How to Get Rid of Negative Equity on a Car

Negative equity in a car loan occurs when the outstanding loan balance exceeds the vehicle’s current market value. This situation is sometimes called being “upside down” or “underwater.” It often arises due to rapid depreciation, especially for new vehicles that lose a significant portion of their value soon after purchase. Long loan terms, which stretch out the repayment period, and low or no down payments also contribute to negative equity by keeping the financed amount high while the car’s value declines. This financial state can complicate future vehicle transactions, making it challenging to sell or trade in the car without incurring additional costs.

Paying Down Your Loan

Actively reducing your loan principal faster than the vehicle depreciates is a direct approach to addressing negative equity. One effective strategy involves making larger monthly payments than the required minimum. Even a small increase in your payment can significantly reduce the principal over time, thereby closing the gap between the loan balance and the car’s value.

Another method is to make extra principal-only payments whenever possible. Funds from sources like tax refunds, work bonuses, or unexpected windfalls can be directed specifically to the loan’s principal, accelerating the payoff process. Before implementing this, it is important to confirm with your lender that extra payments will be applied directly to the principal and not just counted as a prepayment of future interest.

Making bi-weekly payments can also be beneficial if structured correctly. Instead of 12 monthly payments, you make 26 half-payments annually, effectively adding one extra full payment each year. This accelerates principal reduction and can reduce the total interest paid over the loan term. Budgeting to free up these extra funds is a practical step.

Selling or Trading a Vehicle with Negative Equity

Disposing of a vehicle with negative equity requires careful planning, as the sale price will not cover the outstanding loan balance. Before attempting to sell or trade, it is essential to determine the exact payoff amount from your lender and obtain a realistic market value for your vehicle using reputable appraisal sources. This provides a clear understanding of the negative equity you need to address.

When selling privately, you must cover the shortfall between the sale price and the loan payoff amount. For example, if you sell the car for $15,000 but owe $20,000, you need to pay the lender the $5,000 difference out of pocket. This might involve using savings or securing a personal loan to clear the auto loan. Once the loan is fully paid, the lender will release the vehicle’s title, which you can then transfer to the buyer, completing the sale.

Trading in a vehicle with negative equity at a dealership involves different considerations. Dealerships often offer to “roll over” the negative equity into the financing for a new car. This means the deficit from your old loan is added to the principal of your new car loan, increasing the total amount financed and potentially extending the loan term. This practice can immediately put you in a negative equity position on your new vehicle and lead to higher interest costs. It is advisable to negotiate terms carefully when trading in a vehicle with negative equity, as this strategy can perpetuate the cycle of negative equity.

Refinancing Your Auto Loan

Refinancing an auto loan involves obtaining a new loan to pay off your existing one, potentially offering more favorable terms. This strategy can be effective in managing negative equity. The primary purpose of refinancing is to secure better loan conditions that facilitate faster principal reduction or make monthly payments more manageable.

One situation where refinancing can help is if your credit score has improved or if market interest rates have decreased. A lower interest rate on the new loan means more of your monthly payment goes towards the principal balance rather than interest, accelerating the path to positive equity.

While generally not ideal for negative equity, a slightly longer loan term might reduce your monthly payment, freeing up funds. These freed-up funds could then be used to make additional principal payments despite the extended term. However, this approach carries the risk of prolonging the negative equity situation if extra payments are not consistently made.

Eligibility for refinancing typically depends on factors like your creditworthiness, the age of your vehicle, and its mileage. Lenders evaluate these aspects to determine the risk associated with the new loan. The process generally involves gathering financial documents, submitting an application to a new lender, and if approved, the new loan pays off the old one.

Driving the Vehicle for a Longer Period

A long-term strategy to overcome negative equity is to keep the vehicle for an extended period. By continuing to make regular loan payments, the outstanding balance will eventually decrease below the vehicle’s depreciating market value. Over time, the loan balance will naturally decline, allowing equity to build.

This approach requires patience and a commitment to maintaining the vehicle. It assumes the car remains reliable and that its maintenance costs do not become prohibitive. The longer you own the vehicle and continue to make payments, the more equity you accumulate.