Trading in your Car? Here’s what you need to know about negative equity and your insurance.
If you’re about to trade in a vehicle you still owe money on, and the trade-in value doesn’t equal what you still owe on the loan, here’s an important thing to consider before you roll that debt into your new vehicle’s finance contract. Your automotive policy will not cover the loan amount, just the value of your new vehicle.
Negative equity – sometimes referred to in the car sales business as being “upside down” – means that the value of your vehicle as a trade in is less than the amount you still owe against the loan you took out to pay for it.
This scenario was never much of an issue 10-15 years ago, but the market desire for lower monthly payments has led to automakers offering extended term finance contracts, some as much as 84 and even 96 months. That makes a vehicle more affordable on a month-to-month basis, but obviously costs more in interest by the end of the term. It also means the time it takes you to reach a state of equity – where the vehicle is more valuable than the outstanding balance of the loan – longer. Often, drivers are ready for a new vehicle before that equity level is reached.
Let’s say you trade in your vehicle and receive $15,000 from the dealer, but still owe $18,500. Subtract what you get in trade against the loan and you still owe whomever financed the vehicle $3,500. More often than not, you’ll be presented two options: pay the balance in a lump sum; or, roll the difference into the financing contract for your new vehicle. The roll-in seems an attractive option from a cash flow perspective, but has implications if your vehicle is involved in an accident and written off as a total loss.
Recently, someone we know rolled over $10,000 from their previous loan into the financing contract for a new vehicle valued at $40,000. So, while the vehicle was worth $40,000, they actually were making payments on a $50,000 car loan. Then they were in a bad accident, and their new vehicle had to be written off. The insurance company promptly paid out the maximum policy limit for the new vehicle, but the driver was still on the hook for the $10,000 difference rolled into their contract from their previous loan. They now must pay that $10,000 out of pocket, or secure financing through another lender to pay it off, because they only have coverage for the listed vehicle on the policy, and NOT the value of the loan against it.
There are dealerships that provide a product known as “gap insurance” to cover the difference, but your auto policy will not – it’s not even an optional add-on.
Here at DPM Insurance Group, “Your Security – Our Responsibility” means we’re also here to provide you the insurance information you need to help you make a decision. If you’ve been vehicle shopping and are prepared to make a purchase, give one of our brokers or CSRs a call BEFORE you close the deal, and we can let you know everything you need to make the best decision for you… and your wallet.