How to trade in a car with negative equity
When you walked into the dealership, you fell in love with your current car. It was so shiny and new.
Five years later, you’re no longer in love with your worn-tire gas guzzler and wondering if you could just trade it in for the next beauty.
Then you remember that you still owe your current pile of junk. And that to get monthly payments low enough to afford your current car, you skipped the six-year (or seven-year…or eight-year) term offered by the dealership.
You’re not the first person to fall for a set of out-of-reach wheels, especially as auto loans have continued to climb. The average loan amount for a new vehicle was $37,746 in the third quarter of 2021, according to Experian.
To offset the cost, more and more people are extending the term of their loan to lower their monthly payments. In fact, the 72-month car loan is now the most popular car loan option, with the 84-month car loan coming second, according to Edmunds. For the non-mathletes among us, it’s a six- or seven-year car loan.
Then consider that new cars lose 20% in value the moment you take them out of the lot, and that depreciation is more than a third of the average annual cost to own a car, according to AAA.
All of these factors combine to create the scenario where you owe more than your car is worth, which means you have negative equity in your loan – i.e. your car loan is upside down or under water.
Unfortunately, there’s no point looking in the rear view mirror at this point to figure out what you should have done with the loan of your old car, but you still have options to recover – it’s just a matter of making decisions. smart financials.
What to do if you have an upside down car loan
Before getting ahead, are you sure that your vehicle is worth less than what you owe? Let’s run the numbers.
How to Calculate Your Car’s Equity
Here’s how to calculate your vehicle’s equity:
Value of your vehicle – loan repayment amount = equity
You can find out how much your vehicle is worth by consulting the National Automobile Dealers Association Guide, Edmunds and Kelley Blue Book.
Each of the price guide websites can vary in estimating your car’s value, so check with all three and then use the average number for your vehicle’s value.
When determining how much you owe on the loan, use the loan repayment amount, not the principal, because the repayment amount can include things like fees and taxes that you still owe.
So if your car was worth $18,000 and your loan repayment was $15,000, you would have $3,000 in positive equity. Yay! If you want to trade in your car for a newer one, the dealer must apply that $3,000 to your down payment, reducing the overall amount you pay for your next car. Congratulation!
However, if your car was worth $18,000 and your loan repayment amount was $20,000, you would have $2,000 of negative equity – you owe more on your car than it is worth. Sorry.
But that’s why we’re here, so let’s take a look at your options and get you on the fast track to financial freedom.
How to trade in a car with negative equity
Stuck with an underwater car loan on a vehicle you need to unload? So let’s start with the worst idea and work our way up.
1. Carry over the amount you owe in a new car loan
If you’ve heard or seen dealership advertisements that promise to pay off your loan and get you into a new car, you might be thinking what a great idea that is. Good…
“It’s a terrible idea, but it’s an option, and a lot of people take it because it sounds easy, but it makes it worse,” said Todd Christensen, AFC and head of education at moneyfit.org. . “That makes it even harder to get out of debt.”
If you have an accident and the car is destroyed, the insurance company will pay the value of the car, not the amount you owe. Consider purchasing gap insurance to cover the difference.
According to the FTC, this whole promise to pay off your loan isn’t entirely accurate – the dealership will pay the bank to settle what you owe, but it will add that amount to your next loan or subtract it from your down payment.
And maybe they’ll add a fee, just for good measure.
And because the dealership had to fund the rest of your old loan plus the new because you couldn’t pay off the first — thus making the new loan more risky — you can also expect to pay a higher interest rate.
And adding your negative equity to your new loan amount likely puts you under water on the next car loan as soon as you sign the paperwork. So the vicious circle continues.
It all adds up to a bad idea.
But if that’s your only option, Chistensen suggested ways to minimize your next loan:
Switch to a less expensive car. If you’re currently paying for a half-ton pickup truck and can shift your loan to a midsize sedan, you might consider a smaller payment even after adding the underwater debt amount to the new loan. Avoid the premium package as well.
Ask for a shorter loan term. You’ll pay more per month, but if you take a five-year loan instead of taking the seven-year term, you’ll pay less interest in the long run and that helps reduce the chance that you’ll end up with another loan under -marine.
Look for cashback offers on the next car. If the repayment is large enough, you may be able to use it to pay off the negative equity in your old loan.
Get pre-approved for a loan. Shopping around for a pre-approved car loan for your new loan potentially helps you get a lower interest rate than a dealership would offer.
None of these options will absolutely keep you from starting underwater on your next car loan, but they can help reduce the time you’ll spend getting out of the hole.
2. Transfer your underwater car loan into a lease
Although leasing a car means you won’t own the vehicle, you can benefit from not having to continue paying off negative equity when you reach the end of the lease term.
“I rarely recommend leasing a vehicle, but it would often be a better idea than carrying your negative equity over to your next car loan,” Christensen said. “It increases their lease payments – that’s obviously a negative – but on the plus side they don’t have to worry about being underwater with a lease.”
3. Repay negative equity
Paying off the negative equity in the car as quickly as possible is better than the first two options because you’re actually helping yourself out of debt instead of just passing it on to your next payment.
If you have the money to pay off the negative equity, that’s an obvious choice, but you could also consider taking a side job or temporarily cutting back on personal expenses – you could even get paid to drive your car and leave the old heap of bric-a-brac win his dungeon.
Use every extra dollar you earn to pay off debt and get your auto loan back out of the water before you trade it in for the next vehicle.
4. Sell the car yourself
You know how number 1 on our list was the easiest (and least financially savvy) option? Here’s the hardest way to get out of your underwater car loan, but it could also be one of the most lucrative: sell the car yourself.
The payoff for the extra effort might be worth your time rather than exchanging it at the dealership. Christensen noted that the difference between selling on your own instead of settling for the trade-in offer could be the difference of a few thousand dollars, depending on the car.
If you know someone in your network of family, friends, and colleagues who would like to buy the car, that makes the selling process a little easier. Otherwise, you’ll have to advertise the car and sort out potential buyers who will likely want to schedule a test drive. And you may have to go to the bank to transfer the title since you still owe the car.
5. Hang on to your car
This, in the end, is the best option, financially speaking. If you can keep your car not just until you get out of the water, but for years after the loan is paid off, you can put your old car payments in a separate account and build a down payment – or maybe be the full payment – for your next car.
Yes, that’s not always an option – especially if your current car is in need of expensive repairs – but you should at least weigh the cost of repairs against the long-term financial benefits of keeping your old wheels.
These might not be the new wheels you dreamed of, but they put you in control of your financial future.
Tiffany Wendeln Connors is associate editor of The Penny Hoarder. Lily his bio and other work herethen find her on Twitter @TiffanyWendeln.
This was originally published on The Penny Hoarder, which helps millions of readers around the world earn and save money by sharing unique job opportunities, personal stories, giveaways and more. The Inc. 5000 ranked The Penny Hoarder as the fastest growing private media company in the United States in 2017.