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.
It’s a risky position to be in. If you decide to sell it, the sale price won’t cover your auto loan. Likewise, if you get into an accident, your insurance will only pay for the value of the car and 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 and will still owe money on the loan.
The fact is that increasing numbers of people have car loans that leave them upside-down. In 2014, 27 % of car sales were made to people with negative equity who owed an average $4,257 on their loans. In most cases, people who are upside down on an auto loan were too eager to buy a car in the first place. They didn’t understand the consequences of the situation until it overwhelmed them.
It takes great discipline and the ability to work through creative strategies to get out of this debt.
How You Get Upside Down On A Car Loan
People should know that cars lose at least 20% of their value as soon as you drive them off the lot, but they’re so enthusiastic about getting a new car they don’t account for that when arranging financing.
Add dealer incentives, smaller down payments and a willingness among lenders to create rollover loans (adding in the negative equity from the previous car) and it’s easy to understand why more than 50% of new car owners are under water the minute they drive off the lot.
Some other reasons that people get upside down on the car loans:
- Inadequate research. Many people overpay for a car because they didn’t do enough research on costs for similar makes and models before buying. Paying $25,000 for a car that is worth only $20,000 means you already are upside down on your new car.
- No money down, long loan terms. These popular incentives sound too good to be true…because they are! Cars depreciate 20% almost immediately and lose 50% of their value by the third year. If you don’t put at least 20% down, you’re upside down right away. If you’re still paying for a car that is five or six years old, your payments can’t keep pace with the depreciation.
- Unnecessary options. People allow themselves to be talked into costly options they don’t need or won’t use like a sunroof, leather upholstery, DVD player, etc. Not only does that create more debt, it is impossible to recoup the cost of those options when you resell the car.
- Roll over loan. If you owe money on your old car, the dealer will often offer to roll that negative equity amount into the loan for a new car. This means you are paying two loans at once – the balance on the old car, plus whatever money you’re financing on the new car. In most cases, that means the total financed already is more than the car is worth and you’re upside down again.
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 you have 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 or, if you can afford higher monthly payments, find a loan with a shorter payment term. This allows you to pay off the loan quicker and build equity at a faster rate.
It may be possible to transfer the balance of your car loan to a credit card with a 0% introductory offer. At the end of the introductory period – 12-15 months on some cards – refinance the remaining balance at a credit union or peer-to-peer lender.
If you’re intent on getting rid of your car, and it is in at least “good” condition, sell it privately rather than trading it in at a dealership. Private sales of cars produce significantly higher return than trade-ins.
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 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.
Tips For Avoiding an Upside-Down Car Loan
It’s best to avoid an upside-down car loan altogether whenever possible. Be diligent with research before you buy a car and understand all the costs of options, financing and taxes so you aren’t already upside down when you drive out the door.
The following tips can help you avoid an upside-down auto loan:
- Choose the shortest repayment plan you can afford. Shorter repayment plans mean lower interest rates and faster payoff. For example, borrowing $25,000 for four years at 2.51% would mean a savings of $1,400 over a six-year loan for $25,000 at 3.44%.
- Make a down payment of at least 20% of the car’s total cost. This equals the 20% depreciation on the car that happens when you leave the lot.
- Before you buy, consult Kelley Blue Book and Consumer Reports to estimate the true value of the car. This will keep you from overpaying for the car.
- Ask about incentives. Dealers may offer enough cash incentives to make up the difference for the 20% depreciation that happens almost immediately when you buy a car.
- Pay off your car loanbefore you sell or trade-in. You can’t be upside down on a paid off car.
- If you know you’ll only keep a car for two or three years, consider leasing instead of buying. A lease means no loan, which means you can’t be upside down.
- Opt for the basic model of a new car. Options add to the initial cost of the car, but quickly lose their value as the car depreciates.
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.
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.
Selling Your Upside Down Vehicle
When you are hopelessly upside down on a vehicle and need relief from that distressing debt, selling the car and taking out a second loan to cover the negative equity could be the best option.
In short, if you owe $15,000 and your car is worth $10,000, you are $5,000 upside down or have $5,000 in negative equity. If you sold the car for what is was worth ($10,000) and took out a loan to cover the balance, you would be making payments on a $5,000 loan, not a $15,000 loan.
However, you also would be without a car. This could be a bigger problem if other transit options – bus, subway, carpool, bicycle, walking – are not readily available to get to work, the grocery story, doctor’s office and other necessary stops.
If you do have easy access to transit and want to sell your upside down auto, the steps are fairly simple. First thing to do is determine your car’s true value. Consult Kelley Blue Book or Edmunds to get an accurate appraisal. Be sure to provide honest information about its condition, mileage and options, all of which affect the resale value.
Next, call the bank that holds your car loan and ask what the payoff balance is.
Now, do the math:
Payoff Balance – Car’s Worth = Negative Equity.
Using the example above, that would be $15,000 minus $10,000 = $5,000 in negative equity.
Now comes the hard part: Finding a place that will lend you $5,000 for an unsecured loan! The truth is that you must be a very good customer or have an excellent credit score (or both) to convince a bank or credit union to loan you money in this situation.
There are other places to find the money – family, friends, credit cards – but at least you’re dealing with a $5,000 loan and not a $15,000 loan and you no longer have the expense of owning a car.