Demystifying Car Equity: Positive and Negative Equity Explained

Understanding car equity is crucial for anyone looking to buy or sell a vehicle. Whether you're considering trading in your car or selling it, knowing whether you have positive or negative equity can significantly impact your financial decisions. In this blog post, we'll break down the concepts of positive and negative equity, why they occur, and what steps to take in each scenario.

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What is a Lien?

A lien is a legal claim placed on your vehicle by a bank or financial institution when you borrow money to purchase it. This lien serves as a way to protect the lender's interest until the loan is paid off. As long as there is an outstanding balance on your car loan, the lien remains, and you cannot sell the vehicle without clearing this debt.

Understanding Positive and Negative Equity

Positive Equity: Positive equity occurs when the market value of your car exceeds the balance of your loan. In simple terms, your car is worth more than what you owe on it.

Negative Equity: Conversely, negative equity arises when the market value of your car falls below the balance of your loan. In this scenario, you owe more on your car than it's currently worth.

Why Can a Vehicle Have Negative Equity?

Negative equity often occurs when you haven’t owned your car for a long time. New cars depreciate rapidly, especially within the first year. Additionally, during the initial stages of your car loan, a significant portion of your payments goes toward interest, making it challenging to keep pace with depreciation.

In early 2022, used car market values reached all-time highs due to a chip shortage and low-interest rates, reducing the likelihood of negative equity. However, with current high-interest rates and cars returning to more typical depreciation levels, negative equity may become more common during the early stages of a loan.

Positive Equity: What to Do

If you find yourself in a positive equity situation, where your car is worth more than your loan balance, you're in an advantageous position. When selling your car with Autozen, we can assist in clearing the loan. We'll handle the payment to the financial institution and provide you with the remaining balance.

Negative Equity: What to Do

Selling a car with negative equity may seem daunting, but it can be a wise decision in certain situations. For instance, if you no longer need the vehicle (e.g., you have two cars in the household and just need one), selling it might make sense. While it may require upfront cash to cover the shortfall, it can save you money in the long run.

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Consider this example:

Imagine you owe $25,000 on your car with a $500 monthly payment, and the current market value is $22,000. In this scenario, you have negative equity of $3,000. However, you have the option to sell the car right away, even though it means covering the $3,000 shortfall. By doing this, you may think you're losing that $3,000 upfront. But consider the alternative.

Let's explore what happens if you decide to keep the car for a year while making your monthly payments of $500. Over the course of that year, you will have spent a total of $6,000 on payments. After making these payments, your loan balance is reduced to $19,000. However, during this time, the market value of your car continues to depreciate. Let's say it depreciates by 10%, which amounts to $2,200. So, after a year, your car is now worth $19,800. In this alternative scenario, you have positive equity. Your remaining loan balance is $19,000, while your car's current market value is $19,800, resulting in positive equity of $800. 

Sounds great? Not so fast!

Let's compare the two options again:

  • Option 1: Selling the car now results in a $3,000 loss, but you no longer have the car, and you've resolved the negative equity situation.

  • Option 2: Keeping the car for a year has cost you $6,000 in payments. You are making $800 when you are selling the car so you ended up spending $5,200 net on that car. You are $2,200 behind compared to if you had taken care of negative equity upfront. This calculation still doesn't include other potential costs of keeping the car, such as insurance fees or issues related to a vehicle that's not being used, such as battery problems

Dealing with Negative Equity When Replacing Your Vehicle

If you plan to replace your vehicle and don't have enough cash to cover negative equity, some dealers may allow you to roll that negative equity into your new car loan. While this may seem like a solution, it can lead to increased debt and financial strain.

In such cases, it's essential to be realistic. Consider getting a car that is worth less than your current vehicle or even postponing the replacement until you can manage the negative equity without rolling it into a new loan. Rolling over negative equity can result in paying interest on both the new car and the shortfall, putting you in a deeper negative equity scenario.

Free Man and Woman Talking in Car Salon Stock PhotoAutozen Transaction Statistics

At Autozen we’ve completed thousands of transactions, and we've assisted in clearing loan balances for approximately 30% of the cars we've helped consumers sell. This indicates that more than two-thirds of our consumers have already paid off their loans and own their cars outright, a number that has remained stable over the last two years.

Among consumers with a loan, approximately 75% had positive equity, while 25% had negative equity. These numbers have fluctuated slightly but are trending well, with only 22% of consumers experiencing negative equity in the last three months. This stability in the context of accelerating depreciation levels and higher interest rates for newer loans shows that consumers are making informed decisions in relation to their individual circumstances when selling their cars.

Using Autozen's Valuation Estimate Widget

Before making a decision about selling your car, you can utilise Autozen's Valuation Estimate Widget. This tool allows you to get an estimate of your vehicle's current market value. By comparing this estimate to your outstanding loan balance, you can quickly determine whether you're in a positive or negative equity scenario. This information can be invaluable in making informed choices when it comes to selling your car.

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Car equity, whether positive or negative, plays a significant role in your financial decisions when buying or selling a vehicle. Being aware of your equity status and understanding your options empowers you to make the best choices for your situation. Whether you're in positive or negative equity, Autozen is here to assist you in navigating the process, ensuring a smooth and informed car-selling experience.