There are a lot of terms and jargon thrown around by auto sales representatives when you are going through the car buying process which can be quite confusing for consumers to navigate. One term that customers truly are confused about is the notion of NEGATIVE EQUITY. Canada East Rides is here to explain what negative equity is, how you can find yourself in a position in which you have it, and what steps you can take to avoid it from happening to you.
What is Negative Equity?
It means that you have more owing on your current car loan than your vehicle is actually worth. For example, let’s say you owe $10,000 on your current loan but your car is only appraised at $8,000. That means you owe $2,000 more than your car is worth, or in other words, you have $2,000 in negative equity. This is never a good thing because you will pay more than the vehicle is worth to buy it out.
How Does Negative Equity Happen?
- Choosing a long term on your loan: This reduces your monthly payment to make the vehicle more affordable but it also means you pay less down on the principle each year. The longer the term, the higher the risk for negative equity because your car depreciates (drops in value) faster than you are paying off the loan.
- No or little money down: Making a small down payment or none at all can increase your risk of negative equity because you are owing the maximum value of the car right off the bat. Depending on how your loan is set up, putting a minimal down payment could have you owing more than your car is worth within the first year!
- Wear and Tear: If you put a lot of kilometers on your vehicle each year or you do not take care of it after the purchase, it will depreciate in value quicker than you are paying down the loan.
- Multiple Trade-ins: If you owe money on a current vehicle and are looking to trade it in for a newer vehicle, this amount will be added to the new loan. For example, if you have $2,000 in negative equity and are buying another car for $10,000, you are now paying $12,000 for the new vehicle (the $2,000 is added into the new loan). Now you are owing $12,000 on a vehicle worth $10,000 meaning your $2,000 of negative equity from the first loan is being rolled into the next loan. If you do this over and over again, it will compound with each trade.
How to Avoid Negative Equity
Anytime you have more owing than your vehicle is worth it is costing you money, so it is important to do what you can to avoid it by:
- Keeping the kilometers as low as possible
- Take care of your car with routine servicing and maintenance.
- Avoid long term loans.
- Put money down on your car if possible.
- Avoid multiple trade-ins if you currently have negative equity, you lose each time!