Is Your Interest Rate Causing Negative Equity?

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Contributing Writer

Bethany Hickey is a graduate from the University of Michigan-Flint, with a bachelor’s in English-Writing. She is a content writer for Auto Credit Express, CarsDirect, and many other automotive blogs, as well as the Poetry Editor for UM-Flint’s writing magazine.


, Contributing Writer - November 9, 2020

When you take on a bad credit car loan, there’s a chance that you have a high interest rate. A high interest rate can make it hard to stay out of negative equity, but we have some tips to stay above water on your auto loan.

How Your Car Loan Interest Rate Can Lead to Negative Equity

If you aren’t paying off your car loan quickly enough to combat high interest charges, then you could risk putting yourself in a negative equity position. Negative equity is when you owe more on the vehicle than it can sell for or what it’s actually worth.

A lot of things can cause negative equity, like depreciation, overpaying for a car, or not having a down payment, but a high interest rate can really put you at risk. With an auto loan that has simple interest (most do), you’re charged interest daily on the balance of your car loan. The higher your loan amount, the longer your auto loan, and the higher your interest rate, the more time you’re likely to spend in negative equity because these things increase the overall cost of your loan.

A higher interest rate can stack up charges quickly. If your interest rate is in the double digits, like many bad credit borrowers, then it’s in your best interest to focus on decreasing your interest charges to get back into an equity position.

Combating Negative Equity

There are multiple ways to combat negative equity. You can pay extra on your auto loan whenever you can, or round up your payment to catch up to or exceed your vehicle’s actual cash value. Most car loans nowadays don’t come with prepayment penalties, but check with your lender to be sure.

A common tactic many borrowers take to pay off their auto loan early is rounding up their monthly payment. Say your payment is $318, you could round up to $350 and pay down your loan quicker. It’s not that much extra cash, but you’d pay off an extra $384 on your car loan over the course of a year.

Some borrowers also pay on their vehicle twice in one month: pay half of the monthly payment early in the month and the other half at or around the due date. This is called payment splitting, and it lowers the amount of interest that adds up over time.

Whenever you get a windfall of cash, like from a tax refund, you could pay down your auto loan even faster. If you can’t round up every month or use the payment slitting method, then pay extra whenever you can – every little bit can make a difference in the long run.

Lowering Your Auto Loan Interest Rate

If you think it’s going to be hard to pay extra on your car loan each month, or you just don’t have that type of room in your budget, then consider refinancing. Refinancing is when you replace your current auto loan with another one, usually with a lower interest rate or a lengthened loan term.

Often, bad credit borrowers start a car loan with a higher interest rate, then once their credit score is better from managing the auto loan well for a year or two, they refinance and get a lower interest rate.

To refinance your vehicle, you need to meet some requirements:

  • The car loan is at least one year old
  • The vehicle is less than 10 years old and has fewer than 100,000 miles
  • Your credit score is better than it was when you started the loan
  • You don’t owe too much or too little on the car
  • You’re in an equity position

To be able to refinance, you can’t be in negative equity. It’s not ideal, since high interest rates can cause negative equity, but if you can work to get your loan balance at least equal to the vehicle’s value, then you could qualify for refinancing.

Repairing Your Credit Score With a Car Loan

Many borrowers who need bad credit auto loans have had some credit issues in the past, or they’re new borrowers. While having a negative equity car loan isn’t the best feeling, that loan can still repair your credit if it’s being reported to the credit bureaus.

Even if you owe more on the vehicle than it’s worth, each on-time payment improves your credit score. Another thing you should remember is that nearly every negative mark on your credit reports drops off after seven years. Bad credit doesn’t have to stay bad forever! Once your credit score is improved, you can increase your chances of getting approved for better interest rates on your future auto loans.

If you have a car loan that isn’t being reported, then consider a subprime auto loan. Subprime lenders assist borrowers who’ve had credit issues, bankruptcy, or those who are just starting their credit journey. Their loans are reported, so while you take on a bad credit car loan, you’re working to rebuild your credit history.

To get matched to a dealership with bad credit resources, complete our free auto loan request form. CarsDirect knows that it can be a hassle to find a lender that’s willing to assist borrowers with poor credit. We make finding a dealer easier by finding one in your area that has the resources you need without any obligation and at no cost to you. Get started now!

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, Contributing Writer

Bethany Hickey is a graduate from the University of Michigan-Flint, with a bachelor’s in English-Writing. She is a content writer for Auto Credit Express, CarsDirect, and many other automotive blogs, as well as the Poetry Editor for UM-Flint’s writing magazine.


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