If you have an auto loan on a car and you owe more on the loan than the car’s worth, you have negative equity. You can trade in a car with negative equity, but you’ll need to pay off the negative equity or roll it into your new car loan. If your car has negative equity, it’s usually best to wait to trade it in until you’ve addressed it.
Written by Attorney Eric Hansen.
Updated November 28, 2021
Having a trade-in vehicle, along with a down payment, can make financing a new car a little easier, more convenient, and more affordable. But what if your car is upside down? No, there hasn’t been a terrible accident. An upside-down vehicle is a financed car that has negative equity. Negative equity means that the car itself is worth less than the remaining loan balance you owe.
You might be asking, can you trade in a car with negative equity? The short answer is yes, but the longer answer is that you may want to wait and explore other options. This article will discuss how negative equity happens and what you’ll want to consider if you’re thinking of trading in a vehicle that has negative equity.
It's Not Unusual To Be Upside Down on a Car Loan
You’ve probably heard the old adage that a car loses a lot of its value the moment you drive it off the car dealership lot. Well, it’s true. A new car can lose 20% or more of its value within the first year that you own it, starting when you drive it off the dealer’s lot. That’s why it’s not uncommon to be upside on your car loan.
Remember, being upside down means you owe more on the car than the car is worth. It’s also called having negative equity. This can be an issue if you’re looking to trade in your vehicle or sell it to a private party.
How To Calculate Equity
When you’re in the market to buy a new or used car and you’re planning on trading in your current vehicle, you should make some calculations to see whether you have positive or negative equity. Positive equity is when the value of the car exceeds the amount you still owe on your auto loan. This puts you in the best position to sell your car or trade in your old car to a dealership.
To see whether you have positive or negative equity, you’ll need to know the value of your vehicle and the amount you owe on your auto loan. The difference between the two figures is the amount of equity you have in your vehicle.
Say, for example, that you have a car that’s worth $5,000, and you owe $2,500 on it. In that example, you’d have positive equity in the amount of $2,500 ($5,000 - $2,500 = $2,500). But if you have a car that’s valued at $5,000 and you owe $6,500 on it, you’d have negative equity in the amount of $1,500 ($5,000 - $6,500 = -$1,500). That’s not a good spot to be in. It will be very difficult to trade in your car, as it currently is upside down.
How do you know the value of your car? You can find it by searching Kelley Blue Book, Edmunds, or similar sites. These websites give you the estimated values of your cars by taking into account the make, model, year, and condition of the vehicle. They also sort the listings into trade-in value, fair market value to a private party, and fair market value at a dealership.
To find out how much you owe on your car loan, you should contact your lender or loan servicer. You can also look at your auto loan account online or through your lender’s app.
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To Trade or Not To Trade?
You really have two choices when it comes to trading in a car with negative equity.
The first option is to wait until your loan is no longer upside down. This is usually the better choice for a few reasons. If you’re able to wait on the trade-in, you may be able to get rid of the negative equity. One way to do this is by making additional principal-only payments alongside your regular monthly payments. This will help you pay down your loan faster. You’ll want to be careful using this strategy if your loan includes a prepayment penalty. Check your loan terms to see if there is a prepayment penalty.
The other option is to go ahead and trade in the vehicle and deal with the negative equity. While you’ll have to take care of the negative equity one way or another, doing it while trading in your car can be a lot more difficult. You may need to pay the difference out of pocket or roll it into your new car loan. Either can be quite expensive.
Trading In the Vehicle and Dealing With the Negative Equity
There are a few different ways to pay off the negative equity if you decide to trade in a vehicle that’s upside down. Again, strongly consider waiting if you can. But if you must trade in the car, consider these options.
Pay off the negative equity upfront.
If you have the money to address the difference between the loan amount and the car’s value, you can pay it out of your own pocket. Say you still owe $10,000 on your vehicle and the dealer offers you $8,000 for the trade-in. This means you have $2,000 in negative equity. If you have $2,000 on hand, you can pay it to your auto lender to address the payoff amount. This option is clean, but many people don’t have that kind of money lying around.
Roll over the negative equity into your new car loan.
Instead of paying off the $2,000 difference, you could consider rolling it over into your new car loan. The car dealership will add the $2,000 to your new auto loan. This might sound appealing and it’s certainly easier than coming up with a large chunk of change, but it means that you’re borrowing more on your new car loan. It could also make you upside down on your new car loan pretty quickly.
You’ll also need to consider the consequences of having a larger loan amount. That usually means that you’ll be making higher monthly payments for a longer period of time with perhaps a higher interest rate. Be certain that your current loan is entirely paid off and that you’re released from financial and legal responsibility on the old loan. Moving forward, you don’t want to have to make car payments each month for two loans.
Consider a less expensive car.
If you decide to trade in your upside-down car, consider buying a cheaper car. If you get a used vehicle, instead of a new car, this can help minimize the initial drop in value as you drive off the lot. Getting a less expensive car also means you’ll be financing less. This can make for a lower monthly payment and less expensive loan. It also means you’re less likely to wind up in another negative equity situation.
Consider a private party sale.
Selling your car to a private party is usually more profitable than trading it in to a car dealership. Most car dealers won’t give you more than the wholesale value for the car because they want to profit on the resale of the vehicle.
If the amount you owe on your car loan is more than the car’s worth, you’re upside down. Having negative equity is not uncommon. You’re not alone, but you’ll want to take it into consideration when you start to think about trading your car in or selling it. If you end up trading in your car, you’ll have to address the negative equity. You can do that by paying the amount upfront or rolling it into your new car loan financing. Rolling it into the new loan puts you at risk of being upside down again, though. The better option is to wait to trade in your car until you’re no longer upside down.