Most people who are in a car loan and did not put a lot of money down have what is called “negative equity”.
What is Negative Equity?
Negative Equity is a term car dealers use to explain that their customer (you) owes more money on their car (the loan payoff) than the car is worth for trade-in (Actual Cash Value or ACV). Often, the number is similar to what an insurance company would give you if the car is totaled or stolen.
There are really two different types of people with negative equity:
1. People who owe only a little more than their car is worth on trade-in. Under $3,000 for people with average credit.
2. People that are BURRIED in their trade.
Maybe you noticed the part on #1 where it says “people with average credit”. Most dealers probably consider average credit to be in the 600-640 Beacon score range and having at least 3 major trade-lines (car loans, home loans, large credit cards) that have/had been open for a couple of years. The better your credit score, the easier it is to get a lender to absorb your negative equity on your new auto loan AND you can roll more negative equity over to your next auto loan.
Even though someone with negative equity and good credit can find it easier to roll the negative equity over, they will notice that the more negative equity they roll over, the higher the auto loan interest rate will be. It is a simple relationship between risk and interest rate with the lender. The higher the loan-to-value (LTV) ratio is, the more risky the loan is for the lender
If you have poor credit, and you need an auto loan that allows you to trade out of a large amount of negative equity, there are a few points you need to consider. First, your payments are almost always going to go up. Because of loan to value restrictions lenders place on auto loans, it is easier to trade out of negative equity into a more expensive vehicle. Once you add the negative equity to the loan, you end up with a higher payment. Second, you will probably need to have a down payment. Think about it, if you are $5000 upside down in your car, you have to have $6000 down just to have a NET $1000 down payment. Usually a dealer will be able to help you out and absorb some of their negative equity, but it is tough for a dealer to absorb all of it. When a dealer absorbs your negative equity, they are basically taking money that would be profit with a normal customer, and giving it up to you so that they can sell another car that day.
Auto loans with negative equity are difficult to put together, unless you have stellar credit. To make it easier on you, know what you are working against from the start. Check and see what your 10-day payoff is on your current loan. Then check to see what your trade in value is. There are many sites that you can get an idea of what your car is worth, obviously no dealers go off these sites, but they do help give you an idea. These sites only work well if your car is less than 5-years old, and has less than 75,000 miles on it. Most old, high mile cars have very little trade-in value no matter what kbb.com says it is worth for trade-in.
Once you have established the estimated trade-in value, and your payoff. You know about how much negative equity you have. There is however one more thing you can do to lower your negative equity. If you bought GAP coverage or an extended warranty on your car, you can cancel any remainder on them. The warranty company or GAP company will give you a refund on any unused portion and credit that directly against your payoff.
So now you know: Your trade-in value, your payoff, and your cancelable products that can lower your payoff. What is next? Obviously you need to know your credit rating. There are many places online that you can get your credit score. The free sites do not always give you all you want to know about your credit report. Also, you need to evaluate your budget and figure out exactly how much you can put for an auto loan down payment and how much per month you can afford for your car payment. Be realistic, and remember that the more you can put down, the more it will help your situation.