What to do if You Have Negative Equity

This is known as negative equity, or being "upside down" on your loan.

There's really nothing wrong with this - as long as you plan on keeping the car and paying off the loan.

But there are times when you may want to trade into a new car before the loan is fully paid off.

In this case, negative equity becomes a big problem.

You may have seen advertisements where dealers claim they can trade you out of your vehicle "no matter what you owe".

They may be able to trade you out of your vehicle, but what they don't tell you is that you will still have to pay off whatever you owe. There is no free lunch when it comes to negative equity.

You have three options when you're in this situation:

Option 1: Keep the Car and Pay Off the Loan

The smart thing to do when you're upside down is to simply keep the vehicle and pay off the loan. Eventually, there will be a point where you build up enough equity in the car to offset whatever you owe on it.

If you're deep in negative equity territory, this may not happen until your very last payment.

Option 2: Pay Off the Negative Equity

If you have the cash available, you can just pay off the negative equity whenever you sell or trade-in your car.

If you don't have enough cash, you really shouldn't be looking at getting a new car in the first place. It doesn't make financial sense.

But if you insist on getting a new car, you can offset negative equity by purchasing a car that has a cash-back rebate.

You can apply the rebate towards the negative equity. If the rebate is not enough to cover the negative equity, then you still have to pay money out of pocket.

Option 3: "Roll Over" the Negative Equity into New Loan

It is illegal in most states to include negative equity in a new car loan, but there's an easy way around this.

Car dealers will simply raise your trade-in allowance while at the same time raising the purchase price of the new vehicle.

For example, if your trade-in is worth $5,000 and you have $2,000 in negative equity, the dealer will pay you $7,000 for your trade-in, and raise the negotiated price of the new car by $2,000.

This is the worst thing you can do when you have negative equity because you will be digging yourself into a deeper hole.

Eventually, you will default on the payment, ruin your credit, and have your car repossessed if you keep rolling negative equity into new loans.

On top of that, you will be paying additional taxes, interest, and fees on the negative equity that was rolled over.