Four Tips on How to Deal with Negative Equity
January 29, 2019 | By Mason Roberts
Let us travel to the upside-down, where the things you own are not worth what you paid for them. Nightmarish, right? You know what’s scarier? You might not know that you’re already there. So, let’s begin by explaining what being upside-down, also known as negative equity, means, so we can discuss how to handle it (and how not to handle it).
What Is Negative Equity?
Negative equity is the amount you owe on a loan that is no longer attached to the worth of your purchase. Once you buy a car and drive off the lot, the value of the car will depreciate almost immediately, and that loss will only increase in the years that follow.
Some cars are better than others when it comes to retaining their value, depending on the make, model, and reviews; but there will still always be a gap between the initial retail value and its value over time.
When you take out a loan, you are taking it out at the retail price, which means that any depreciation in your car’s value equates to you owing more on your car than what it’s worth—that is negative equity.
How Did I Get Here?
There are a couple of ways that you can accrue negative equity. One of the easiest ways to find yourself in the upside-down is by buying a car that was way above your budget, or by not putting down a large enough down payment. If your loan has high interest, too long a term, or a combination of these two, then you could also wind up owing more than necessary.
One of the worst paths to negative equity is by rolling over from a previous loan into a new one when purchasing a new car. First off, this could mean bad news for your credit score. And second, you will likely be in even more debt than you were in already.
How Much Negative Equity Do I Have?
Now that we know what negative equity is and how we got saddled with it, let’s calculate just how deep in the pit we are. Simply take what you currently owe on your car (aka your current loan amount) and subtract your current car value. You can go to sites like Car Gurus to estimate your car’s value, both as a private seller and through trade-in.
Before moving on, let’s create an example: say you still owe $8,000 on your car, but online you’ve found that the value of your car is only $6,000. That means that you have $2,000 of negative equity, which means you actually lose money if you attempt to sell your car with that existing gap in its value.
How to Deal with Negative Equity
So, you realize that you’ve fallen down the rabbit hole of loans and debts and negative equity(—oh my!), and you’ve done the math. But what are you going to do about it? Well, let’s list some of the options you should consider.
1. Bite the Bullet and Pay It Off
The most straight-forward and “easy” way to deal with negative equity is to just pay it off. Stick with your current car and drive it for what it’s worth, even if there are other cars with features you prefer. Once you get to the point where you break even or owe the same amount your car is worth you won’t owe anything extra that you won’t make off your old car itself. Only then should you consider selling it or trading it in.
2. Refinance Your Loan
Another option is to refinance your loan in order to owe less on it. What this means is finding another loan with better terms (smaller interest rate, shorter pay period, etc.), and paying off your old loan with the new one. But it can be difficult to find a lender that will allow for a new loan with negative equity. Your best bet would be to refinance with a bank you have a good credit history with here in Alabama, a credit union, or a lender who specializes in bad credit.
One of the types of loans that might best help you pay off negative equity is a payday loan. You can take out the amount of your negative equity in the form of a payday loan to break even with your old loan; this could allow you to sell your car sooner if that is your goal. With the short-term period of a payday loan, your interest won’t be through the roof as long as you pay it back on time!
3. Rebates, Rebates, Rebates
If you’re desperate to replace your old car, then look into rebates on new cars to eliminate your negative equity. Some companies offer “conquest” rebates, meaning that a competing car company will offer incentives if you purchase from them rather than your current one. Let’s provide another example: you owe $10,000 on your loan for a car that is worth $8,000, and you have found a new car that will cost $20,000 with a $3,000 rebate.
If you trade-in your old car, the dealer will pay off your $10,000 loan and add on your $2,000 of negative equity to your cost, making the total cost of your new car $19,000. That leaves you with $1,000 in positive equity! But it’s important to note that depreciation will once again catch up with you if you don’t pay off your loan as quickly as possible.
4. Be Prepared: Gap Insurance
When you purchase a new car, you have the ability to purchase gap insurance (guaranteed asset protection), which covers the difference between the loan balance and the market value of a vehicle. The only times this insurance will not cover that difference is if you default on a loan or have had your car repossessed.
While this option is preventative rather than curative, it’s another factor to carefully weigh in the decision-making process. You may still be able to acquire it later down the line of owning your car, but it will be with some difficulty, so it’s something to consider sooner rather than later.
What Not to Do
As with anything else involving loans and money and cars, you do need to be watchful of how you’re attempting to manage your problems. Although there are others to consider and research, we’ll address two of the biggest caution signs when it comes to dealing with negative equity.
Don’t Sell to a Dealer
While you can trade-in your car in order to pay off some of your loan, there is one tiny problem associated with it—more than likely, the dealership will underpay you what you could otherwise make by selling the car yourself.
It will definitely be easier to sell your old car the mainstream way, so if that’s more important to you that making the money back, then that may be the path for you. But if you want to make as much money as possible in this transaction, do research and advertise your car yourself, and sell it that way.
The Quicksand of Credit Cards
Another option while refinancing is to do so via a credit card. When you open a new credit card, you will usually be given an interest-free period of time, anywhere from six months to a year.
You can take advantage of this time period by paying off your old loan with your new credit card while avoiding any interest for that set amount of time. This is actually something you can do to your benefit, but only if you can pay off the debt in that time period because if you do not, the interest will probably catch back up with you and you will accrue more negative equity while potentially damaging your credit.
One more bump on this road is that, depending on the credit card, you might not be able to proceed with zero interest since your old loan would be a cash advance rather than a purchase. It’s vital to do research prior to making any decisions, as it is before you commit to any of these options.