Car equity is the value of your vehicle, less what you owe on your car loan. If you're vehicle is paid off, its entire value is equity. If you still owe money on your loan, the equity is any amount of value beyond your loan balance. If you owe more for your loan than the vehicle is worth, you are in negative equity. When it comes to car loans, this is not the position you want to be in.
Equity is important because when there is equity in your vehicle, you can use that value instead of cash when you're making a trade, and use the value in your vehicle as part of a down payment. When your loan balance is more than the value of your vehicle, you don't have that luxury.
In fact, if you have negative equity and something happens to the vehicle, you may be left footing the bill after your insurance claim has paid its worth. Insurance claims only cover the value of the vehicle, not the total of the loan. This is why it's important to know your equity position. Without it, you can't plan for the future as far as your car loans are concerned.
How to Determine If Your Car Has Equity?
To determine whether your car has equity, you need to know the market value of your vehicle and the total balance remaining on your loan. To find the market value, you can get your vehicle appraised at a local dealership, or you can go online and answer some questions on a valuation site such as Kelley Blue Book or NADAguides.
Next, subtract the value of your car from the total balance of your loan. If your loan balance is larger than your vehicle value, you have negative equity, but if the value is larger than your loan balance, you have equity.
What Is Positive vs. Negative Equity?
What is positive equity? Positive equity is just called equity, and it's better to have than not to have it. When you have equity in your vehicle, you open up many doors for savings on your next car.
Negative equity, however, puts you in a whole different and worse financial situation. Being underwater on your loan means you can't cover the balance by selling your vehicle, and you will need to come up with the cash to get out of the loan when you need another car.
Your only other option is typically to roll over your negative equity. This may sound like a great deal, but really, you're just making your next loan balance higher. If you roll over your negative equity too many times, it will become impossible to repay the loan or outrun the negative equity, keeping you in a cycle of debt.
Here are some simple examples of each type of equity:
- If your vehicle is worth $10,000, and you owe $15,000 on your car loan, you are upside down, or in a negative equity position by $5000.
- On the flip side, if you only owe $10,000 on your loan and your vehicle is worth $12,500. You have $2,500 in positive equity.
Financial Decision-Making and Car Equity
When you have equity in your vehicle, it's easier to trade it in or sell it. This is because you can sell the car you have and still repay your loan while keeping the excess as a down payment for your next car.
If you have negative equity, the sale of your vehicle won't repay your loan, and you will have to pay out of pocket or roll over your negative equity. This makes you even further behind on your new loan and keeps you in a negative equity position on your next vehicle.
Additionally, if you have negative equity, you may not be eligible for refinancing, which can become necessary in certain situations. If you do find a lender willing to roll over your negative equity when refinancing, you will ultimately just be paying more than the vehicle is worth to keep it.
On the other hand, if you have equity, it can be easier to refinance, and you may even be able to use the equity in your vehicle as a loan. This means doing a cash-out refinancing, where you get the equity in your vehicle as a lump sum of cash. This can seem appealing, but be aware that these refinancing loans typically come with a higher interest rate.
Strategies to Improve Your Car Equity
There are many techniques for improving the equity position of your vehicle. Some tips include paying down your loan faster, keeping your vehicle clean, and choosing the right loan. Let's look at a few examples of how you can improve your car's equity.
Since equity is your vehicle's value compared to its loan amount, the quicker you pay off the loan, the more equity your vehicle will retain. The goal is to pay off your loan faster than the vehicle depreciates. Depreciation is inevitable, but it happens at a fixed rate and does not depend on your loan balance. So, by paying off your loan more quickly than scheduled, you can improve your equity position.
Another way to maintain value in your car is to keep it clean and damage-free. Your vehicle's actual cash value, or ACV, is the amount that a buyer will pay for the car. You want this to be as high as possible, and the more well-maintained and clean your vehicle is, the better the resale value will be.
Finally, the last tip for maintaining equity in your vehicle begins before you even take on a loan. Getting the right loan with the right terms for your situation can help you maintain equity in your vehicle as well. There are a few tips that you'll want to keep in mind while you're rate-shopping and trying to find your next car loan:
- Keep your loan term short. The shorter your loan term, the higher your monthly payment is, but this also means you're paying your loan faster than the vehicle is depreciating. This will help you maintain equity in your car.
- Avoid a high interest rate. The higher your interest rate, the more it will cost you to borrow money, and the less of it goes toward your principal. Keeping your interest rate manageable reduces your total loan cost and builds equity faster since more of the payment goes toward the loan balance and not the interest payment.
- Make a sizeable down payment. The bigger the down payment amount, the lower your loan cost, and the greater your chance you have of getting ahead of negative equity from the first day of your loan. Remember, your vehicle's value compared to the loan balance is equity, so the less you have to borrow, the better off you are.
- Check for pre-payment penalties. When you take on a loan, be sure there are no prepayment penalties attached to it. If you avoid these, it's easier and more cost-effective to repay your loan ahead of schedule to stay ahead of depreciation. This will help you maintain equity.
- Buy a car that holds value. Certain brands and models are known to hold their value better than others, and make a better option when you're considering resale value. Some trucks, luxury vehicles, and sports cars tend to lose value more quickly than other vehicles.
Using the advice above, you can help maintain the value of your vehicle, so that you have equity to use when you need it.
