Negative equity can be a scary thought and predicament. Many people understand negative equity in other markets. They think of the housing market and other high end loan markets. When the value of the asset is less than the outstanding balance of the loan, people get scared. They feel as though they are losing money.
Those who want to purchase a car can be worried. They think about taking in their car to trade it in for a new one. They come to realize that they actually owe more on the car than it is worth. When they trade in a car, they could still owe thousands on the vehicle. Fortunately, negative equity with car loans does not matter in most situations.
The Initial Drop
Negative equity occurs with every single car that is purchased and put on a loan. Cars lose their value over time. As soon as the car is purchased, it loses some value. This means the car that was just purchased for $20,000 may only be worth $16,000 as soon as you take it from the dealership to your home. This is negative equity. You still owe the $20,000 of the loan, but your asset (the vehicle) is only worth $16,000. Over time, this evens out.
Long Loan Payment Schedules
Long loan payment schedules stretch out the negative equity even further. In general, the further along the payment schedule you are, the closer to even (or above) the asset will be. If you have acquired a 5 or 6 year loan, you will have a longer period of negative equity. You are paying less on the car per year, which means you take more time to hit the even number of debt to asset value.
When to Worry
If you are planning on selling your car soon after you get it, you should worry. When you attempt to sell a car within the beginning stages of the payment cycle, you are likely to owe more on the vehicle than it is worth. If you need to sell the car, you will be losing thousands of dollars by selling it.
When to Relax
If you are selling a car that you have had for a long period of time, you are fine. If you are on the final payments of your vehicle, you will not owe more on the loan than the car is worth. The negative equity will vanish over time, and is something that does not need to be worried about.
It is important to realize that, for a brief amount of time, your car loan will be "under water". This means that you have negative equity. Every car will have negative equity, as long as the bulk of the car is paid for through a loan. Unless you plan on selling the vehicle (or lose the vehicle due to missed payments), the negative equity will not affect you. Eventually, the numbers will even out, and you will not be "underwater" anymore.