How to trade in a car with negative equity

Quick insights

If you want to get rid of a car with negative equity, you may be able to arrange a negative equity trade-in. You also can negotiate a trade-in deal that rolls over the negative equity. Trading in a car with negative equity can be difficult, but with a little bit of research, you can find a deal that works well for you.

What is negative equity on a car?

When the amount you owe on your auto loan is greater than the vehicle's value, you have a negative equity car loan. Many people refer to it as being upside down on your car loan. Cars decrease in value the minute you drive them off the car lot. A new car can possibly lose 20% of its value in the first year. With the rapid depreciation, it is easy to owe more than your car is worth if you used financing.

Negative equity often happens if you don't put enough money down. It also occurs if you put a lot of wear and tear on your car. The car's condition can deteriorate and reduce the value. Long-term car loans that are six or seven years often lead to negative equity. The more time it takes to pay off your car, the more likely you are at risk for negative equity. 

How negative equity works with a trade in

You can transfer negative equity into a new car. This is referred to as rolling over the loan. Dealers can sometimes recommend rolling the negative equity into your next car loan. This is very convenient, but it is not advised. It can immediately put you into negative equity on your new car loan. You are creating a larger loan amount with more interest. 

This option should only be considered if you don't have the money to pay off the negative equity and are struggling with your current car payments. It can also be worthwhile if the new loan has a lower interest rate, or you are buying a less expensive car.

How much negative equity can I roll over?

Lenders typically set limits on the amount of negative equity you can transfer to a new agreement. This limit often depends on your credit profile and the value of the new vehicle you want to purchase. Many institutions allow you to roll over a balance as long as the total new debt does not exceed a certain percentage of the new car's value. A conversation with your lender can clarify your specific rollover allowance.

How to roll over a car with negative equity

When rolling over a car loan with negative equity, you'll want to take the following steps.

1. Discover how much negative equity you have

Contact your lender or login to your account to find out just how much you currently owe on the contract.  Research the estimated value for your current car online. Compare the value to the amount that you owe. If the car is worth $15,000 and you still owe $20,000, that is $5,000 of negative equity.

2. Consider a less expensive vehicle

A simple way to reduce your debt is to purchase a less expensive car. You may want to consider a used or pre-owned model to offset the depreciation. New vehicles can depreciate substantially throughout a car’s life. Buying a car that is just a few years old can help you achieve positive equity faster.

3. Select the right financing period

When rolling over your debt, it can be tempting to select a longer contract. This can give you lower monthly payments. You could end up paying more for your car overall with accumulated finance charges and a higher interest rate. A shorter contract with the same interest rate can increase the monthly payment while shortening the time it takes to pay off the car completely.

4. Estimate your financing

Use an auto loan calculator to help you estimate a monthly payment. A monthly payment calculator can help you determine a total financing amount that includes the pay-off value of your current vehicle and the cost of the new vehicle. You will also need to include the financing duration and APR. This allows you to see what may be affordable. 

5. Get prequalified before visiting a dealer

Before you step into the dealership get prequalified. This helps you save time and stay within your budget. Once you are approved, you can visit your dealer with confidence in the amount you have to spend.

6. Review the contract 

Once you have negotiated the contract, review it carefully to ensure all the terms are in writing. You may want to double-check all the numbers before you sign any documents. A few weeks after the deal has been completed, make sure your previous loan has been paid off. The lender should mail these documents to you notifying you that the old loan is settled.

How to tell if your negative equity is part of your new car loan

A careful review of your new contract can reveal exactly how your previous balance was handled. Dealerships are required by law to provide clear disclosures about all costs included in your new financing agreement. You can check the itemized breakdown on your paperwork to see the exact amount of negative equity added to your total principal.

Should I trade in a car with negative equity?

Financially, it can make sense to trade in a car with negative equity if the car is in poor condition and unreliable. You don't want to put yourself in a position where your vehicle is costing you a lot of money in extensive repairs. Trading in a car with negative equity can be beneficial if you can find a vehicle that is less expensive and fits into your budget.  

However, you need to be careful, as you could go into greater debt and more negative equity. If you can hold off on buying a new vehicle, you can reduce your negative equity by making extra payments on the car loan. Delaying a trade-in is often the best option financially, but it only works if you can hold off your trade-in until you've saved enough to pay off the loan.  

Your negative equity must be paid off sooner or later. If you need a newer car sooner, you may consider paying off the negative equity all at once out of your own pocket. For example, if you currently owe $15,000 on your car and the dealer offers $12,000 for a trade-in, you can make up the $3,000 difference to your lender. Before you do this, check and make sure that there is no prepayment penalty.

The bottom line

A trade-in with negative equity requires careful financial consideration and a clear grasp of your new obligations. A rollover can help you secure a different vehicle, but it increases your total debt and monthly payments. A patient approach and a thorough review of your contract may help you make an informed decision for your financial future.