Upside Down on a Car Loan

If you owe more on your car than the car is actually worth, you are upside-down in your auto loan. In other words, you have negative equity in your car.

It’s a risky position to be in. If you decide to sell the car, the sale price won’t cover your loan. Likewise, if you get into an accident, your insurance will only pay for the worth of the car, not the total cost of the loan. That means you won’t have any extra money from the insurance to put down on your next vehicle.

The fact is, though, that increasing numbers of people have car loans that leave them upside-down. In 2007, nearly 30 percent of consumers owed more money for their cars than their cars were worth. When people traded in their cars for newer ones, they still owed an average of more than $3,600 on their old ones. That means they owed thousands of dollars on cars they didn’t even own anymore.

Avoiding an Upside-Down Car Loan

It’s best to avoid an upside-down car loan altogether whenever possible.  Research your options before you buy a car to avoid becoming upside down on your loan. The following tips can help you avoid an upside-down auto loan:

  • Choose the shortest repayment plan you can afford. This saves you money in interest over the life of the loan. Then if you want to sell the car after a few years, your loan will already be paid off and you’ll have positive equity in your car.
  • Make a down payment of at least 20 percent of the car’s total cost. A car typically loses 20 percent of its value in the first year, and much of this loss occurs right when you drive the car off the lot. So if you buy a brand-new car and don’t make a large down payment, you’ll start out with an upside-down loan.
  • Research the value of a used car before you buy it. Consult Kelley Blue Book and Consumer Reports to estimate the true value of the car. If you don’t, you could overestimate its worth and agree to pay too much. This is another surefire way to get stuck in an upside-down loan.
  • Pay off a car loan before you sell the car. If you buy a new car and trade in one that still has an upside-down loan, the car dealer could roll the remaining portion of your debt into the loan for your new car. This causes your new car to start off with even more negative equity. Your dealer may do this without your consent, so always know what you’re paying for.
  • If you know you’ll only keep a car for two or three years, consider leasing instead of buying. This will stop you from having any loan in the first place.
  • Opt for the basic model of a new car. If you buy extras, the price of the car may increase more dramatically than its value, giving you a larger loan without a higher-valued car. If you do opt for extras, add their cost to your down payment.

One of the few times it’s acceptable to have an upside-down car loan is if you plan to keep your car for many years. You may buy a brand-new car and start off with an upside-down loan.

But if you plan to pay down the loan in five years and keep the car for 10 years,  you’ll own the car long before it’s time to sell it. Over the total time you own your car, you’ll be able to convert your negative equity into positive equity, meaning it’ll be worth more than you owe on it.

How to Get Out of an Upside-Down Car Loan

The best way to get out of an upside-down car loan is to keep the car and continue paying it off until you own it, or at least until the loan amount is lower than the value of the car. Another tactic is to pay extra money each month toward the loan principal. This allows you to build up equity at a faster rate.

If you’re intent on getting rid of your car, sell it privately rather than trading it in at a dealership. You’ll have a better chance of cashing in on its true value instead of being forced to accept less than the car is worth.

If you are too far in debt for these strategies to work and you can no longer pay your monthly bill for the auto loan, consider debt help options. Two of the most commonly utilized options are debt consolidation and debt settlement.

When you consolidate your debts, your car loan will be combined with some or all of your other debts in one large loan. The new loan typically comes with lower interest rates and better repayment options.

In debt settlement, you — or a settlement firm working on your behalf — will negotiate with your creditors to have your owed balances reduced.

If you finances are in worse shape, you might consider filing for bankruptcy, a process that can clear all or most of your debts. Find out if this option is right for you by meeting with a credit counselor.

Al Krulick

Al is an award-winning journalist with dozens of years of writing experience. He served as a drama critic, high school teacher, arts administrator, theatrical producer and director. He also dabbled in politics, running twice for a seat on the U.S. House of Representatives for Florida. Al is a Certified Debt Specialist with the International Association of Professional Debt Arbitrators and specializes in real estate, credit and bankruptcy advice.

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