Rolling Negative Equity Into New Car Loan

Rolling Negative Equity Into New Car Loan – The US auto industry has a negative equity problem. Negative equity is when you go to trade in your car, but the remaining balance on your car loan is HIGHER than the value of your car. You have the option of writing a check for the remaining loan balance or “rolling over” the negative balance to your new car loan. More and more users fall into this bad trap. Below is a graph of the negative equity trend over the past 10 years.

In 2010, 22 percent of new car buyers had bad credit when they went to buy a new car. In 2020, that number has doubled to 44 percent (source Edmunds.com). The dollar amount of negative equity increased from an average of $3,746 in 2010 to $5,571 in 2020.

Rolling Negative Equity Into New Car Loan

The first reason that contributes to this situation is the simple fact that a car is a depreciating asset, which means that its value decreases over time. Since most people take out a loan to buy a car, if the value of your car depreciates faster than the amount of the loan, you may find that your car has a trade-in value when you go to trade in your car. $5,000, but you still owe the bank $8,000 for the unpaid balance on your car loan. In these cases, you have to take $3,000 out of pocket to pay off the car loan, or some borrowers can roll $3,000 into a new car loan, putting them in the same situation for life. from a neighboring car.

How To Avoid Upside Down Car Financing And Stay Above Water

Compare this to a home mortgage. Historically, the value of a home increases over time, so you pay off the loan while your home increases a little each year. The difference between the property’s value and what you owe on the loan is called “equity.” You get wealth in this asset over time against the ever-decreasing race between the value of your car and the amount you owe on the loan.

When I consult with young professionals, I often advise them to stick with a 5-year car loan and not be tempted by a 6- or 7-year loan. The more you extend your payments, the cheaper your car payment will be, but you also increase the risk of ending up with negative equity as you go. trade in your car. I believe that one of the main factors contributing to this negative equity problem is the increasing popularity of 6 and 7 year car loans. Don’t worry if you can’t afford a 5 year loan on the car you want, extend it to 6 or 7 years so you can make the payments every month.

Let’s say the car you want to buy costs $40,000 and the interest rate on your car loan is 3%. Here are the monthly payments for a 5-year loan versus a 7-year loan:

Nice difference in payment amount, but what if you decide to trade in your car anytime in the next 7 years, that increases your chances of having negative equity when you go to trade in your car. Also, a 7-year car loan will cost you $1,271 more in total interest than a 7-year loan.

Will A Dealership Buy A Car If It’s Not Paid Off?

The main objection I have to this is “cars are lasting much longer than they were 10 years ago, so it justifies getting a 6 or 7 year car loan versus a traditional 5 year loan”. My answer? I agree that cars last longer than they did 10 years ago, BUT you are forgetting the following life events that can put you out of balance:

The lesson of history is that it is difficult to predict what will happen next year, let alone what will happen in the next 7 years, the bigger the car loan, the higher the risk of a life accident. it puts you in a negative equity position.

A common solution to a negative equity problem is to roll the negative equity into your next car loan. If this negative balance continues to accumulate car after car after car, at some point you will hit the wall and the bank will no longer lend you the amount you need to buy a new car and take the amount of negative balance loan for a new one. car. .

Too many people assume they always have a car loan, so they pass up the opportunity to take out a 5-year car loan, pay it off for 5 years, and then own the car for 2-3 years. , not only have you saved a significant amount of interest, but now you have additional income to pay off your debt, increase your retirement savings, or increase your savings.

Guide To Selling Your Car On A Loan

The best financial decisions are rarely easy to make. Taking out a 5 year car loan instead of a 6 year loan will result in a higher monthly car payment which includes your take home payment but when you go to trade in your current car you will be paying yourself down the road instead of having the pain of negative balance heading to the table, have the balance on your current car to apply to your next payment.

Unfortunately, this problem is likely to increase over the next 7 years due to supply shortages due to the rapid rise in US car prices post-Covid-19. When people trade in their cars, they get a higher value for their trade, which helps them avoid bad balance right now, but they also buy a new car at a higher price at the same time, which can lead to more people. when car prices are normal, a negative equity event where the car is worth much less than what they paid for and they still have a large amount of good car loan.

Hello, I’m Michael Ruger. I am the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog. I have created a blog because there are many events in life that require important financial decisions. The goal is to help our students avoid big financial mistakes, find financial solutions they didn’t know about, and improve their financial future.

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