KEY POINTS
- If you owe more on your car than it is worth, you might have the option to secure a bigger loan to cover the outstanding amount when purchasing a new car.
- This is known as funding a deficit in value.
- Consumers who borrow money to cover the difference between the value of their car and the amount owed on it are at a higher risk of having their car repossessed within a two-year period.
For many individuals, purchasing a car is essential as it serves as a primary mode of transportation. Given the high cost associated with buying a vehicle, it is a common practice among people. borrow money to fund the purchase of their car.
Regrettably, if you are taking out a loan to purchase a vehicle, there is one action that you probably should avoid. This action significantly increases the chances of your car being repossessed.
If you have negative equity on your car and finance it, the chances of it being repossessed are higher.
A recent report by the Consumer Financial Protection Bureau revealed that individuals who finance negative equity are over twice as likely to experience their vehicles being repossessed within two years, compared to those with a positive trade-in. Moreover, they are 1.5 times more likely to undergo car repossession than buyers who did not have a trade-in.
Can you clarify the meaning of this?
Equity is the difference between the value of your car and the remaining balance on your car loan. For example, if your car is worth $10,000 and you still owe $1,000 on it, your equity in the car is $9,000.
At times, individuals may end up with a situation where the amount they owe on a car exceeds its actual value. This can occur if they did not make an initial payment, extended the loan term significantly, and did not make substantial progress in reducing the debt. When the amount owed surpasses the car’s resale value, it results in a situation known as “negative equity.”
When purchasing a new car, you may encounter a situation where you owe more on your current car loan than the vehicle is worth. This is known as negative equity, and it can make it difficult to trade in or sell your car for an amount that covers your outstanding balance. In such cases, some dealers and lenders offer the option to roll over the negative equity into a new loan. This means you can borrow more money to pay off the remaining balance from your previous loan.
Suppose you have a car valued at $20,000, but you still owe $24,000 on it. Now, you want to purchase a new car worth $40,000 without making any extra down payment. If you decide to trade in your current car, you would only receive $20,000 for it. However, you would still have to settle the remaining $24,000 debt on the vehicle.
If you choose to finance negative equity, this indicates that you may secure a car loan for $44,000 to cover the cost of purchasing your new vehicle as well as settling the remaining $4,000 from your current loan.
What are the negative consequences of financing negative equity?
Obtaining a loan to cover negative equity can lead to financial difficulties as you will owe more money on your new vehicle than its actual value. This means that you may find yourself in a situation where you owe more on the loan than the car is worth for an extended period of time.
Given that you have Having negative equity and financing a new car might indicate that you are overspending. This is because you still have an outstanding balance on your current car and are taking out a loan to purchase another vehicle.
Your car loan If your balance increases, your payments will also increase, which may make it difficult for you to afford them. A checking account is a type of bank account that allows you to easily deposit and withdraw money for everyday transactions. each month.
Here are some important reasons why it’s not advisable to finance negative equity and why the risk of repossession increases if you choose to do so. Instead of opting for this option, focus on paying off your existing car as soon as possible, even considering making additional payments if feasible.
It is advisable to hold onto your current car for an extended period of time, unless there is a valid reason to do otherwise. By following this approach, you can work towards paying off your loan, continue using the vehicle, and eventually eliminate the need for a car payment. This will free up your finances to focus on more significant objectives.
