Negative equity occurs when the amount owed on a loan surpasses the car’s current value.
Car owners who purchased vehicles during the pandemic are facing a growing problem known as negative equity
Many individuals, including Atlanta resident Morgan Nichole Scott, find themselves in this predicament after buying cars at inflated prices due to the surge in demand and limited inventory. Scott, a single mother of four, experienced difficulties when she attempted to trade in her car at a dealership. They refused to accept her vehicle as a trade-in unless she paid the negative equity, which would have meant taking on an additional $1,300 monthly payment for a new car. This situation is not unique to Scott, as automotive research firm Edmunds reports that the average negative equity value of auto trade-ins increased by nearly 24% in April 2023 compared to the previous year.
The pandemic contributed to this negative equity trend through microchip shortages and supply chain disruptions, leading to a scarcity of new cars and soaring prices for both new and used vehicles. Stimulus payments and reduced consumer spending temporarily alleviated financial strains for some individuals, prompting them to take on higher loans.
Chris Kleczynski, head of product for automotive lending at PenFed Credit Union, believes negative equity will become a more significant issue as used car prices continue to drop. The problem arises when car owners attempt to sell or trade in their vehicles, as they must cover the negative equity difference. Refinancing at lower interest rates or paying extra on the loan principal can help reduce negative equity over time.
For those unable to keep a car with negative equity, rolling the negative equity into a new loan may be the only option, albeit an expensive one
Chris Kukla from the Consumer Financial Protection Bureau advises individuals to reduce the amount of negative equity rolled over by using online pricing guides and comparing lenders to find the best rates. Refinancing at a lower interest rate and payment is another possibility, but it may not be feasible for everyone in the current rising rate environment.
Car owners facing negative equity are urged to assess whether replacing their underwater vehicle is a necessity or a desire. By evaluating their needs, they can determine the best course of action to address their negative equity situation.