Here’s What Happens When You Have Equity in Your Car

A car is an expensive purchase for many people. As a result, it's common to take out a loan to buy one. But, as you pay down your loan balance, you will accrue equity in your car. Having equity in your car is a great thing for you. It means you have one less financial worry. Drivers with equity may also be able to cancel a specific kind of auto insurance.

Here's what it means to have equity in a car, along with some tips on how this can affect both your finances overall and your auto insurance needs.

What does it mean to have equity in your car?

Equity is the gap between what your car is worth and what you owe on it. For example, if you have a car worth $20,000 and you only owe $10,000 on the vehicle, this means you have $10,000 worth of equity.

You can have positive equity, like the example above. And that's a good thing. If you have positive equity, you could sell your car and walk away with enough money to repay your car loan in full. This gives you a lot more financial flexibility if you decide you don't need a vehicle any more or if you decide you want to buy a new car.

Drivers with positive equity may also be able to eliminate GAP insurance from their auto insurance coverage. GAP insurance covers the difference between what an insurer pays for a vehicle that is totaled and the remaining balance due on an auto loan.

GAP insurance is necessary for people without much equity in their car because if their vehicle was totaled, insurance would only pay what the car is worth -- and that would be a problem if the driver owed more than that amount. The driver would have to pay off the loan for a vehicle they no longer had.

This isn't an issue any more once a driver has equity in their vehicle. However, it is important to check with the auto loan lender to determine if GAP insurance is required before canceling coverage.

Drivers could also have negative equity if they owe more than their vehicle is actually worth. For example, a driver with a car loan of $20,000, but whose car is worth only $15,000 would have negative equity.

This driver would want to have GAP insurance to make sure they didn't have to come up with $5,000 out of pocket if their car was totaled and their insurance only paid $15,000 while they owed $20,000. If a driver wanted to sell a car with negative equity, the driver would also need to pay off the remaining loan balance personally if they couldn't sell the car for enough to cover it.

How can you make sure you have equity in your car?

If you want to make sure you have positive equity, not negative equity, it's best to make a reasonable down payment when buying a car -- at least 10% to 20%, as new vehicles tend to lose value quickly once driven off the lot.

You should also avoid taking a car loan with a long payoff time, as this can mean you pay down the loan so slowly that the value of the car falls faster than your loan balance.

If you can do these things in the course of buying a vehicle, hopefully you will end up with positive equity and the financial benefits that come with it.