It’s common wisdom among car buyers that you lose a portion of a new car’s value when you drive it off the lot. Despite this, sometimes it still makes sense to buy a new car. But if you don’t have much of a down payment and you have to finance at a higher rate, it’s possible that you could owe more than the car is worth for a long time.
In some cases, it makes more sense to simply lease a car. But customers who still want to buy can end up “underwater” on their car, owing more than it would resell for.
What is negative equity?
Being “underwater” on a car, or having “negative equity”, simply means that the car isn’t worth what you owe on it. As a buyer makes payments, they eventually bring the amount of their loan under the amount the car is worth since payments outpace depreciation after the initial purchase drop.
Historically, this has been an indicator that a buyer simply purchased too much car, spent too much, couldn’t get a reasonable finance rate, or bought a new car too quickly. It’s fine to have negative equity on a car after purchasing it for a while, but trading it in while you’re still “upside-down” on the car means you’ll owe the additional amount as part of your new loan.
A recent article from Edmunds demonstrates a worrying rise in negative equity for car trade-ins. Not only are more negative vehicles being traded in, but they’re also generally showing higher amounts owed. This would generally be cause for concern, as the amounts owed are added onto the customers’ new loans and lock them into even longer terms.
In a country that’s already experiencing unprecedented economic fallout and widespread unemployment, things appear to be worse than usual in the auto industry.
The upside of negative equity in the auto industry
However, things aren’t as bad as they seem. Many “underwater” vehicles are being traded in because auto manufacturers and dealerships are offering unprecedented deals. If you’ve been eyeing a new vehicle and there’s suddenly an 0% interest offer (or even something better), why not make the leap?
But dealer incentives and generous financing don’t explain all the numbers. While many customers are shrewdly taking advantage of the opportunity, many others are making ill-informed purchases that may hurt their financial security down the line.
The uncertain economy makes this a great time for dealers to take on additional discounts, but they’re also luring in some customers who simply can’t afford to be further upside down on their cars.
Why do customers trade-in upside-down cars?
Some buyers don’t have the luxury of deciding when they want to buy a new car. A costly repair or worse, like an accident, can force the customer back to the dealership before they expect.
Even a lease ending at an inopportune time can create a situation where someone is stuck purchasing a vehicle. The auto industry is doing everything they can during this difficult time to pay their bills and get customers in a new car, and plenty of buyers are bringing in cars with negative equity.
The auto industry dates back over a century and hopefully the pandemic will simply be a footnote in its history. But on the dealership floor right now, people on both sides of the desk are struggling.
For a lot of buyers, trading in a vehicle with negative equity makes sense. And dealerships are willing to take these vehicles in trades to get another one out the door. Generous offers like 0% financing and cash back make it a reasonable option to purchase a new car, even in the middle of a pandemic. But it’s the cars coming into the dealership that tell the worrying story.