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Trading in a Car With Negative Equity - Complete Guide

By Jason Collins | November 24, 2021

According to the credit tracker Experian, the average length of a new-vehicle loan has increased to almost a six-year term. The extended loan term has seen an increase in the number of car buyers who trade in a vehicle on which they owe more money than it is actually worth. This is known as negative equity or being "underwater" or "upside down."

If you have a vehicle with negative equity, then trading in that car becomes a financial challenge, but not impossible. Let's take a look at negative equity in more detail and the process behind a negative equity car trade-in.

What is Negative Equity on a Car?

Equity is the difference between your vehicle's actual cash value or ACV and the total amount you owe on your auto loan. Negative equity is when you owe more on your car's loan than what it is worth.

Most of the time, negative equity won't affect you until it comes time to sell or trade-in your car. The more negative equity your vehicle has, the more expensive exiting your auto loan is when you want to trade in your current vehicle for a new car.

When trading in a vehicle with negative equity, you will need to pay the difference between the trade-in value of the car and your auto loan balance. This needs to happen to transfer the car's title to the new owner.

You can pay the difference with a cash payment or another loan, which means you roll over what you owe on your current loan into a new auto loan.

Why You Have a Negative Equity Car Loan:

You can get yourself upside down on your auto loan in several ways.

You didn't put down a large enough down payment:
New cars have a high depreciation rate in the first year on the road. So, if you make little to no down payment on a new car, you can find yourself underwater on your loan quickly, even as early as the first year of your loan.

You put a lot of wear and tear on your car:
If you subject your car to a lot of driving or your car's condition deteriorates quickly, then its value may drop lower than other cars of the same make, model, and model year. This is due to depreciation.

You have a long car-loan term:
More than 40% of car loans originating from 2017 have loan terms longer than six years, according to the Consumer Financial Protection Bureau. You may have longer to pay off your loan, but stretching out the term can increase your risk for
negative equity.

Do You Have a Negative Equity Car?

If you want to trade in your used car, financed with an auto loan, you need to find out if your car has negative equity.

To calculate whether you are upside down on your car loan and how much negative equity you have, you need two important pieces of information:

  • The estimated value of your car
  • The remaining balance on your auto loan
  • The Estimated Value of Your Car

To help you estimate the value of your car, you can use third-party automotive websites as a helpful reference. Websites like Kelley Blue Book and Edmunds offer tools to help you estimate your vehicle's trade-in value.

You will need to input the following information for your car:

  • The make and model
  • The year
  • The number of miles clocked on the odometer
  • The Remaining Balance on Your Auto Loan

Borrowers can find how much they owe on their car loan by contacting their lender. This is the easiest way to find out what your remaining balance is. You can either call your lender or log into your account on your lender's website to view your vehicle's payoff amount.

Remember, your loan payoff amount can be different from your current loan balance. This is because the loan payoff amount includes any interest you accrued until the day you settle the loan, as well as any unpaid fees.

Calculating the Negative Equity

Once you know the estimated value of your car and the remaining balance on your car loan, you can calculate whether your current vehicle has negative equity.

Subtract the estimated value of your vehicle from the payoff amount on your loan.

If your car is worth more than what you owe on your loan, you have positive equity in your vehicle; this is the ideal situation when you want to trade in your old car for your next car on your wanted list.

If the amount owed on your car loan is higher than the estimated value of your car, then you definitely have a negative equity car loan.

If you have a negative equity car, your next steps will depend on how far underwater you are. If you are in a slightly negative position, it will be easier to trade in your car. However, if you have high negative equity, then the car buying process may be a challenge if you plan to trade your negative equity car in for your next car.

Negative Equity Car Trade-In

When trading in a negative equity car, you have two main options available:

  • Delay the trade-in until you are no longer upside down on your loan
  • Continue with the trade-in and pay off the negative equity.

Delay the Trade-In and Overcome the High Negative Equity

Delaying your trade-in until you are no longer upside down on your auto loan is the better option financially. This option works best if you can wait before getting your new car and buy yourself some time to turn the high equity around.

If you have time on your side, you can try the following:

Make larger monthly payments or extra payments towards the loan amount. You can make a serious dent in your negative equity situation by making larger monthly payments towards the loan to bring the loan amount down. You can also contribute extra payments towards the auto loan over and above your monthly payments. By delaying your trade-in, you have more time to reduce your car's negative equity, and you won't have to use as many out-of-pocket funds to help purchase your next car.

Some lenders charge borrowers a prepayment penalty if they pay their loans off before the loan term on their contract. Make sure the terms on your contract do not include this penalty.

Make a lump sum car payment for the difference. If you have the funds available, you can pay your lender a large lump sum payment for the amount of the negative equity. Once the negative equity is cleared, you will be in a stronger position to trade in your car.

Roll Over the Negative Equity

If you do not have time to wait for your current vehicle to reach an equity position, trading it in is still possible.

It's common for lenders and credit unions to allow borrowers to roll over their vehicle's negative equity in their new car loan. Basically, you are refinancing your negative equity through the new loan. However, this isn't an option offered by all lenders, and you will need to shop around for the right deal for your situation. You will also need to ensure you don't have bad credit before applying for the roll-over into your new loan, as you may be declined.

Often, car dealers will suggest rolling over the negative equity into your loan for your next car. It may be convenient for car dealerships to conclude their sale if you refinance your negative equity, but it is unwise for you as the car buyer. The roll-over option will immediately make you upside-down in your new car loan. In the long term, you create a larger loan amount, and you will pay more interest. You may receive a higher interest rate since you are a higher risk to lenders when rolling over your negative equity.

However, the risk may be worth it if you are struggling to make car payments and need to trade it in for a cheaper car. In this case, the best option is if your new loan has a lower interest rate, which is often achieved if you have a good credit score. If you need to downsize by purchasing a cheaper car, your payments may become more manageable, even if you bring your negative equity into the new car loan.