A negative equity loan is a loan balance that exceeds the market value of your car or home. In other words, you owe more than what you own. This often happens when something you buy with debt loses value faster than you pay down the loan balance.
Negative Equity Auto Loans
With most standard auto loans, you pay down the loan balance over a set period. A portion of each monthly payment goes toward interest costs, and the remainder goes toward the loan balance. Eventually, you pay off the entire auto loan balance. This process is called amortization.
Auto loans can become negative equity loans when the car loses value faster than you are paying down the loan balance. For example, a brand-new car might cost $25,000. After a few years, its value might drop to just $15,000 (cars tend to depreciate quickly). If you still owe more than $15,000 on your car loan at that point, you have a negative equity auto loan. If you decide to sell the car, you might have to pay extra money – by writing a check, for instance – as you may only be able to get $15,000 for the car, but owe more than that on the loan.
To avoid this issue, you need to pay down the loan (or finance it) faster than the depreciation of the car’s value.
Negative Equity Home Loans or Underwater Mortgages
Most people expect real estate values to rise over the years, but that is not always the case. Property values can decline for various reasons. Major economic events like a recession can cause property values to drop, and local factors can affect smaller areas. Even a single home in a strong market can lose value if there are structural issues or other unique problems with that property. If your home’s value drops, and you owe more on the mortgage than the property is worth, you will be underwater on that mortgage.
Reverse Mortgages
Price changes are not the only risks. Certain types of mortgages can become “underwater” – another term for negative equity – if your loan balance increases over time. When you do not pay enough each month to cover the interest costs on your loan, those costs can be added to your loan balance. This is particularly likely when you make no payments at all, as in the case of a reverse mortgage.
When using a reverse mortgage, being underwater may not be catastrophic. In many cases, you or your heirs may not have to pay off the loan balance, but check with your bank to avoid any surprises.
What Happens If I Sell My Negative Equity Car or Home?
Auto Loans
If you owe more on your car, you have several options for selling it. If you can pay off the amount due, that is ideal. Contact your lender to discuss the details of settling the loan along with selling the vehicle. If you are trading in your car or financing the purchase of another vehicle, it may be possible to roll the amount due into your new auto loan.
Note: Rolling your old car debt into your new car loan can be risky. You will have negative equity from the start, so it does not really solve the problem. Eventually, you will have to pay off that debt, but this strategy may help you buy some time.
Loans
Homes
If you are underwater on your home loan, you may still be able to sell your home. A short sale allows you to sell the property for less than the amount owed with your lender’s permission. The question is whether you will need to pay back the difference between the amount owed and the sale price of your home.
In some states, known as non-recourse states, you may not owe any money for the deficiency – the difference when the property value is less than your loan balance. However, in many states, lenders can try to recover the difference from you. This means the loan can linger after the sale. A licensed attorney may be able to help you in this situation.
How to Handle an Upside-Down Loan
If you find yourself owing an upside-down loan, you’ll be facing tough decisions.
Keep Your Property and Repay the Loan
One option is to keep your car or home and continue making payments on the loan. Unfortunately, this isn’t always possible. Expensive repairs can make the car more trouble than it’s worth. Or you may need to relocate and sell your home for various reasons.
Note: When dealing with an upside-down car loan, it may be appropriate to use gap insurance to manage your risk.
Sell and Repay
Another option is to sell – just to end things. The bad news is that selling won’t bring in enough money to pay off your loan, so you will have to come up with the remaining cash or expose yourself to the deficiency.
If you’re selling the car, it may be best to sell it yourself. You may be able to sell the car for a higher price to a private buyer than selling it to a dealership.
Negotiate
You may be able to reach an agreement with assistance from your lender. Discuss your situation with them and with loan officers from your local bank or credit union. One option may be to sell your car and pay off the remaining balance over time. You can also consider a voluntary repossession. You won’t have a car anymore, but if you pay the proceeds of the sale to your loan balance, you will have less debt to pay off.
Note: Always think about how the option you are considering will impact your credit score.
Make Extra Payments
It may be easier said than done, but if you have extra funds available, it may make sense to use them to pay down your loan balance more quickly. This can provide flexibility and allow you to sell when you need to without seeking permission from your current lender.
Refinance
If you are borrowing at high interest rates, it may make sense to refinance into a better loan. If you qualify for lower rates, you will pay less in monthly interest. As a result, this can create a bigger gap in your loan balance, and you may return to normalcy faster.
Conclusion
When you owe more than something is worth, it’s called being upside-down – and you’re in a tough position. There are usually several options for getting out of an upside-down loan, but none of them are appealing. The ideal is to pay off underwater loans out of pocket, but this isn’t possible in most cases. If something happens (and you need to sell your car or home before you can pay off the debt), contact your lender to discuss the options available to you.
Source: https://www.thebalancemoney.com/upside-down-loans-315585
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