Simply put, an upside down car loan happens when you owe more on a vehicle than it’s worth. Cars depreciate a lot during the first three years of ownership. If you don’t make a fairly large down payment when you buy a new vehicle, it’s not unusual to owe more money than a car is worth for the first few years of ownership. After a few years of regular payments, you can usually get into positive territory again and your car is worth more than you owe on it.
Another way that you can get into an upside down car loan is taking out a very long term loan to keep the monthly payments as low as possible. Without a large down payment, this means that your car is depreciating much faster than you’re paying it off and your loan is upside down for much longer – five years or more isn’t uncommon.
Why is Negative Equity Bad?
It’s always a good idea to establish positive equity as soon as possible. Suppose you have a car accident or your car is stolen and it’s totalled and you have negative equity in it. Your insurance company could give you far less than what you actually owe on the car. You’re on the hook for the outstanding amount and you’ll have to continue to make payments on a car that you can’t even drive anymore.
If you decide to trade in your vehicle and the trade in value is $10,000 but you still owe $15,000, you either have to pay off the extra $5000 or roll it into the new car loan. That means a bigger car loan and higher monthly payments. If you keep trading a vehicle with negative equity in on another vehicle, the loan size snowballs and it becomes more difficult to eliminate your negative equity. If you have negative equity in a vehicle and you have to sell it because you can’t afford to make the payments, you can’t just use the money to pay for living expenses. In fact, you can end up with no car and a continuing monthly payment.
How to Avoid an Upside Down Car Loan
- Buy used and let someone else pay for the depreciation. Most of a vehicle’s depreciation occurs during the first three years of ownership. If you buy a used vehicle that’s three years old, the worst of the depreciation has already happened.
- Make as big a down payment as possible, even if that means holding off on buying a new vehicle for a couple of years and putting money away. A healthy down payment can offset depreciation and keep you in a positive equity position for the entire term of the loan.
- If you have negative equity in a vehicle, don’t trade it in on another vehicle until you have the extra money to pay off the negative equity, or continue to make payments until the the car is worth more than you owe on it.
- Avoid very long term loans. The longer the term of a car loan, the lower the monthly payments, but the longer your loan is upside down unless you make a big down payment. You owe more than your car is worth for much longer and you can end up owing thousands of dollars on a car that’s worth virtually nothing or doesn’t even run anymore.
- Save money until you can pay cash for a vehicle. It can be tough to save up enough money to pay cash for a new vehicle but with careful budgeting you may be able to save enough to pay cash for a good used vehicle with many years of life left in it.
- Don’t buy an expensive vehicle with frivolous accessories. Some people think that expensive options increase resale value. That’s sort of like installing a pool in your backyard. It’s expensive, some people don’t even want it, and few people are willing to pay extra for it when you sell. Expensive, luxury vehicles can depreciate tens of thousands of dollars in the blink of an eye.
If You Simply Must Have a New Car
If you have negative equity but you still want a new vehicle, consider a lease. If you trade in a vehicle for a lease, any negative equity will be tacked on to the lease so your monthly payments will be higher. However, at the end of the lease you can give back the car, your negative equity will be erased, and you can start fresh. You may also be able to roll the balance owed on a vehicle into a new car loan but again, your monthly payments will be higher. If you shop around carefully for incentives like cash rebates, you may be able to offset your negative equity.
If you’re in need of a car loan but you’re concerned that your credit history is holding you back, contact Auto Loan Kelowna. It takes just a couple of minutes to apply, and you could be driving your new vehicle today!