How to Overcome Negative Equity.
by Dave LaLonde on Thursday, August 9th, 2007Twelve years ago when I first started helping people buy a car with bad credit there were only a few lenders willing to give people with credit problems a traditional type of loan. When I say a “traditional type of loan”, I mean a lender that reports to all three credit reporting agencies and had monthly repayment terms via a traditional payment book.
At that time, it was more common for consumers with bad credit to buy cars from local “We Finance” used car dealers that had a buy here pay here “pay as you go” program. With these programs, the consumer visited the car dealer weekly to drop off their payment. In most cases, the “rent to own” vehicle was an older car valued between $1,000 and $5,000.
It was a major step toward rebuilding credit when national finance companies entered the sub prime lending arena around 15 years ago. The first special finance lending programs had repayment terms of 24, 36, or 48 months. Rarely would a lender approve a loan with a 60 month repayment term. These short repayment terms allowed consumers to buy a better car than they could purchase at a buy here pay here used car dealer. Based on our data, the average car purchased utilizing these terms was around $10,000.
Since that time, the sub prime market has expanded. Today, many Americans have bad credit or know someone who has bad credit. With the increased demand for bad credit auto loan services we have seen an increase in the number of sub prime lenders that are willing to lend money to people with bad credit. The increase in lenders means increased competition. Increased competition has resulted in more competitive programs for consumers.
Today, people with bad credit are getting traditional type auto loans at lower rates, lower down payments and longer terms than ever before. On the surface, these items all seem to be good things for consumers. It allows a person with bad credit to buy a newer car with less money out of pocket resulting in an affordable car payment.
What’s the problem?
The problem this has created is that there are now many Americans who are stuck with a vehicle they no longer want or doesn’t suit their needs. They are stuck with the vehicle because they owe much more on the vehicle than it is worth. As an example:
- A consumer with bad credit buys an inexpensive brand new car for $18,000.
- They buy the car with no money down and finance it for 72 months at a 15% .
- With state fees and sales tax the total amount financed is $19,500.
- 36 months later the car is worth ½ it’s original value, $9,000.
- 36 months later the consumer still owes $11,757.
The example above is the best case scenario and assumes that the car, 36 months later, is still in great shape. Often it is not and it is worth less than ½ its original value. As you can see, a consumer that followed this path would owe at least $2,700 more on the vehicle than the vehicle is worth. They have $2,700 in negative equity.
So what options does someone with negative equity have?
If they have made the payments on time, there is a chance that they can refinance the loan at a shorter term and a lower rate. In other words, if there is 36 months left, refinance it for 24 months. This will bridge the Loan to Value gap more quickly.
Often, however, a new vehicle is needed because a change in lifestyle requires an upgrade in transportation. If this is the case, the following advice may help:
To avoid repeating the situation, try and put as much money down as possible when you trade in your car.
If you are able to afford a much higher payment, consider rolling the negative equity into a short term lease. You may have a higher payment, but at the end of the short term lease you can walk away with no negative equity.
If you have not made the payments on time and still have bad credit you will have fewer options. I’ve helped a lot of people with negative equity and bad credit buy a new or newer car. I would, however, recommend that if you have negative equity, only trade your car in because you have to, not because you want to.
To lessen the Loan to Value gap, new cars with large rebates work well. You can often find these cars during model year change over. Late model used cars that are out of season may also work well. For example, a convertible in the winter time, or an off-lease car in high supply compared to demand. This is normally due to a high volume promotional lease event in the past.
