What exactly is negative equity? It is created when you owe more on a vehicle than it is worth, trade the vehicle in, and then roll the balance of the loan into another vehicle purchase. Here is an example: You decide to trade your vehicle in on a newer model. The loan payoff is $20,000. However, your value is only worth $15,000. You have negative equity of $5,000. And, in most instances, even if the dealer tells you that they are paying off your loan, the dealer will add that $5,000 to the purchase price of your new vehicle. As a result, your loan and your monthly payments for the new car will increase. And, the longer the loan, the longer it will take to reach positive equity in the vehicle.
Understanding how negative equity works in a vehicle trade-in can help you make a better informed choice about purchasing and financing a car, and help you know when a car dealer's ads or statements regarding your trade-in are misleading.
Here are some tips to help you avoid negative equity:
1. Find out what your vehicle is worth before starting negotiations with the dealership. You can go to websites by Kelly Blue Book, Edmunds, or NADA, or take your vehicle to your local CarMax for a written appraisal.
2. Consider holding off on the purchase of the new car until you have paid down the loan on your current vehicle to an amount close to its projected trade-in value. You may even want to pay a bit more monthly on the principal to speed up the process.
3. Read the purchase contract very carefully and ask the dealer how the negative equity is being treated in your purchase. If the dealer tells you that it is paying off the loan on your vehicle, but they are really making you pay the negative equity, then it will be included on your sales contract. The negative equity might appear in a "negative equity disclosure" box which states that it was added to the purchase price, it may be an itemized addition before the final "out the door" price, or it may be calculated by addition of the loan payoff to the purchase, less the trade-in allowance that the dealer is really giving you for the car.
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