What Is Negative Equity On a Car Loan?

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negative equity on car

Negative equity on a car loan is what is what happens when the value of a car loan is less than the outstanding balance of the car loan. If your car loan has an outstanding balance of $10,000 and the current market value of your car is $8,000, then that would mean you have negative equity on your car loan. Negative equity on a car loan essentially means that you are scheduled to pay more on a car loan than the car is worth.

What is Negative Equity on a Car Loan?

Having negative equity on a car loan is also known as “being underwater.” Cars tend to lose value over time, so if the depreciation rate of the car moves faster than the rate at which the loan balance is being paid, it will result in negative equity.

Does insurance cover negative equity?

No, insurance does not cover negative equity on a car loan. In the event that your car is totaled, insurance will cover the value of the car based on the insurance company’s estimate. If that estimate is less than the outstanding balance on the car, you will be responsible for the difference. 

You will have an option to add gap insurance through either your car insurance company or the car dealer. Gap insurance helps you pay the differences between the depreciated value of the car and what you still owe. Learn more about car insurance here.

How much negative equity will a bank finance?

Banks have different rules on how much negative equity they will let you roll into a new loan. Typically, the industry range is between 125% and 130% of the new vehicle’s retail value. 

Can you roll negative equity into a lease?

Negative equity can be rolled into a lease. The negative equity will be added to the monthly payments of the lease, and the negative equity on the loan will be paid over the duration of the lease. It isn’t the most ideal way of dealing with negative equity, but it is an option if you owe more on the auto loan than the car is worth.

Do dealerships pay off negative equity?

Dealerships may tell you that they will pay off your negative equity, but it is unlikely. Typically, dealerships will add the value of your negative equity onto your new loan. 

This means that if you owe $5,000 but your car is worth $2,000, then the difference of $3,000 will be added to your new loan total. Check out this article if you want to learn more about how to trade in and refinancing vehicles works.

Going in with the right tools will help you talk the dealership into a deal that works in your favor. 

Can negative equity hurt my credit?

Negative equity will not directly hurt your credit but it might influence your auto loan rate on a new car. A bank may look at the fact that you’re rolling in negative equity, which could result in a higher interest rate over the life of the loan. 

Example of negative car equity

Imagine you took out a car loan years ago on a brand new vehicle for $20,000. You’ve made payments on the vehicle over the life of the loan, and now you want to upgrade to a new model-year vehicle but you still have an outstanding balance on your existing auto loan. 

You have an outstanding balance of $12,000 and the dealer says that they will purchase your old car from you, but Kelley Blue Book (KBB) gives your car a market value of $10,000. This is an example of negative equity. You still have the option of purchasing the new car, but you will have to make up the difference in the amount owed to the bank. 

You can decide to pay off the difference in cash or roll the negative equity into the new car loan. If the new car is $25,000 and you decide to roll the $2,000 into the new car loan, you would essentially take out a $27,000 auto loan for the purchase of the $25,000 vehicle. 

Reasons you might have negative equity on your car

Negative equity on auto loans is much more common than you may think. Below are several reasons that consumers may find themselves with negative equity on their auto loans.

Loan term is too long

Your loan term on your auto loan is long, putting you underwater on your car loan over time. Many banks now offer loan terms up to 84 months, and if you elect to take out a loan with a lengthier term, then you run the risk of paying off the loan at a much slower rate than the depreciation of the vehicle. While a longer term may be appealing because of the lower monthly payments, it will likely cost you more over time. 

Your car is in poor shape

Your car is not in the best condition to get resold. If your car has sustained damage—whether minor or major—it devalues the car. When you receive an assessment on the value of your car, it means the buyer is looking for a car that they can sell to another buyer later on down the line. 

The more repairs a buyer will have to make on your vehicle, the less money they are willing to offer you for it. Scratches, dents, tears in upholstery, and broken components can reduce the value of your vehicle, putting you in a position where you have negative equity.

You placed little to no down payment on the initial car loan

If you placed no down payment or a small down payment on the car at purchase, you run the risk of having negative equity on the vehicle. A down payment of 20% is typically suggested because it generally puts you in a position of having positive equity on the vehicle. A smaller down payment will result in you falling behind on equity for your vehicle, which can leave you underwater on the auto loan shortly after purchasing.

4 ways to reduce negative equity

1. Keep your car in great condition 

Cars that are in good to excellent condition tend to have higher market value. In order to get a higher offer from the bank on your vehicle, it is important to keep up with maintenance and the cleanliness of your car. This will maximize the value of your car and lessen the chance of you having negative equity on your vehicle. 

2. Large down payment

Some banks will allow you to take out an auto loan with a small down payment. Aim for a twenty-percent down payment. This will give you equity on the car, which can be used to counteract the fast rate of depreciation that most vehicles experience.

3. Make additional payments towards the principal balance

If making a down payment of twenty percent isn’t an option, look into paying extra towards the principal each month. This will shorten the term of your loan, which will save you from spending a lot on interest while also earning more equity on the vehicle faster.

4. Sign up for MoneyLion’s Credit Builder Plus Loan

Use the Credit Builder Plus Loan to pay the difference in negative equity on your auto loan. The loan covers up to $1,000 with no hard credit checks and you’ll build credit history with each on-time payment. 

Improved credit score means better loan rates

Having negative equity on an auto loan is never a fun experience, but there are ways to make sure that it doesn’t happen again. The Credit Builder Plus Program is perfect for helping you build your credit and secure a lower interest rate on your next car loan. This will save you money over the life of your loan, ensuring that you pay more towards the principal of your loan instead of on the interest on the loan.

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