What Happens When You Owe More Than Your Car Is Worth?
If you owe more on your auto loan than your vehicle is currently worth, you have what is commonly called negative equity. You may also hear this situation described as being "upside down" on your car loan.
Negative equity is important to understand before trading in your vehicle or purchasing another one because it can affect the amount you need to finance.
How Negative Equity Works
The basic calculation is straightforward:
Negative Equity = Loan Payoff − Vehicle Value
For example, suppose your vehicle has an estimated trade-in value of $20,000 and your current loan payoff is $25,000.
The difference is $5,000. You have approximately $5,000 of negative equity.
Why Can You Owe More Than the Vehicle Is Worth?
Vehicles generally depreciate over time. Your loan balance, however, decreases according to the repayment schedule.
Negative equity can develop when the vehicle loses value faster than the loan balance declines.
Several factors can increase the possibility of negative equity, including:
- A small or zero down payment
- A long loan term
- A high purchase price
- Rolling previous negative equity into a new loan
- Rapid vehicle depreciation
What Happens When You Trade In the Vehicle?
If you trade in a vehicle with negative equity, the difference between the loan payoff and trade-in value still needs to be addressed.
Depending on the transaction and lender requirements, you may be able to pay the difference in cash or include it in the financing for the replacement vehicle.
Example of Rolling Negative Equity Into a New Loan
Suppose your current vehicle is worth $18,000 and you owe $23,000.
You have approximately $5,000 of negative equity.
If you purchase a $30,000 vehicle and finance the negative equity, the starting balance could be substantially higher than the $30,000 vehicle price once taxes and fees are included.
This can make the new loan more expensive.
Can You Avoid Rolling Negative Equity Into a New Loan?
One option is to wait and continue making payments on the existing vehicle until the loan balance becomes closer to its market value.
Another option is to make an additional payment toward the existing loan, if doing so fits your financial situation.
You can also consider purchasing a less expensive replacement vehicle if you need to replace the current vehicle sooner.
How a Down Payment Can Help
A down payment on the next vehicle can reduce the amount financed. However, a down payment should be considered alongside your overall cash reserves and budget.
Calculate Your Trade-In Equity
Our car loan calculator allows you to enter your trade-in value and current payoff amount. The calculator then uses the resulting trade-in equity when estimating your next auto loan.
Final Thoughts
Negative equity does not necessarily prevent you from purchasing another vehicle, but it is important to understand the additional amount being financed.
Before trading in an upside-down vehicle, compare the current loan payoff, realistic vehicle value and proposed new loan amount.