In recent years, we've seen a rise in the number of people with negative equity in their cars. According to Edmunds.com, in 2012, only about 23 percent of cars traded in were worth less than what was owed on them. In the last quarter of 2017, 32.5 percent of traded-in vehicles had negative equity. It's also important to note that the amount of negative equity has also increased, up from $4,500 in 2015 to $5,100 in 2017.
How does negative equity happen? How to avoid it?
1. Depreciation. A new car loses 25% of its value in its first year. This means that after the first 12 months, you already owe more than the car is worth, offset only by the amount of down payment you made. Tip: make a more substantial down payment.
2. Paying too much for your car. Many car buyers are "payment shoppers" for whom a good deal is all about the monthly payment, without keeping an eye on the actual price of the vehicle. You may consider a payment to be affordable, but in reality you paid $2,000 to $4,000 more for the car over MSRP. Tip: Negotiate base on price and shoot for an amount less than MSRP.
3. Carry-overs of past negative equity. In California, we like to change cars every three years or so, and dealers/finance companies make it easy by giving us the option to carry over negative equity to the new car loan. This'll put the buyer in a state of negative equity from Day One! The bad news is, it'll only get larger as the car depreciates.
It plays out like this: You owe $18,000 but your car is worth $15,000 as a trade. You still owe the negative equity of $3,000. You have to pay that $3,000 out of pocket to make the trade happen, but lucky you, because the dealer gives you the option of carrying over that amount to the new loan. In effect, the lender will finance the $3,000 negative equity for approximately $50-$60 a month ( $20 per thousand financed) on top of your new car payments. Tip: Stick to your car until what you owe is equal to what it is worth, which could be a lot longer than you want, but you'll come out with a clean slate and start a new loan free of past balances. Also, paying the balance out of pocket, increasing the amount of your down payment, or selling our car to a private party.
I mentioned earlier that one way to offset depreciation is to make a larger down payment (20% or more is recommended). This will also achieve a couple of things: 1) You"ll get a better (lower) interest rate, 2) you'll have lower monthly payments, and 3) you could pay off the car sooner.
Another way is to buy or lease a vehicle with a large rebate. Nissan offered a $10,000 rebate for their Titan XD during the end-of-model-year clearance last year. The Ford Focus came with a rebate of up to $5,500, as did Volvo's XC60 and X90. These makes and models may not have made your top three list, but consider what wonders their rebates could do for your overall situation.
Final Word of Advice: Try not to get into an endless cycle of negative equity carry-overs. If you're already in it, make a plan to get out.
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