Trading in a car with negative equity is challenging for any vehicle owner. Negative equity essentially means that you owe more on your car loan than the vehicle is worth, which makes the financial side of trading it in difficult. However, that doesn’t mean you don’t have options. Here’s what you need to know about dealing with negative equity when trading in a car.
How Does Negative Equity on Cars Happen
Negative equity happens when a vehicle’s value drops below the amount remaining on the car loan. This is most common when a person buys a new vehicle without a down payment. While depreciation rates can vary, during the first year of ownership, many new cars lose around 20 percent of their value. Making the scheduled payments on a car loan don’t reduce the remaining balance by that same amount. As a result, negative equity occurs.
However, new vehicles bought with a loan and down payment, as well as used cars purchased with a loan, can also end up with negative equity. Shifts in the vehicle market can accelerate depreciation. Additionally, declines in a car’s condition can cause it to lose value faster than if it’s well-maintained.
Why Trade-In a Car with Negative Equity
Generally speaking, trading in a car with negative equity isn’t the wisest financial decision, as it comes with a variety of challenges that aren’t always the easiest to navigate. However, it could become a necessity for several reasons.
If your vehicle payments aren’t manageable, trading in the car could allow you to get something more affordable. Then, you may have an easier time balancing your budget moving forward, making it potentially worth any financial downsides related to the trade-in.
You might consider trading in a vehicle with negative equity if the car itself no longer serves your needs, too. For example, if you have a two-door car and then you have a baby, transitioning to a four-door vehicle could be a must for practicality.
At times, trading in a vehicle with negative equity may also make sense if the costs of maintaining it are becoming unmanageable. If you’re likely to spend far more in repairs and maintenance than you would if you could transition to another car, even the financial drawbacks of trading in a car that’s underwater could cause it to be a smart move when you consider the bigger picture.
How to Trade in a Car with Negative Equity
Check Several Dealerships
If your goal is to trade in your vehicle and there are several dealerships in your area that sell cars you’re considering buying, make sure to speak with them all. Dealerships may make different offers on your trade-in, so you may find that choosing one over another works in your favor.
For example, if you have a car with a loan balance of $11,000, one dealer may state it has a trade-in value of $9,000, while another would give you $10,000. By choosing the dealership with the higher offer, you’re essentially reducing the amount of negative equity you need to address.
Just make sure that any savings from the reduction of negative equity aren’t outweighed by a higher purchase price on the new car. Often, this is simple if both dealerships have vehicles that are the same make and model, have identical features, and the cars are in similar condition. If not, then you may need to do some research to see if you’re getting the right price on the vehicle you’re planning to purchase or if what you’d pay would eliminate any benefit from the reduction in negative equity.
Roll the Negative Equity into Your New Loan
In some cases, a car dealer will allow you to roll the negative equity from your existing car loan into your new vehicle loan. With this option, you don’t have to worry about addressing the negative equity before completing the trade-in, making it more convenient than some alternatives.
However, if you go down this path, you’re at a much greater risk of having negative equity on your new vehicle. Depending on the terms of the new loan, you also may pay more in interest and fees.
If this is a route you’re considering, make sure you focus on finding a low-cost vehicle that will meet your long-term needs. You may be better off choosing a used car over a brand-new one, as those usually experience less depreciation during the first year. In turn, you can return to positive equity faster.
Choosing a shorter contract term may also help. Interest rates are usually lower when the loan term is shorter. Plus, a higher percentage of your monthly payment goes toward the principal. Again, this helps you achieve positive equity in less time.
Finally, make sure to shop around for financing options that will allow you to roll the negative equity into your new loan. You may be able to get a better interest rate by exploring lenders outside of what the dealer offers, so it’s worth checking.
Pay Off the Negative Equity
For vehicle owners with some cash savings available, you may have the option of paying off the negative equity during the trade-in process. Working with a dealer allows you to find out what the dealership is willing to pay for the car. Then, you’ll know exactly how much you need to pay to your lender to break even.
With this option, it’s helpful if you can send the required payment to eliminate the negative equity to your current lender. By doing so, you eliminate some of the hoops you may otherwise have to jump through to complete the trade-in process. Just make sure any offer made by the dealer is good long enough for the payment to fully process. That way, you don’t risk the vehicle getting reassessed by the dealership and ending up with a lower offer.
Delay Trading the Car In
If the financial drawbacks of trading in a car with negative equity are too much to bear, then waiting until you achieve positive equity could be your best choice. At that point, the trade-in could pay off the loan, allowing you to eradicate the connected debt. Then, you can move forward with a clean financial slate.
How you approach this can vary. Continuing to make regular payments can allow you to cross the tipping point, but this is the slower of the two options. Alternatively, you can make extra principal payments to reduce the loan balance faster. Just make sure that your loan doesn’t come with a prepayment penalty if you go that route, as that may offset any of the financial gains related to tackling the balance faster.
An Alternative to Trading In: Try a Private Sale
Usually, the trade-in value of a vehicle is less than its fair market value through a private sale. As a result, instead of trading in a car with negative equity, you could see if you can get a suitable price from a private buyer.
This approach is a bit tricky, as you’ll need to involve your lender in the process. Otherwise, you won’t have a way to satisfy the loan and transfer the title to the new owner, functionally making it impossible to complete the sale correctly. However, it’s potentially worth considering if the current loan balance aligns with what a private buyer may pay.
Do you have any tips that can help people who are trading in a car with negative equity? Have you ever faced a negative equity problem with a trade-in and want to tell others what it was like? Share your thoughts in the comments below.
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Tamila McDonald has worked as a Financial Advisor for the military for past 13 years. She has taught Personal Financial classes on every subject from credit, to life insurance, as well as all other aspects of financial management. Mrs. McDonald is a former AFCPE Accredited Financial Counselor and has helped her clients to meet their short-term and long-term financial goals.