Negative equity can make it difficult to sell your old car or purchase a new one.
You will also have to borrow a large sum of money for your new loan if you are unable to get rid of the negative equity on your old loan.
Is it possible to avoid negative equity?
Yes, it is.
Given below are some ways to avoid negative equity on your next car loan.
Purchase An Affordable Or Used Car
I know having a big and expensive car sounds great and everything.
But trust me, keeping your new car in a good condition requires a lot of financial effort. No matter how expensive your car is, it loses about 9-10% of its value the moment you drive away from the dealership and after that by 15-18% each year.
If you don’t have the money to purchase the car of your dreams, don’t do so unless you want to be swimming in negative equity. It is a risky move since a bigger loan will mean a greater risk of negative equity.
You can consider getting a cheaper car which is within your budget to avoid negative equity on your car loan. You can use this car affordability calculator to estimate the car purchase price you can afford based on your annual income and other factors.
You can also consider getting a used car since it will be much cheaper than a new one. By the time you purchase a used car it would have already completed the majority of the depreciation phase. This means you will be able to sell it at a price close to the one you paid for your car.
Make A Good Down Payment
Making a good down payment means lower monthly payments and less interest paid during your loan term.
The more money you pay in advance, the less money you will need to borrow for your car. This significantly decreases your risk of acquiring negative equity.
A reasonable down payment can also help you offset depreciation and prevent you from ending up upside down on your loan as soon as you make your purchase. You also get approved for auto loans more easily.
If you are planning to purchase a new car, it is recommended you make a down payment of at least 20% of the car’s price. For used cars, aim for at least 10% of the price.
Consider Getting GAP Insurance
GAP (Guaranteed Asset Protection) insurance is a type of auto insurance which protects the borrower from losses which arise when the car is totaled by paying the difference between the original value of the car and the balance which is owed on the loan.
You should consider getting a gap insurance if,
- You are unable to make a reasonable down payment.
- You have negative equity rolled over from an old car loan into your new one.
- Your car is financed for more than 58 months.
- You are leasing the car.
- The depreciation rate of your car is high.
You can purchase GAP insurance from your dealer, lender or insurance company.
If you choose to purchase from a dealership, it will cost you about $400-$700. Car insurers charge less than the dealer. On most auto insurance policies, GAP insurance adds about $20-$40 to the annual premium.
If you happen to get negative equity on your new loan, GAP insurance will help pay the difference.
Slow Down Your Car’s Depreciation Rate
Although the initial depreciation which takes place during the first few months cannot be controlled, there are certain things you can do to slow the depreciation rate.
The slower your car depreciates, the lesser you risk going into negative equity.
- Pick a car model which is known for having a low rate of depreciation. This means choosing a car which has good fuel economy, low running costs and is reliable.
- Follow a good maintenance routine and take care of your car properly. Get it serviced every once in a while.
- Look up previous resale values of your car’s model to get an idea of how much your car will be worth when you sell it in the future. Steer clear of models which have poor resale values.
- Keep your mileage as low as possible to minimize the effect of depreciation.
It is not very difficult to avoid negative equity if you are careful about your purchase. Before you buy a car, make sure you have sufficient money to finance it.