Four Easy Tips to Manage Your Negative Equity
April 4, 2019 | By June Mckaig
What could be worse than owing on a loan? How about owing on what you owe on a loan. Not only is that crazy sounding, but it’s also a crazy situation—at least, it can be. So let’s begin by defining the problem, also known as negative equity, and then let’s discuss how to handle it and how not to handle it.
Defining Negative Equity
Negative equity is the amount you owe on a loan that is no longer attached to the worth of your purchase. Once you buy a car and drive off the lot, the value of the car will depreciate near immediately, and that loss will increase in the years that follow. Some cars are better than others in this regard depending on the make, model, and reviews; however, there will still be a gap between the initial retail value and its value over time.
When you take out a loan, you are taking it out at the retail price, which means that any depreciation in your car’s value equates to you owing more on your car than what it’s worth—that is negative equity.
How Did I Get Stuck with Negative Equity?
There are a couple of ways that you can accrue negative equity. One of the easiest ways to find yourself in a snake pit of negative equity is by buying a car that was way above your budget, or by not putting down a large enough down payment. If your loan has a high interest or too long a term, or a combination of these two, then you could also wind up owing more than necessary.
One of the worst paths to negative equity is by rolling over from a previous loan into a new one when purchasing a new car. First off, this is a poor consolation for your credit score, and second, you will likely be in more debt than you were previously.
How Much Negative Equity Do I Have?
Now that we know what negative equity is and how we got saddled with it, let’s calculate just how deep in the pit we are. Simply take what you currently owe on your car (aka your current loan amount) and subtract your current car value. You can go to sites like Car Gurus to estimate your car value both as a private seller and through trade-in.
Let’s create an example before moving on: let’s say you still owe $8,000 on your car, but online you’ve found that the value of your car is only $6,000. That means that you have $2,000 of negative equity, which will make it a loss of money if you attempt to sell your car with that existing gap.
Dealing with Negative Equity
You’ve done the math. You know that you’ve fallen down the rabbit hole of loans and debts and negative equity—oh my. So what are you going to do about it? Well, let’s list some of the options you can consider.
1. Easy Yet Hard: Pay It Off
The most straight-forward, “easy” way to deal with negative equity is to pay it off. Stick with your current car and drive it for what it’s worth, even if there are other cars with features you prefer. Once you get to the point where you break even or owe the same amount your car is worth, then you can consider selling or trading in your car, as you won’t owe anything extra that you won’t make off your old car.
2. Wrangle the Snakes: Refinance Your Loan
Another option is to refinance your loan in order to owe less on it. What this means is finding another loan with better terms (smaller interest rate, shorter pay period, etc.), and paying off your old loan with the new one; however, it can be difficult to find a lender that will allow for a new loan with negative equity.
Your best bet would be to refinance with a bank you have a good credit history with here in Utah, a credit union, or a lender who specializes in bad credit.
One of the types of loans that might best help you pay off negative equity as well as a payday loan near you.
You can take out the amount of your negative equity on a payday loan in order to break even with your old loan, which will allow you to sell your car sooner if that is your goal. With the short term period of a payday loan, as long as you pay it back on time, your interest won’t be through the roof!
3. Rebate Bingo
If you are desperate to replace your old car, then look into rebates on new cars in order to eliminate your negative equity. Some companies offer “conquest” rebates, meaning that a competing car company will offer incentives if you purchase from them rather than your current one. Let’s provide another example: you owe $10,000 on your loan for a car that is worth $8,000, and you have found a new car that will cost $20,000 with a $3,000 rebate.
The dealer, if you trade-in your old car, will pay off your $10,000 loan and add on your $2,000 of negative equity to your cost, making the total cost of your new car $19,000. You will then have $1,000 in positive equity; however, it’s important to note that depreciation will once again catch up with you if you don’t pay your loan off as quickly as possible.
4. Prepare Yourself: Gap Insurance
This option is preventative rather than curative. You may be able to acquire it later down the line of owning your car, but it will be with some difficulty. When you purchase a new car, you have the ability to purchase gap insurance (guaranteed asset protection), which covers the difference between the loan balance and the market value of a vehicle. The only times this insurance will not cover that difference is if you default on a loan or have had your car repossessed.
Do Nots of Negative Equity
As with anything else involving loans and money and cars, you do need to be watchful of how you’re attempting to manage your problems. We’ll address two of the big caution signs when dealing with negative equity, although there are others to consider and research.
Don’t Sell to a Dealer
While you can trade-in your car in order to pay off some of your loan, there is one tiny problem associated with it—more than likely, the dealership will underpay you what you could otherwise make by selling the car yourself. It will definitely be easier to sell your old car the mainstream way, so if that’s more important to you that making the money back, then that’s the path for you; however, if you want to make as much money as possible in this transaction, do research and advertise your car yourself, and sell it that way.
The Quicksand of Credit Cards
Another option while refinancing is to do so via a credit card. When you open a new credit card, you will usually be given an interest-free period of time, anywhere from six months to a year. You can take advantage of this time period by paying off your old loan with your new credit card while avoiding any interest for that set amount of time. This is actually something you can do to your benefit, but only if you can pay off the debt in that time period because if you do not, then the interest will likely be large and you will accrue more negative equity while potentially damaging your credit.
Another bump on this road is that, depending on the credit card, you might not be able to proceed with zero interest since your old loan would be a cash advance rather than a purchase. It’s vital to do research prior to making any decisions, as it is before you commit to any of these options.