– By Danielle Beauvais, Esq.
Picture this: you have your eyes on a new car. You would like to trade in your current vehicle to serve as down payment, but owing more on the car than the car is worth, you are “upside down” on your car loan. Just as your excitement begins to deflate, a bank agrees to roll the difference between the loan and the car’s current value into a new loan so you can buy the car. This previous loan remainder is called “negative equity” at the time of the new vehicle purchase.
You are in the red on the date of purchase. You are driving home with a new car but from Day 1, because you are paying for the remainder of the first loan on top of the new loan. As a result, your monthly payments will be higher, and your interest rate will probably be higher too. You are even more “upside down” than before buying the new car.
In 2014, 27% of consumers who traded in a vehicle still owed money on the vehicle, and they carried an average negative equity of $4,257.¹ Many carry negative equity from car to car.
Suppose that your new car turns out to be a “lemon”. The manufacturer is offering to buy the car back, i.e., refund the price of the car, less a mileage deduction. Here is where your negative equity becomes a real obstruction: in exchange for the purchase price, you have to surrender the vehicle with a clear title, but you still owe, say, $4,000 over the price of the car due to the prior loan. In order to have the car bought back, you would have to pay that $4,000 at the time of the car surrender. You are now in a paradoxical situation where you have to pay to have the car bought back. Those who cannot pay the negative equity are essentially stuck with their lemon. Worse, the car they traded in was probably just fine.
¹ Upside Down and Under Water on a Car Loan, by Philip Reed, Senior Consumer Advice Editor for Edmonds.com