Understanding Negative Equity as It Relates to Your Vehicle
Written by DriveAxis.ca August 17, 2022
Often referred to as being “upside down” on a car loan, the concept of negative equity is a unique problem for car owners who are still paying off their loans. When it does occur, it can drastically affect their ability to leverage the vehicle for sale or trade-in value, which is why it pays to understand how negative equity actually works.
By avoiding this situation, car owners and prospective new buyers will be in a much better position, and have more options available to them when it comes to purchasing another car. Read on to learn more about negative equity, who it affects, and whether you should be worried about it or not.
WHO IT AFFECTS
Negative equity primarily affects car owners who wish to sell their car later down the road, or use it as a trade-in to buy a new one. It tends not to affect people who wish to keep their cars for the long term, as they can simply pay off their remaining balance and be done with it. If you’re a car owner who likes to trade up every few years for the latest and greatest new vehicles, you may encounter a problem if negative equity creeps in.
HOW IT WORKS
Negative equity sets in primarily when people take out car loans, rather than buy the vehicle outright for one large sum. As those car payments continue over time, the amount owed will level off with the actual value of the car. Part of this is due to depreciation, which affects all vehicles to different degrees.
Some models hold their market value for years on end, while others can experience drastic drops even in the first year. When it comes time to sell a vehicle, owners may end up owing more than what the car is actually worth, which means they’ll be on the hook to close out the difference in value.
HOW NEGATIVE EQUITY OCCURS
There are many reasons why negative equity plagues car buyers, but they are largely avoidable. The issue with negative equity centers largely around buyers making ill-advised decisions when it comes to buying a car, or the loan repayment process. For instance, many buyers want the latest and most expensive gadgetry in a car model that is, for all intents and purposes, out of their price range. Nevertheless, they splurge, but then experience difficulty paying it off.
Lack of a down payment is another trap that many car buyers fall into. Sure, this step can be skipped in order to avoid coughing up a large amount of cash in the beginning, but you’ll pay for it as time goes on, especially if you’ve taken out an extraordinarily long loan.
That issue has become much more prevalent in the last two decades, according to all available data. Customers are taking out car loans that exceed 4-5 years, and many are now opting for repayment schedules as long as 8 years. The logic is simple, yet flawed - pay less per month on car payments, but at a far greater overall cost when the loan has finally been repaid in full.
Interest rates are another, even though many auto companies have become competitive on this issue. However, they’re only willing to go so far, and higher interest rates can be exacerbated by poor or nonexistent credit. If interest rates tack up even by a percentage point or two, it can lead to thousands of dollars lost over the course of just a few years, forcing negative equity to set in.
ESCAPING NEGATIVE EQUITY
Unfortunately, there are only a few methods of escaping the quagmire of negative equity, and they all involve tough decisions and some personal sacrifice. However, this short term pain will equate to greater long term gain, not to mention a healthier financial outlook for you and your family.
The most obvious first choice is to sell the car, swallow any immediate losses, and move on. This will help offset at least some of the negative equity, and you won’t be paying thousands upon thousands of dollars to wipe out the loan over the course of a few years. Choosing this method may leave you without a vehicle, but it can free you up to gather your finances, regroup, and choose a far more affordable pre-owned vehicle.
Another option is to speak to your lender and ask for options. It doesn’t always work, but the lender may suggest that you refinance the loan through your bank, or another source offering a lower interest rate. Often, people take out consolidation loans to wipe out several debts simultaneously, but it’s your choice whether you wish to take this route, or refinance a dedicated car loan. Bear in mind that this usually requires excellent credit, especially if you’re trying to secure a lower interest rate. Otherwise, you may fall into the same negative equity trap as before.
Negative equity isn’t the end of the world - it’s simply a temporary challenge that can be dealt with in order to set you up for a brighter future. Remaining stuck in the negative equity trap is unwise, and it pays to know when to cut your losses and move on. At DriveAxis.ca, we offer a myriad of high-quality pre-owned vehicles, many only a few years old, which offer the same equivalent comforts, styling and performance as the newest models on the block. If you sell your car to escape negative equity, you may be better-suited to shop with us for a car that meets your needs and desires.
Contact us today so that we can learn more about your situation, and whether negative equity is affecting you. If so, we might be able to help you escape the trap, and get back to living a stress-free life.