How does depreciation of the used car value affect the loan balance over time?

Depreciation is a process by which a car loses value over time and usage due to normal wear and tear. For used cars, depreciation is typically most significant in the first few years and tapers off as the vehicle ages. When you obtain a loan to purchase a used car, the value of the car and your loan balance will not decline at the same rate.

In the initial stages of a loan, the outstanding loan balance may decline slowly because the majority of your EMI is going toward interest rather than principal. During the same period of time, the car's market value may decline more quickly due to depreciation. Combined, a borrower's outstanding loan balance may exceed the value of the car, and this is often referred to as being ""upside down"" or having negative equity. This situation is usually exacerbated by providing a low down payment or an extended term loan.

If you are upside down on your loan, you may have problems if you want to sell the car, or it is stolen, because the amount you receive is not enough to pay off the outstanding loan balance.

To mitigate the risk of negative equity, you can do the following:

• Make a larger down payment to reduce your initial loan balance.
• Choose a shorter loan term to pay off the principal faster.
• Select a car model that has a good reputation for maintaining value.
• Do not roll other costs, i.e. insurance, accessories, into the loan.