Car Loan Negative Equity Explained

Our guide explains negative equity in car loans, how to avoid it, expert insights and practical tips to help you avoid financial difficulties from a car loan.

Updated 17 March 2024

Summary:

Negative equity is a common financial situation for anyone with a car loan. It's often described as being "upside down" and occurs when the balance owed exceeds the vehicle's current market value.
Negative equity is a straightforward concept but has implications for car owners. Many New Zealanders quickly find themselves underwater when buying a car, which, alongside car repayments, can become stressful.
We've published this guide to help explain why understanding negative equity is important if you're considering financing a car or have a car loan already.

Our guide covers:

How Does Negative Equity Occur? How Common Is It in Car Loans?
Does My Car Loan Have Negative Equity?
Why Does Negative Equity Matter? What are the Risks?
Understanding the Options if You Have Negative Equity
Frequently Asked Questions

Know This First: Getting out of negative equity takes commitment and financial sacrifices:

If you're facing negative equity in your car loan, speeding up your repayments is the most effective action. This doesn't just mean paying on time, but paying extra whenever possible to counterbalance what you owe to your lender with the value of your card.
Every extra dollar you put towards your loan will lower your negative equity - we suggest going through your bank account and credit card payments and identify areas where you can cut back, and channel that money towards your car loan to get your loan and your car's value back in sync.

Car Loan Expert Founder Christopher Walsh highlights the risk of immediate negative equity with a new car loan:

"Negative equity often occurs when a new car requires a small deposit. Given the ads in the Herald, Stuff, and other media promoting 'zero deposit' car finance deals, it's not hard to owe more than your car is worth when 100% loans appear to be the standard way of buying them.

New cars almost always lose a substantial part of their value quickly - sometimes as much as 20% in the first year. This depreciation combines with low deposit loans to ensure you owe more on the car than its current value. When you sign up for a long-term loan (such as six or seven years), the higher the risk of negative equity in the first few years of the loan.

Car loans are, for many New Zealanders, hugely financially crippling. If a financed car later becomes a liability, selling it despite having negative equity might be financially sensible if it's in poor condition and becoming a money pit due to extensive repairs. However, you'll need to find the money to settle the balance on your lender's terms.

Before signing any car loan contract, it's crucial to carefully consider the financial implications of low or no deposit car loans, especially when it comes to new cars. Cars sink in value fast - don't fall into the negative equity trap".

How Does Negative Equity Occur? How Common Is It in Car Loans?

Depreciation, deposits and the loan term length cause negative equity in car loans. We explain these in detail to help you make an informed decision about a car loan.

1. Depreciation: The Silent Factor

Anyone buying a new car will find it starts losing value as soon as they drive it home – this is depreciation. New cars can lose a significant portion of their value in the first few years, often as much as 30% in the first year alone per this Consumer report.
This rapid decline means the car's market value drops quicker than the loan balance decreases, especially in the initial years. If you finance the full purchase price of a new car, you're likely to face immediate negative equity, often around 20%, right from the first week.
This rapid depreciation is a significant factor when taking out a car loan, given you're underwater from day one.
The good news is that used cars typically depreciate at a slower rate. If you're looking to buy a used car and finance the purchase price, you're less likely to encounter the same degree of negative equity as quickly as with a new car purchase.

2. Deposits: The Less You Offer, the Riskier the Car Loan

Opting for a small or zero deposit can seem attractive initially but increases the risk of negative equity. A lower deposit means you're financing much of the car's cost. As the car depreciates, you might owe more than its current worth, pushing you into negative equity.

3. Loan Terms: The Longer, the Riskier (and Costly)

Longer car loan terms, while offering lower monthly payments, can also contribute to negative equity. This is because there's more time for the car to depreciate. If the car's value falls faster than you're paying off the loan, negative equity becomes a real possibility, especially in the later stages of a long-term loan.
There is also the added cost of paying more interest overall by having a longer loan term, as outlined in our car loan repayment guide.

Does My Car Loan Have Negative Equity?

Determining if your car loan is in negative equity is straightforward. Start by finding the current market value of your car - there are several free tools available for this:

Trade Me's Value My Car tool: A popular choice for getting a quick estimate.
BestCar tool: Offers another perspective on your car's market value.
ValueMyCar.co.nz: Provides additional data points.

Know This: The values you receive will likely vary - MoneyHub's car valuation guide provides further guidance. Once you have an estimate of your car's current value, you'll need to subtract the balance remaining on your car loan. If the result is negative, meaning you owe more on the loan than your car's current value, you are in negative equity.

For example, if your car's current market value is $15,000, but you still owe $18,000 on your car loan. In this scenario:

$15,000 (Car's Value) - $18,000 (Loan Balance) = -$3,000
This negative balance of $3,000 represents your negative equity and indicates that you owe $3,000 more than what your car is currently worth.

Why Does Negative Equity Matter? What are the Risks?

Negative equity can have substantial financial implications, particularly when you're looking to sell or trade-in your car, for the following reasons:

Challenges in Selling or Trading: If your car is worth less than the amount you owe, selling it or trading it in becomes financially challenging. You must cover the gap between the sale price and your loan balance out of pocket.
Rollover Debt on New Car Loans: If you're buying a new car and have negative equity on your current car, you might be tempted to roll the existing debt into your new car loan. This practice increases the total amount you owe, potentially leading you into a cycle of negative equity and a debt mountain that is expensive to pay off.
Increased Financial Burden: Rolling over debt can also mean higher loan amounts and potentially higher interest rates, leading to increased monthly repayments. Car loans are expensive enough without negative equity rollovers, which almost always strain your finances, especially if your new car also depreciates quickly.

Important: How to Minimise the Risk of Car Loan Negative Equity

The 'best' car loan has a low interest rate, affordable monthly payments and an outstanding balance well below your car's value. Our suggested methods minimise the risk of having a car loan that drags you under:

Put down a substantial deposit: A larger deposit reduces the borrowed amount, lowering the risk of negative equity. We suggest considering at least 20% of the car's purchase price as a down payment.
Choose shorter loan terms: Too many New Zealanders lock in their car loan for too long, and the total interest costs rack up and are outrageous. Although longer loan terms mean smaller monthly payments, they increase the likelihood of negative equity due to longer interest accrual and slower principal repayment. This is why we like shorter loan terms, which help to keep you ahead of the car's depreciation curve and minimise the total interest costs you'll pay.
Maintain the car: The better you maintain it, the higher its resale value. Regular maintenance, careful driving, and keeping the car clean can help retain more of its value. This way, even if you decide to sell or trade in the car, you're more likely to get a price closer to your loan balance.

Understanding the Options if You Have Negative Equity

Most people who owe more to their car lender than the car's worth will continue to make repayments until the loan is repaid in full. However, if you're looking to sell your car with finance owing, you'll want to maximise the sales price to minimise the shortfall of the car loan.

For most people, this will involve listing the car and selling it privately, given that it's likely to get a higher price than trading it in at a dealership.

Warning: We strongly suggest resisting the temptation to roll the negative equity into a new car loan. This only increases your debt and total interest costs and can lead to a cycle of negative equity. While few lenders in New Zealand offer this arguably dangerous debt, rolling the negative equity may be tempting to fast-track with a purchase.

If you have negative equity and your car is stolen or written off, the situation can become complex and financially stressful because the loss is 'realised,' meaning you must immediately deal with the cash shortfall while arranging another car. The standard process is as follows:

Understand your insurance cover: If your car is written off or stolen, comprehensive car insurance will come into play. These insurance policies typically cover the car's market value at the time of the incident, not the amount you owe on your loan.
GAP insurance addresses this risk: GAP (Guaranteed Asset Protection) insurance covers the difference between what your comprehensive policy pays and what you still owe on your car loan. If you have negative equity, GAP policies pay the difference - our guide to GAP Insurance explains more.
Dealing with the loan balance: You'll be responsible for the remaining amount if the insurance payout doesn't cover the entire loan balance (which is likely if you have negative equity). This can be a significant burden if you're without a car but still have to continue making loan payments.
Negotiating with lenders: If it's clear you owe money to the lender after getting your insurance payout, you'll need to talk to them upfront if you're going to struggle to make an immediate payment. Lenders usually offer options like loan extensions or deferred payments to help manage the financial strain.

Frequently Asked Questions

Can negative equity affect my credit history?

While negative equity doesn't directly affect your credit profile or history, how you manage your car loan does. If you continue to make timely payments on your car loan despite having negative equity, your credit history remains unaffected.

However, if you struggle with payments or default on the loan, this will be added to your credit profile and negatively impact your future borrowing applications.

Can refinancing help with negative equity?

Refinancing a car loan with negative equity is challenging but not impossible. You'll need to find a lender willing to refinance the loan amount that exceeds the car's value.

This will almost always come with higher interest rates and stricter terms, meaning it may not be cost-effective.

Are there any special considerations for Electric and Hybrid cars with negative equity?

Electric and hybrid vehicles depreciate differently than traditional cars, which can impact how quickly you find yourself in negative equity (and the extent of it).

When financing such vehicles, it's crucial to consider their specific depreciation trends and market demands.