When you’re locked into a car loan, you never want to end up in a position when you’re in what’s known as negative equity. Negative equity on a car loan means that the value of the vehicle you’re paying is less than the amount you owe on the car. For example, if the car you own has a value of $20,000 and you owe $26,000 on the loan, you would have negative equity of $6,000. Another common term used instead of negative equity is being in an “upside-down” loan. In this article, we’ll tell you what you need to know about negative equity and how to get yourself out of an upside-down loan.
Why Negative Equity Happens
Because buying a car is such a large investment, most Canadians are forced to pay the car in increments over a few years. Because of the rate of depreciation, especially in new vehicles, it’s not uncommon for car owners to end up in negative equity. It is important to know that if you’re planning on keeping the vehicle long-term, being in a negative equity loan is not so bad. As you make payments on your loan, over the years the amount you owe will eventually be even with the market value of that vehicle. The main problem with being in an upside-down car loan is if you’re hoping to sell or trade the vehicle. If you end up selling the car for less money than what you owe, you’ll need to pay the difference to close out the loan.
4 Reasons People Get in Upside Down Car Loans
1. Buying a car above your budget. It’s not uncommon for car buyers to get over-excited at the dealership and agree to buy a car that exceeds their price range. This is especially true for first-time car buyers who tend to opt for all the small upgrades that add up quickly. Most experts advise car buyers to buy a car that’s payments don’t exceed 10% of your paycheque.
2. You skipped a down payment. We know how tempting a 0 down car loan sounds, but getting a 0 down car loan increases your chances of ending up in a negative equity loan. The more money you can put as a down payment, the less likely you’re to end up in an upside-down loan.
3. Having a high interest rate and a long-term loan. While extending your loan term to make your monthly payments smaller is tempting, it will ultimately have you paying more in interest. You’ll also end up paying more in interest if you have bad credit. Both of these factors can increase the odds of you being caught in an upside-down loan.
4. Managing two car loans simultaneously. Adding an additional car loan to your current one may seem like a good idea but it’s a huge reason Canadian’s get into negative equity. Many Canadian’s struggle to manage both car loans end up even further in debt. If you are considering managing two loans, it’s important to do a thorough audit of your finances to ensure you can afford to pay off both loans simultaneously.
4 Ways to Get Out of Negative Equity
1. Talk to your lender. The first thing you should do about getting out of negative equity is talk to your lender. You’re probably not in a position to pay out the loan in one lump sum, so maybe the lender has other options for people in your situation. Maybe the lender is willing to set up extra monthly payments so you’re able to pay off the loan quicker. Anytime you’re able to put additional money towards the loan you should. Being able to keep the vehicle while managing debt will go a long way as eventually, you’ll be able to sell that vehicle and get some money for it.
2. Refinance your loan. If your lender isn’t able to help you out in any way, the next option would be to try and refinance your car loan. If you have a good credit history, you may be able to refinance the loan at a better interest rate. It is important however to remember that if you refinance your loan for a longer term you’ll end up paying more in interest.
3. Cut spending, find extra income. This one may seem obvious, but it needs to be said. If you’re facing financial difficulties, you need to do an audit of your spending. Cut any costs that aren’t absolutely necessary and put that money towards your debt. If you’re able to pick up extra hours at work or start a side gig to make some extra money, you should.
3. Consider getting rid of the car. If you’ve tried all three of the tips above and you’re still going deeper and deeper into debt, you need to consider getting rid of the car and cutting your losses. You should try and sell it for as much money as you can so the outstanding balance you have to pay at the end is as low as possible. It’s recommended that you do anything and everything to increase the value of the car. Little things like cleaning the car and fixing any minor mechanical issues is a great way to do this.
How to Avoid Getting in a Negative Equity Car Loan
The best way to avoid getting in a negative equity car loan and putting yourself through financial stress is to do research before you sign a loan agreement. You should never agree to a loan if you’re not confident you’ll be able to manage your payments. Fill out our application today and we’ll get you pre-approved for a great car that you can afford!