When purchasing a car, one of the options available to buyers is rolling over negative equity from an old loan into a new car loan. While this may seem like a convenient solution, especially if you’re upside down on your current loan, it can lead to serious financial consequences. In this blog post, we’ll discuss the dangers of rolling over negative equity in a car loan, how it works, and why you should avoid it if possible.
What is Negative Equity?
Negative equity, often referred to as being “upside down” or “underwater,” occurs when you owe more on your car loan than the car is worth. This situation typically arises if your car depreciates in value faster than you’re able to pay down the loan. For example, if you bought a car for $20,000 and after a few years it’s worth only $10,000, but you still owe $12,000, you have $2,000 in negative equity.
How Rolling Over Negative Equity Works
Rolling over negative equity means taking the amount you owe on your current loan and adding it to the loan for your next car purchase. This is common in situations where you want to trade in your car but still owe more than the car is worth. Instead of paying off the remaining balance, you roll it into your new loan. For instance, if you owe $5,000 on your old car, and you trade it in for a new one with a loan balance of $10,000, your new loan might end up being $15,000.
While this may seem like an easy way to get into a new car, it can quickly lead to financial difficulties.
The Dangers of Rolling Over Negative Equity
- Higher Loan Amounts and Payments
By rolling over negative equity, you’re increasing the amount you owe on your new car loan. This can result in higher monthly payments, making it harder to afford your car. Even if the new loan is for a car you can afford, adding the negative equity means you could end up paying far more than the car is actually worth.
- Example: If you’re financing a $10,000 car loan but add $5,000 in negative equity, your loan increases to $15,000. Your monthly payments will be based on that higher amount, and the interest you pay over the life of the loan will also be significantly more.
- Car Depreciates Faster Than Your Loan Balance
Cars depreciate quickly, especially in the first few years of ownership. If you roll over negative equity into your new loan, you may find yourself upside down again within a short time. This means your car could be worth less than the amount you owe, making it harder to sell or trade it in the future without taking a loss.
- Example: If you owe $15,000 on your car and it’s only worth $12,000, you’re already upside down by $3,000. As the car continues to depreciate, this gap could grow, leading to more negative equity.
- Increased Interest Payments
By rolling over negative equity, you’re also increasing the total amount you’ll pay in interest over the life of the loan. The more you borrow, the more interest you’ll accrue, especially if the loan term is long. This means you could end up paying significantly more than the car is actually worth, making your vehicle much more expensive in the long run.
- Example: If you borrow $15,000 at a 6% interest rate for five years, you’ll pay more in interest than if you only borrowed $10,000. Over the course of the loan, that extra $5,000 in negative equity could result in hundreds or even thousands of dollars in additional interest payments.
- Difficulty in Selling or Trading In the Car
One of the main risks of rolling over negative equity is that it can be difficult to sell or trade in the car. If the car’s value is less than what you owe, you won’t be able to use the trade-in value to pay off the loan. This could leave you stuck with a car you no longer want or need and could prevent you from upgrading to a newer vehicle without taking on even more debt.
- Risk of Repeating the Cycle
If you keep rolling over negative equity, you may find yourself caught in a cycle of debt. As you continue to roll over the balance from one loan to the next, the amount you owe continues to increase, and you may find it harder to escape the cycle. This could leave you perpetually upside down on your car loan and prevent you from ever fully paying off the loan.
How to Avoid Rolling Over Negative Equity
- Pay Down Your Current Loan Before Trading In Your Car
If you find yourself upside down on your current car loan, consider paying down the loan balance before trading in the vehicle. This might involve saving up extra money for a few months or taking out a personal loan to pay off the negative equity. By eliminating the remaining debt, you can avoid rolling it into your new car loan.
- Choose a More Affordable Car
If you have negative equity, consider purchasing a less expensive car to avoid increasing the size of your loan. By choosing a more affordable car, you can keep your loan balance lower and avoid adding more debt to your new loan.
- Refinance Your Current Loan
If you’re upside down on your loan but still want to keep your car, refinancing could be an option. This can help lower your interest rate or monthly payments, making it easier to pay off the loan more quickly. In some cases, refinancing could allow you to pay off the negative equity and avoid rolling it over into a new loan.
- Make a Larger Down Payment
When buying a new car, try to make a larger down payment to offset the negative equity from your old loan. The more you can pay upfront, the less you’ll need to borrow, reducing the impact of the negative equity on your new loan.
Conclusion
Rolling over negative equity in a car loan may seem like an easy solution, but it can lead to higher monthly payments, more debt, and difficulty in selling or trading in your car. To avoid these risks, consider paying down your current loan balance, choosing a more affordable car, refinancing, or making a larger down payment. By taking these steps, you can avoid the dangers of negative equity and make smarter financial decisions when purchasing your next vehicle.
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