit for you physically, socially, and financially.
If your budget allows it, you should strive to make larger payments, as this will reduce the probability of running into negative equity, as well as, decrease the outstanding balance on your loan. You could also consider refinancing the loan. If you decide to take this route, your monthly payments will decrease, and that extra discretionary income can be saved and put toward your next vehicle!
- Pay off the Loan’s Outstanding Balance:
This option assumes that you have money saved to put towards the down payment on a new vehicle. If so, you have two approaches to consider. Firstly, this one ties back to the second option mentioned of keeping your current vehicle for a little while longer. Instead of a new vehicle purchase, you could use the saved capital to pay down the remaining balance on your loan; however, if this does not appeal to you, and you are absolutely set on a new vehicle, you, fortunately, have an alternative. This may be abut of a stretch, but in some cases, lenders will approve a car loan without a down payment, namely for those with “Good” to “Excellent” credit. In this scenario, you could use the money saved for the down payment to pay down or pay off the loan that is contributing to your negative equity status. You could potentially save some money using this approach; however, persuading a lender to approve a car loan without a down payment can be a difficult process.If you have a solid credit history and a lender deems you as a reliable source of on-time payments, this method could work for you.
Overall, the smartest strategy to reduce your negative equity is to keep your current vehicle, at least until it reaches a break-even point or its value exceeds the outstanding balance on the loan. Unfortunately, this is not always the case, so you may find that rolling over your outstanding balance into a new vehicle loan might be the best method for you. If you are set, or find it absolutely necessary to purchase a new vehicle, you must be willing and able to afford the higher monthly payments associated with this method. It is essential to have money set aside or budgeted to ensure that you will make your car payments on a monthly basis. Of course, the unpredictability and ever-changing nature of life forces you to adapt. You may find that your coupe is too small for family vacation; your luxury sedan is way out of your budget; or your SUV isn’t as great as you though it would be. Regardless, of your situation, we, at Krietz Auto are here to help. Please, feel free to reach out to us at anytime to talk to one of our experienced, professional sales team members, who will be more than happy to find a vehicle, and a loan that is best for you!