Reader questions – Negative equity in a car
A reader recently wrote in with the following question:
Now I don’t know a lot about this readers situation, and the best decision depends on many different factors, but I’ll make a few assumptions and give you what I feel are the best options for what do if you have negative equity in a car.
1. Dont trade in your car, just keep driving it.
Now because I don’t know much about this reader’s car, this may not be practical. Maybe this car doesn’t work for them anymore and they really need a new one for reasons I don’t understand. For most people though, I think the best way out of this situation would be to not buy a new car and to instead keep the one you have for a long time. If you play around with my car cost calculator, you will see that the longer you own a car, the cheaper it is to drive on average over the life of the car. This is primarily because depreciation costs are usually the biggest part of the cost of owning a car, and they are much greater if you buy a new car, then get a new one every few years.
Besides lowering the total ownership costs, keeping the car you have for a longer period of time will allow the balance of your loan to be paid down further until you no longer have negative equity (also called being upside down) in your car.
2. Pay down the loan if you have extra cash.
If the reader who wrote this question absolutely has to have a new car, the next best option would be to pay the loan down to a point where they no longer have negative equity in their car. I don’t know if the reader has any extra cash that they can use to pay down their loan, so this may or may not be an option.
If it is an option I would suggest paying the loan down because having an auto loan is just not a very good idea. Sometimes people talk about “good debt” and “bad debt” Good debt is money you borrow that will allow you to make more money, or save more money in the future. Examples of good debt include student loans or mortgages on homes that are likely to go up in value in the long run. Bad debt is money borrowed on things that will go down in value like cars.
Taking a loan out on a car, increases the total amount you pay on that car, because you have to pay both the price of that car, as well as the interest on your car loan. Not having a car loan means you don’t have to pay extra interest on your car, and you can use the monthly payments you would have used paying off your car on better investments. If the reader has enough money to pay down their loan so their trade in isn’t upside down then they can avoid the bad options in #3 or #4.
3. Roll the negative equity in your trade in into your new car. (a bad option)
If the reader absolutely has to have a new car, and can’t pay the loan down any, they may be able to roll the negative equity into a new car loan on their new car. This just means that their new car loan will be the full price of the new car plus whatever negative equity they have on their trade in. You can see this is a bad idea because it increases the total cost of the new car and it puts them right back in the same predicament they were in before, upside down in their new car. The only reason this might be preferable to option #4 is that interest rates on car loans might be better than any other interest rate you can get.
If this is the option you are forced into choosing, I would recommend you make it your goal to keep your new car a long long time so that you can pay your new car off, then save your money so you never have to take out a car loan again.
4. Pay down the car loan with some other kind of new debt. (Probably a worse option)
Yeah, you probably shouldn’t do this. Because I don’t know much about the readers situation, I am including this option in case they are desperate and are out of other options. The reader might be able to pay down their car loan with some other kind of debt. They might be able to do with a second mortgage, or a credit car balance transfer offer they receive in the mail.
Just like option 3 above, you probably shouldn’t do this, and if you do, you should develop a plan on how to get rid of your next car loan and make sure you never get another one. This may be a better option than option 3 if you can get a better interest rate on a loan than you can on a car loan.
What do you think? Do you have better options for somebody with negative equity in their car?