Negative equity occurs when you owe more on your auto loan than your car is worth. If it's time to get a new vehicle, but you have no equity to use toward a trade-in, you may be able to roll over your negative equity into your next vehicle.
Lenders typically cap loan-to-value (LTV) ratios around 125%, meaning your vehicle’s loan can't exceed more than 125% of its value.
Even if you can roll over your negative equity into your next loan, it's not always a good idea, especially if you're already dealing with credit challenges. Here’s some guidance on rolling over negative equity.
Can I Roll Over My Negative Equity?
The two main factors that determine whether or not you can roll over negative equity are your LTV and payment-to-income ratio, as negative equity can increase your monthly payment and the total amount financed.
Every lender varies in their requirements, and every borrower’s circumstances are different, including how much income and available income they have. If your loan balance, with the negative equity factored in, creates a high monthly payment that your available income just doesn’t have room for, you’re not likely to get approved for the auto loan.
Whether you believe it or not, most lenders don’t want to approve car loans that overextend borrowers. And they prefer to approve loan amounts that are comparable to or close to the vehicle’s value.
Rolling Over Negative Equity
When you roll over your negative equity, you're adding the difference between your car's value and your loan amount onto your next auto loan.
Let's say, for example, you have $2,000 of negative equity on your current vehicle, and you're purchasing a vehicle for $15,000. Your negative equity car loan balance would be $17,000. You’re essentially combining your loan balances into one, so it’s similar to debt consolidation. However, whether or not this is possible depends on how much you can reasonably afford.
Rolling over negative equity can be difficult
Depending on how much negative equity you have, you may be able to roll all of it over – but it depends on your budget, what you qualify for, and the lender you're working with.
Negative equity can make it harder to sell or trade your vehicle. But how much negative equity is too much? If your auto loan is hundreds or even thousands of dollars more than your car’s current market value is, then selling it for what you owe can become a challenge.
Odds are, the amount of negative equity your vehicle has is going to be unique to you. Determining how much negative equity your car has means comparing your existing loan balance to the vehicle’s current value. To do this, get an estimated vehicle value from a site like Kelley Blue Book or NADAguides, and compare it to the 10-day payoff amount that you can request from your lender.
A look at the loan-to-value ratio
A lender may not approve a loan that exceeds the next car’s value by too much because lenders also take into account your LTV. An LTV is your loan amount compared to a car’s actual cash value (ACV). It’s calculated by dividing your loan amount by your vehicle's ACV.
LTV is typically expressed as a percentage, and most auto lenders typically have a maximum loan-to-value ratio of around 125%. This means that your vehicle’s loan shouldn’t exceed more than 125% of its value. Since rolling over negative equity means adding to the total balance of your next auto loan, depending on how much negative equity your current car has, it could exceed this limit.
How Does Negative Equity Affect Your Car Loan Terms?
Negative equity in and of itself doesn't affect your loan terms, but when you start to roll that negative equity forward, it can become a problem. The more negative equity you roll over, the harder it can be to take on a shorter loan term, since a short loan term means a higher monthly payment. Negative equity makes your loan automatically larger, which means paying more than if you had waited to trade a vehicle that has some equity, or at least doesn't have negative equity. In these cases, borrowers often stretch their loan terms longer to make payments more manageable. Therefore, negative equity can make your loan term longer out of necessity.
Factors to Consider When Rolling Over Negative Equity
When you're considering rolling over negative equity onto another car loan you should consider the following points:
- How much negative equity are you rolling forward?
- Can you afford to make the new loan payment and the additional payment on your negative equity?
- Is the added amount of the negative equity pushing you into a new loan term?
- Would it be better to wait until there is equity in your vehicle?
- Will the extra negative equity amount push your interest rate too high?
Are You Stuck On The Trade-In Treadmill?
If you’re always getting negative equity car loans, then you may be on the trade-in treadmill. It’s commonly defined as a cycle of being underwater on your car loan and opting to just roll that negative equity each time you buy. It’s an easy cycle to fall into, too.
Because rolling over negative equity means increasing how much you need to borrow, it also means more interest charges, and possibly, longer loan terms to make the monthly payments more affordable. Before you know it, you’re struggling to pay off the loan quickly enough to keep up with the vehicle’s depreciation (loss of value over time).
Each time you roll over negative equity, you’re likely to start your next auto loan as a negative equity car loan again because you likely borrowed more than the vehicle is worth.
Getting off the trade-in treadmill can be as easy as waiting until your loan balance catches up with your vehicle’s value. Staying current on your auto loan and keeping your vehicle in good shape can help you catch up, or even making extra payments when you’re able to can help. Over time, your car’s depreciation usually slows down, too, if you maintain it.
Build Credit With a Subprime Car Loan
Subprime auto loans are typically for borrowers with credit challenges such as bankruptcy, no credit, situational bad credit, and other tough credit situations.
One of the best ways to improve your credit score is by taking on new credit – like an auto loan that’s reported to your credit. This means your timely payments are reported, too. Maintaining a good payment history on a car loan often means ending the loan with a better credit score than when you started. A higher credit score means a better chance at auto loan approval and qualifying for a lower interest rate next time around.
If you choose to go this route, be sure to keep the rules of negative equity in mind – or wait until there's equity in your current vehicle to use toward your next car. Auto Credit Express can help you find a local dealership if you're ready for your next loan and need a special finance lender. To get started on your next car loan, fill out our simple form.
