If you’ve heard the words “negative equity” or “upside down,” there’s a pretty good chance that you’re trying to trade in your vehicle but you’ve been told that you owe more on your trade than it’s worth.
There are a few things that cause you to be “upside down”: It might be that you’re trading in too early, your vehicle could have damage of some kind that affects its value, or it could be that the market has depreciated faster than you anticipated. Most of the time you can overcome negative equity by financing it into your next car loan, but that’s not always the best option. Negative equity can get dangerous, especially when it starts to compound.
For example, you buy a new car, decide to keep it for two years, and then trade it in. When you trade in a new car that quickly, you will have negative equity. However, let’s say you decide it’s not a big deal; you just take your negative equity (let’s say $3k worth) and roll it into your second car. You drive that second car for a couple of years, and then decide you want to trade the second vehicle in (again two years is too soon). You’ll still owe the negative equity from your first car (negative equity is always paid off last) plus negative equity from the second car because you’re trading in too early.
Following our example, let’s you have $3000 in negative from your first car and $3000 in negative from your second car. With a little luck and a high interest rate, you manage to take that $6000 in negative equity and roll it into your third vehicle. Let’s say you really like this third vehicle, and you want to keep it, but something happens and you need to trade it in. When you go to the dealership, you’ll have the negative equity from the first and second cars, as well as the negative equity from this third car because you’re trading it in too soon as well. Add it all up, and you’ll probably have $10,000 in negative equity. Unfortunately, you really can’t take that amount of negative equity and finance it into anything.
This is how negative equity gets dangerous – it follows you from one car to the next, at least until you completely pay something off.
If you have negative equity, here’s what we recommend:
- Take a step back and ask yourself: “Do I need to buy right now?” If the answer is “no,” or “I’m not sure,” postpone your purchase.
- If you have major damage that’s hurting your car’s value, call your insurance company and get it taken care of. If the damage is minor, go to your local body shop or detailer to get rid of the dents and scratches. In fact, just cleaning and waxing your car will increase its resale value (and therefore reduce your negative equity).
- Rather than going to the dealership, put your vehicle on craigslist and try selling it yourself – you can sometimes cover all of your negative equity when you do that. Take a look at our tips on selling your car yourself, since there are some safety issues with that.
- If you have credit insurance or an extended warranty on the car you’re trying to trade-in, find out if you can cancel your coverage. If you can do this it will reduce your payoff (and therefore your negative equity).
As always, take your time when buying a new or used car. Do your car research, get multiple car financing quotes, and feel free to contact us with your questions.