How to Get Out of Negative Equity on Car Loan

How to Get Rid of Negative Equity on Car Loan

March 5, 2024

Buying a car is a significant investment, and many folks opt for car loans to spread out the payments instead of paying a large sum upfront. However, nowadays, cars tend to depreciate rapidly. As a result, many car owners find themselves dealing with negative equity.

What is negative equity?

Negative equity happens when your car's value drops below what you still owe on your loan. Let's say you owe $15,000, but your car is only worth $10,000. In this scenario, you find yourself in negative equity, specifically $5,000 "upside down" on your car loan. This can make it tough to sell your car or trade it in for a new one.

If you intend to hold onto your vehicle for the long haul, negative equity might not bother you much. In Canada, people typically keep their cars for about 10 years on average. So, you might not even realize you were in negative equity at some point.

However, it becomes a problem if you plan to trade in your car for a new one in a few years.


How to calculate negative equity on your car?

To get started, figure out how deep you're in negative equity. It's a straightforward process - just subtract the estimated market value of your car from the current amount you owe on your auto loan.

For accurate information, reputable online sources like CARFAX Canada or Kelley Blue Book can be consulted to estimate your car's trade-in value. 

Additionally, you can reach out to your lender to find out the exact amount you owe on your car loan.

If the outstanding amount on your car loan exceeds your vehicle's estimated value, the gap between the two is your negative equity.


How to get out of a negative equity car loan?

1. Make additional payments

Get in touch with your lender and explain your situation thoroughly. Ask them if they have any options available to help you improve your circumstances. 

If you can squeeze extra payments into your monthly budget to pay off the principal faster, discuss this possibility with your lender. Making additional payments not only accelerates your debt repayment but also allows you to decrease the outstanding balance faster than your car's depreciation rate.

While you'll still need to address the negative equity, holding onto your vehicle and becoming debt-free can make a significant difference. Although you might face increased financial pressure in the short term, you'll retain some equity to put towards your next vehicle purchase.

Before proceeding, double-check that your loan terms don't include a prepayment penalty. This fee is imposed by certain lenders on borrowers who pay off their loans ahead of schedule.


2. Refinance your current loan

Refinancing offers you the opportunity to decrease the interest rate on your car loan. With a refinanced loan, you'll secure a new loan to replace your existing one, likely with a lower interest rate and improved payment terms.

Opting for a shorter loan term through refinancing can also be beneficial. This allows you to pay off your loan more quickly, reducing negative equity. By making larger payments, you chip away at the debt faster, thus shrinking the gap between what you owe and your car's value.

Lowering your interest rate makes your loan more manageable. With less money going toward interest, a greater portion of your payments goes toward reducing the principal balance. As your principal balance decreases, so does your negative equity.


3. Trade in your car

Opting to trade in your car allows you to downsize to a more affordable vehicle. Since the new car comes with a lower cost, chances are high that your negative equity will also decrease. This makes the repayment process easier, enabling you to escape the underwater loan more quickly.

It's important to keep in mind that you'll still need to address the negative equity. However, if the trade-in significantly reduces the amount, it's a move worth considering.

For example, if you still owe $12,000 on your auto loan but your car's trade-in value is $10,000, going through with the trade-in means you only owe $2,000. This is a more manageable amount compared to the full $12,000.


4. Consider getting a gap insurance

Negative equity can become a headache, especially after a car accident. If your vehicle is totaled, not only are you left without a car, but you're still on the hook to repay your lender.

To mitigate the risks of dealing with negative equity in such situations, consider investing in gap insurance. This optional coverage steps in to bridge the "gap" between what you owe on your car and its actual cash value (ACV). The ACV is the vehicle's monetary value at the time of the accident, not its original cost.

For instance, if your car's ACV is $10,000 and you still owe $12,000 to the lender, there's a $2,000 gap that you would have to cover out of your pocket if the car is declared a total loss.

Having gap insurance means you won't have to worry about covering this difference; it takes care of the outstanding amount. Plus, the cost of gap insurance is typically much lower than comprehensive and collision premiums.

To prevent ending up with negative equity on your auto loan, it's crucial to conduct thorough research and evaluate your financial situation before making a purchase decision. If you're seeking assistance with your car loan in Canada, feel free to reach out to us at Approval Genie! We're here to help.