How to Avoid Owing More Than What Your Vehicle is Worth

Avoid Owing More on Your Car Than What it is Worth

discussion over carA problem more common than ever before for drivers is negative equity. This is when you are financing a car and it gets to the point where you owe more on your car than what the car is worth. If you are the type of person who likes to regularly switch vehicles, negative equity is going to be a major problem for you. Fortunately, there are steps to avoid it.

Why Does This Occur?

Unlike with properly maintained houses, cars depreciate over time; that’s just part of owning a car. The largest percentage of depreciation happens in the first two to three years after the car leaves the lot. In the past, car loans only lasted a couple of months, but now long-term financing is available for 72 months in some cases.

At the beginning of an amortized car loan, you are paying mostly interest and little principle. Over time, you pay more and more towards principle, but this is going to be slower than the rate of depreciation. This isn’t going to be a big deal if you plan on owning the car for ten years or so, but for those looking to sell after a few years they are going to wind up with negative equity that will reduce their buying power.

What You Can Do to Prevent Negative Equity

If you are planning on turning over your car quickly, you may want to consider leasing rather than buying to avoid negative equity. Be wary, though, because many leasing programs have mileage caps and if you drive constantly a lease may not be for you. The other thing is to plan ahead to match the down payments and monthly payments are only going to last as long as you want the car, which will eliminate the horrible feeling when you’re ready to sell and realize you owe a lot more than the car is actually worth.

Remember that paying more upfront will reduce the amount you need to finance, so it may be wise to save a bit more before getting a car rather than going for the longer term loan. Many dealerships also have sales programs where they offer an extra low APR or cash rebates that can also help. Explore your options and take advantage of the many loan calculators available online.

October 11, 2012 by Jamie Rettig