Doing This Doubles Your Risk of Getting Your Car Repossessed
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A car is a vital purchase for most people since most people need transportation to get around. And, since cars are pretty expensive, it's very common for people to take out a loan to finance their vehicle.
Unfortunately, if you're borrowing to buy a car, there's one move you likely don't want to make. That's because it doubles your risk of getting your car repossessed.
Your car is more likely to be repossessed if you finance negative equity
According to a recent study from the Consumer Financial Protection Bureau, consumers who finance negative equity are more than twice as likely to find themselves facing repossession of their vehicles within two years compared to drivers who have a positive trade-in. They were also 1.5 times as likely to have their car repossessed compared with car buyers who did not have a trade-in at all.
So, what does this mean exactly?
Equity is the value of the car that you own minus any outstanding car loan balance. If you owe $1,000 on a $10,000 car, you have $9,000 in equity.
In some cases, people find themselves owing more than the car is worth. This may happen because they didn't put money down and stretched out their loan for a long time and didn't make much progress in debt paydown. If you owe more than what you could sell the car for, you have "negative equity."
When you go to buy a new car, you have to deal with the outstanding car loan balance. If you have negative equity, you can't trade in or sell your current car for enough to do that. So, some dealers and lenders allow you to finance negative equity. You can take on a larger loan to pay back what you still owe your past lender.
For example, let's say you own a car worth $20,000, you owe $24,000 on the vehicle, and you're buying a new $40,000 car with no additional down payment. If you trade in the car, you'd only get $20,000 for it -- but you'd need to pay off $24,000.
When you finance negative equity, that means you could get a car loan for $44,000 so you'd have enough to buy your new car and pay off the extra $4,000 left on your existing loan.
Why is financing negative equity so bad?
Financing negative equity can get you into financial trouble. You'll immediately owe more on your new car than what it is worth. So, you will likely be underwater on your new loan for a long time as a result.
The fact that you have negative equity and are financing another car already could also suggest you're living beyond your means. After all, you still owe on your current car and are already borrowing to buy another one.
Your car loan balance will also be higher, so your payments will be higher. So you may struggle with making them out of your checking account each month.
These are some of the key reasons why financing negative equity isn't a good idea -- and why your chances of repossession are higher if you do it. Rather than make this move, work on paying off your current car ASAP, including sending extra payments if you can.
You should also consider keeping your current car for a long time unless there's a reason not to. This way, you may be able to pay your loan down, keep driving the vehicle, and eventually end up without a car payment so you can devote your money to more important goals.
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