Do You Owe More on Your Car than it's Worth?
Negative equity. Upside down. Under water. All have a similar meaning—you owe more on your car than it’s worth. This is the last situation you want to be in after buying a vehicle. There are some common reasons you may end up upside down on your loan. Doing your research ahead of time can help you avoid buying a car that’s not worth the payments!
The three reasons you may owe more than your car is worth:
- Debt from your trade—If you decide you want to trade in a vehicle that you are still paying on, the payment you receive for the car should cover its loan balance. If the trade doesn’t cover the loan balance, you can either pay the difference out of pocket or roll the remaining loan balance into your new vehicle loan. When you roll the additional amount into the new loan, it can create negative equity on the new car by jacking up the loan to more than the new car is worth.
- Additional expenses—When you purchase a car, whether through a dealer or private seller, you need to account for paying the taxes, title and registration fees, warranties, and/or extra protections. In most cases, these additional expenses are included in the loan, which can contribute to negative equity, bringing your loan balance to more than the vehicle is worth.
- An oversized price tag—You may find a car that costs more than it is worth. If you aren’t able to negotiate the price lower, then you could begin your loan with negative equity.
Four ways to avoid ending up under water with your loan:
- Before you start, learn the value of the car you’re buying or trading. There are many websites that can help you value a vehicle; NADA, Edmunds, and Kelly Blue Book are three of the most popular. When valuing a vehicle, the type of value you’re looking at can make a difference – average trade in, clean retail, private sale, etc. – there will be different values depending on each situation. Be honest and realistic about the body condition of the vehicle and add in any options the vehicle has, as both play a role in determining the value.
- Don’t extend your car financing terms, because the longer the term is, the more of your payment goes to interest rather than principal. Paying aggressively, or taking the loan out for a shorter term, will help you pay the balance down faster. This will prevent you from ending up with more loan debt than the car is worth, which could lose more value than you pay down over the course of an extended term.
- Be mindful of your interest rate. The higher your interest rate is, the less you’re going to be paying on your loan balance each month. Oftentimes, your credit score impacts the interest rate that you’re approved for, so keeping your credit healthy will help get better interest rates (and save you money in the long run).
Note: If your credit score earns you an interest rate that is higher than you’d like, you can always look into refinancing the loan later.
- Make a down payment on the car. The more you put into a down payment, the better your equity position will be—this can be especially important when purchasing new vehicles, as they depreciate up to 20% in the first year.
If you find yourself in a position where owing more than your car is worth is unavoidable, don’t fear! GAP is here! GAP, or Guaranteed Asset Protection, protects you if your car is in an accident, or stolen, and considered a total loss by your insurance company. If your car insurance company does not pay the full loan balance, GAP pays the remaining balance, so you don’t have to pay it out of pocket. There are a number of companies that offer GAP, so comparing the cost of the protection with any additional benefits is worth your while. All GAP covers the unpaid balance of your loan, but some GAP companies also pay part or all of your insurance deductible, and may even give you money towards a replacement vehicle.
Being aware of how negative equity can happen and looking for ways to avoid it will allow for a much smoother vehicle buying process. You’re spending the money each month, so make sure you get the greatest bang for your buck!
Don't buy your next car without reading our Car Buying 101 guide to car shopping.
About Tessa Collette
Tessa Collette is a Senior Consumer Loan Advisor, and has worked for VSECU since 2011. Her position allows her to help our members navigate the lending world and decide which loan product is best for their goals. Creative lending, where she can lower monthly payments and save members money on interest, is her favorite part of her position.