How to Get Out of an Upside-Down Car Loan
If your car is worth more than you owe on it, you can pay off the loan when you sell it or trade it in. But if you owe more than the car’s value, then you’re stuck in what’s called an “upside-down car loan” until you can cover the difference.
An upside-down car loan (or negative equity car loan) often happens because of depreciation to the car or bad loan terms, but you can still get out of it — or avoid it from the start.
- With an upside-down car loan, you owe more on your vehicle than its current market value.
- To get out of an upside-down car loan, consider making extra payments, refinancing or selling the vehicle.
- To avoid being upside down on your loan in the first place, shop around for good rates and try a larger down payment or a shorter repayment term.
What is an upside-down car loan?
An upside-down car loan occurs when the loan balance is more than the vehicle’s current market value.
This often happens when a car depreciates faster than you can pay off your loan. For example, if you owe $20,000 on your car loan, but the car’s current value is only $15,000, then you’re upside down by $5,000.
To find out your car’s current value, you can use resources like Kelley Blue Book (KBB) or Edmunds, which give you estimates based on the car’s make, model, year, mileage and condition.
How to get out of an upside-down car loan
You have four main strategies to help you get out of an upside-down car loan:
Make extra payments on your loan
If your loan doesn’t have prepayment penalties, consider making extra payments on your car loan to reduce the principal balance you owe and pay off your car loan faster.
This closes the gap between what you owe on the loan and the car’s value, but you will need additional financial resources, which you might not always have.
Refinance your car loan
Refinancing your car loan involves paying off your current loan with a new loan. If your new loan has a lower interest rate or a longer loan term, it can reduce your monthly payments, giving you more financial flexibility.
While there is some immediate financial relief, a longer loan term could mean paying more interest over time.
Sell your car
Selling your car with a loan is also an option, but you must cover the difference between the loan balance and the sale price.
In a private sale, you might be able to make more than what you would by trading in the vehicle at a dealership. But if you can’t come up with the cash to pay off the remaining loan balance, and if your car’s value is a lot lower than what you owe, this might be a costly solution.
Pay the loan off
If you don’t need to get out of the loan or car, then you can continue making regular payments until the loan is paid off, or at least until it’s no longer under water.
This way, you won’t need to worry about extra payments or new debt, but it may take longer to resolve the upside-down situation, especially if the car depreciates faster than the loan balance decreases.
How upside-down car loans can happen
Upside-down car loans can happen for several reasons. Here are some common scenarios:
- You bought a car with no down payment. Buying a car without a down payment means you’re financing its full value. Cars quickly lose value, so this can leave you owing more than the car is worth almost immediately. Without any equity up front, the loan balance will likely stay upside down for longer.
- You have a long repayment term. Choosing a longer car loan of 72 or 84 months lowers your monthly payments, but it takes longer to pay down the loan balance. During this time, your car may lose value faster than you can pay down the loan, leaving you upside down for most of the loan term.
- Your car’s value depreciated too quickly. Vehicles usually lose a big portion of their value during the first few years of ownership. If your car’s value depreciates faster than expected, you may soon find yourself owing more on the loan than the car is worth.
- You paid too much for your car. If you overpaid for your car, you may have started the loan with a balance above the car’s true market price. This makes it easier for the car loan to become upside down, as the car’s value quickly falls below the inflated price you paid.
- You’re paying a high interest rate. A high interest rate can slow down your loan repayment, keeping you upside down for longer. With more of your monthly payment going toward interest instead of reducing the loan amount, you aren’t building equity in your car as quickly.
How to avoid an upside-down car loan
You can usually avoid getting stuck with an upside-down car loan by making smart financial decisions up front. Consider these:
- Offer a larger down payment: Making a larger down payment reduces how much you need to finance and lowers your loan balance from the start. If you can afford it, paying more down can protect you from depreciation, since you’ll already have good equity in the car.
- Choose a short repayment term: If you pick a shorter repayment term like 36 or 48 months, you’ll pay off the loan more quickly, and by building equity faster, you’ll have a lower risk of an upside-down car loan. But keep in mind that shorter terms usually come with higher monthly payments.
- Avoid unnecessary add-ons: Additional features, such as extended warranties or service plans, can drive up the total cost of your loan. If you end up paying a lot more than the car’s market value, you might owe more than what it’s worth from the start. If you feel the add-ons are necessary, try to negotiate the price and bring down the total cost of the loan.
- Shop around for rates: Before committing to a loan, shop around to compare interest rates from different lenders. A lower interest rate can slash the total cost of the loan and help you pay it down faster. Also, calculate your future loan payments to see what you can afford.
- Buy a cheaper used car: Buying a used car can help you avoid an upside-down loan, since they’re usually less expensive, meaning a smaller loan balance. At the same time, most used cars have already depreciated significantly by the time the new owner takes possession.
- Pay taxes and fees up front: Paying taxes and fees out of pocket — instead of rolling them into the loan — helps avoid financing more than you need to and keep the loan balance closer to the car’s actual worth. You’ll also be paying less interest, since the principal on the loan doesn’t include those taxes and fees.
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