Negative equity
The value of a new car drops dramatically as soon as you drive it off the lot. That's because it then becomes a used car. It doesn't matter that you only used it for five minutes - it's still used and is worth much less because of that fact.

This depreciation is an important concept to understand when dealing with financing because while the value of your car drops immediately, your loan principal drops more gradually. So if you try to sell the car too soon, you may end up owing more on it than you can sell it for. That's called negative equity.

You can avoid getting into negative equity situations by following these simple rules:

1. Keep your car until it is paid off completely. Obviously, no matter how much your car depreciates, you won't have negative equity if you don't owe anything.
2. Don't buy a car that is too expensive. If you struggle too much to make the payments, you may decide to sell the car earlier than is financially prudent.
3. Don't drag out your payments. You might get a slightly better interest rate and your monthly payment will be smaller. But it will staple you to that car for the financing term. Five years later you'll still be paying for a car that may no longer fit your needs.
4. Make the biggest down payment you can. This will help offset the effect of depreciation and start giving you some positive equity.

Important finance vocabulary

Total Price
This is the price you and the dealer finally agree on, minus any rebates. The dealer will calculate tax based on this amount.

Down payment
This is what you put down to symbolize your intent to pay off the rest of the vehicle. The more money you pay up front, the less you'll pay every month. A larger down payment may also garner you a lower interest rate.

Interest Rate
This is one of the most important numbers to look at when you're choosing a finance option. It's the rate a lender charges you for borrowing money. A higher interest rate will increase your monthly payments. To see how much the interest rate affects the total amount you'll end up paying, play around with our loan calculator.

Term
This how long you will pay on the loan. The longer the term, the smaller your monthly payment, but the more total interest you will pay.

Where do you get the money?
Financing can be arranged either through the dealer or through a separate lending agency. Who should you finance with? Whoever gives you the best deal, of course.

Dealer financing
The big advantage of dealer financing is convenience. You buy and finance the car all at once. But if the dealer is just reselling a bank loan to make a profit, the rates won't be the best. Occasionally dealers offer special rates to get rid of overstock, especially at the end of a model year. So make sure you ask them about financing and compare their offer to your prearranged financing.

Banks
You can usually get a lower interest rate at a bank than a dealership, especially if you are an existing bank customer. They'll probably require a 10-20% down payment to cover the depreciation of the car in case you default on your loan and they need to repossess your car. Smaller banks offer personal relationships, which are important, but may not be able to compete with rates of bigger banks.

Credit Unions
Credit unions have lower overhead costs than banks which allows them to offer lower financing. Sometimes it can be full percentage point lower.

Home Equity Loans
You need to own a home to get a home equity loan. You use your home as collateral for the loan - which is a little bit scary. If you can't pay the loan, they can take your house. But if you're sure you can afford it, a home equity loan is a great way to go because not only can you get a lower interest rate, your interest is tax deductible!

The Internet
As with everything else these days, you can shop for car loans on the Internet. You miss out on any kind of personal relationship, but you can get quick approval and very competitive pricing.

The power of a trade-in
Your old vehicle is basically a very large coupon that you can trade-in for a discount when you buy a new vehicle. If it's worth enough, you may be able to use it as a down payment. Trade-ins are a convenient way to use the car you already own to help purchase a new one.

What you gain in convenience, you may lose in price compared to selling it on your own. Selling a vehicle on your own could be just as easy as a trade-in if you can find a buyer right away. But if you don't have a high-demand car or if you're just unlucky, it could take you quite some time to sell your car. And timing could be a problem if it takes a long time to sell your old car and you need the funds from selling that car to buy the new one.

No matter which route you go, you can maximize the financial benefit you get from your old car by sprucing it up a bit. A clean car gives the impression of a well-maintained car. Even if you've never washed the car the entire time you've had it (please say that's not true!), thoroughly cleaning the outside, vacuuming the inside and taking care of any unsettling odors will make a huge difference when you go to sell it.

Beyond aesthetics, if there are any mechanical problems with the car, the price you get for the car will probably reduce - and then some. If the fixes are relatively minor, have them done. If they are major fixes, it may not make sense for you to take care of them, but at least consider it.

If you're selling the car, make sure everyone knows it. Get a professional-looking "For Sale" sign and write your phone number large enough for someone to read from the street - even if they have bad eyesight. Take a sales lesson from real estate agents and create a flyer that interested buyers can take home with them. They'll be looking at a lot of cars so you want to stay in the top of their minds.