The Negative Equity Dilemma and Lemon Law


It’s an unenviable position to be in. You need (or want) a new car, but you still owe money on the car you’re driving. That problem’s compounded when you owe more money on the car than it’s worth. Then you’re in what’s called a “negative equity” position. Often, people who are in a negative equity position (or those who are told they are) find themselves in a never-ending downward spiral. They trade their negative equity car in and tack on the amount they still owe to the next car loan. A few years later, they go to trade that car in and are in an even worse negative equity position. And so forth and so on.

You might never have thought about the negative equity issue until you find out that your new car is a lemon. When you demand that the manufacturer buy it back (either through state-sponsored arbitration or court) the manufacturer will most likely take the position that it is not liable to pay you back the negative equity from a prior vehicle. In other words, you may be able to get rid of your lemon car, but you may still end up getting stuck with the negative equity from the vehicle you traded in.

If that sounds unfair, it most likely is. A number of state courts in states like Florida, Ohio and New Jersey have decided that a manufacturer must repay the negative equity when it buys back the car. But decisions are not uniform, and in states where the law is in flux, manufacturers take the position that negative equity is your problem.

Yet, the whole issue of negative equity is more complex than it appears. Here are some factors to consider, as well as some guidance about how to avoid or get out of a negative equity situation.

Are You Really in a Negative Equity Position?

Many times, people believe they have negative equity in their car because a car dealer tells them that it’s so. Car dealers often tell potential buyers that their cars are worth less than they truly are because the less a dealer has to pay for trade-ins, the more profit he will make. So, before you go car shopping, it’s important to know how much your current vehicle is worth.

There are a number of ways to determine the value of your vehicle. One way is to go to Kelley Blue Book. You can enter your vehicle information and zip code, and receive three values: trade-in value, private party value, and suggested retail value. You can also check on eBay motors or in your local newspaper to see what the asking and sales prices are for vehicles like yours.

Next, contact your lender and determine the payoff amount for your car loan. You can then subtract the payoff amount from the trade-in value and see whether or not you’re in a negative equity position. Having all of this information prior to shopping for a new or used vehicle will give you much more negotiating power.

If You’re in a Negative Equity Position

If you are already in a negative equity position, either because of your current car loan or a rollover from a previous loan, your best option is to avoid buying another vehicle until you can get rid of the negative equity. You can accelerate this process by making additional, principal-only payments on your car, or by using your tax refund or tax rebate to help pay down your loan.

If you are unable to wait until you’ve built up equity in your current car, you can use manufacturer’s cash rebates and incentives to pay down your negative equity. If you’re in the market for a used car, do your research before signing on the dotted line. You can enter information about the car you’re considering into Kelley Blue Book will give you the suggested retail value of the vehicle. Although new cars come with a “sticker price,” the price of used cars is most often at the discretion of the dealer, so make sure you have all of the information you need in order to negotiate a fair deal.

How to Prevent Accumulating Negative Equity

There are a few simple measures you can take to stop the snowball effect of negative equity before it starts. The first, and most obvious, is to live within your means. Don’t buy a vehicle that you can’t afford. Second, keep your loan term as short as possible. A seven-year car loan almost always puts a consumer in a negative equity position. In the long run, it’s easier to buy a less expensive car and build equity that you can then use to trade up a few years down the road.

Lastly, understand and compare your financing options before you buy. Before you go to a dealership, visit or call your credit union and bank and see what kinds of financing and terms they can offer. When you get to the dealership, make sure to negotiate the sales price of the vehicle separately from any financing package. When you review the dealer’s financing options, compare them to the offers from your credit union and bank. Ensure that you’re comparing apples to apples. If you’re not sure which is the best deal, don’t hesitate to take a few days to think about it. A good deal today will still be a good deal two days from now; dealers who put you into a “now or never” position are simply using high-pressure sales tactics. Don’t fall for it!

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