What Is An Upside Down Car Loan?

You are upside down on a car loan when you owe more than your vehicle is worth. It happens a lot, but there are ways to limit the long-term damage it can do to your finances.

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Being upside down on a car loan happens when you owe more than the vehicle is worth. In other words, you have negative equity.

Upside-down loans are almost inevitable –  vehicles lose 20% of their value as soon as they’re driven off the lot. When you drive a $25,000 car off the dealer’s lot, it’s only worth $20,000 by the time you hit the first traffic light. Depending on how much money you put down, you may already owe more than the car is worth.

The average price for a new car in 2022 was $45,927 and the average loan was $39,340. That means you need a down payment of more than $7,800 to buy an average-priced new vehicle if you want to avoid driving off the lot with negative equity.

If you sell a car with negative equity, it’s not likely you’ll get enough money to cover what you owe. If you total the vehicle in an accident, insurance only pays the value of the car, regardless of how much you owe, which means you’ll still owe the balance and makes it more difficult to get a new car.

“The best financial move for people is to buy a car and drive it well past the point where you have it paid off,” said Jessica Caldwell, a senior analyst at Edmunds, an automobile information and resource firm. “Unfortunately, the trend is that less and less people are doing that now.”

How You Get Upside Down on a Car Loan

Let’s face it: Getting a new car is exciting. Unfortunately, excitement and financial smarts don’t always go hand-in-hand. Excitement can result in an upside-down car loan in many ways.

  • Inadequate research: Many consumers don’t do enough research on cost for similar models. If you buy a car with a sticker price of $30,000 and similar models are selling for $27,500, you are already upside down on your new car.
  • No-money-down loans: Cars depreciate 20% immediately and lose 50% of their value by the third year, so the less money down, the more upside down you will be.
  • Long-term loans: Terms of 72 and even 84 months allow you to keep monthly payments manageable, but you also end up still paying for a car that’s five or more years old. Payments for that long can’t keep pace with depreciation.
  • Roll-over loans: The dealer will often offer roll the negative equity on your old car into your new car loan. This means you’re paying more than what the new car is worth from the start.
  • Unnecessary options: Don’t be talked into options you don’t need or won’t use, like a sunroof, leather upholstery, heated seats, technology that attaches to a smart phone, etc. Options create more debt and it’s impossible to recoup their cost when you sell the car.
  • Expensive car: Buying a car that stretches you to the limit of what you can afford will compete with other necessary payments, like housing, food, student loans and more.
  • High-interest loans: Plan your financing before you go to the car lot and don’t give in to pressure to go with dealer financing at a higher interest rate.

How to Get Out of an Upside-Down Car Loan

So, what’s the solution when you find yourself upside down on a car loan?

The good news is that unless you’ve totaled the car in a wreck or you have to sell in a hurry, there are ways to get out of a car loan.

Calculate Negative Equity

The first step is to know just how underwater your car loan is. Negative equity is an easy subtraction problem – what you owe, minus the vehicle’s value.

Find out the value of your car using Kelley Blue Book or Edmunds, which both have online calculators that determine value using model, year, condition, mileage and more. The National Automobile Dealers Association also has guides. Check more than one source, since calculations can vary. Be honest about the vehicle’s condition – there’s no benefit to temporarily fooling yourself that the car is worth more than it really is.

Find out what you owe by checking your loan account online (most lenders provide this option). The pay-off figure changes daily because of interest accumulation, so for the exact figure (or if you don’t have an online account), call your lender and ask.

As an example, if you owe $17,000 and your car’s value is $11,000, you have negative equity of $6,000. That means, if you sold the car for what it was worth – $11,000 – you’d still owe $6,000 on the loan.

Contact Your Lender

Once you’ve calculated the negative equity, call your lender to discuss options. You may feel uncomfortable doing this. In fact, if you’re behind on payments you may be avoiding your lender altogether. Keep in mind that the lender is just as anxious as you are to find a solution, so they don’t lose money on the loan.

Some lenders may offer refinancing, or another solution. Others may not have any options for you, but it’s still a good idea to find out and to let them know you’re working on the issue.

Continue Making Payments

However you plan to get out of your upside-down loan, the immediate priority is to keep making on-time payments. This continues to pay down the loan, lowering the balance, and also increases equity. Another advantage is that it protects your credit score, which will make it easier to better loan terms next time. If you have a lot of negative equity, look into buying gap insurance to cover the difference between an insurance settlement and what you owe on the loan in case you get into an accident.

If you can’t make car payments, that’s something you must make clear when you talk to your lender. If the lender doesn’t have any options, talking to a nonprofit credit counselor may help. Credit counselors at nonprofit agencies – those accredited by the National Foundation for Credit Counseling – will talk to you at no cost, reviewing your finances, helping you budget, and suggesting options to help decrease your debt.

Make as Many Payments as Possible

Another way to get out from under an upside-down car loan, if you can afford to, is to pay extra toward the principal each month. This will pay down the balance and increase equity faster. Before you do, check whether your loan agreement adds a fee if you pay it off early.

You can also use savings to pay off your loan. The downside is that you no longer have money for a down payment on your next car, and not many banks want to make loans to consumers who don’t have a down payment.

Refinancing an Upside-Down Loan

Refinancing with a new loan can also get you out of an upside-down car loan. If interest rates are lower than what they were when you took out the original loan, refinancing allows you to pay off the car faster, or at least get some equity. Large lenders usually aren’t interested, but a community bank or credit union may consider the option.

If you are a homeowner, a home equity loan may be a good option if it provides savings on interest.

It also may be possible to transfer the balance of your car loan to a credit card that has a 0% introductory offer. At the end of the introductory period – 12-18 months on most cards – refinance the remaining balance at a credit union or peer-to-peer lender.

» Learn More: Paying Car Payments with a Credit Card

Selling Your Upside-Down Vehicle

If you are hopelessly upside down on a vehicle loan, selling the car and taking out a second loan to cover the negative equity is an option. The loan or a cash lump sum will be necessary, because once you sell the car, the lender will no longer hold the title and you will have to pay what you owe.

To sell the vehicle in way that helps your financial situation:

Determine the amount of your negative equity, using the steps outlined above.

Find a way to pay the balance to the lender. This may be a loan, though an unsecured loan may be hard to get without a car to use as collateral. At most banks, you must have a good credit score to get an unsecured loan. Credit union members may have better luck. Other options are family, friends, using a credit card or borrowing against your 401(k). All have drawbacks, so consider your options carefully before jumping in.

When you sell the car, a private sale may get you a better deal than selling it through a dealer. Private sales, particularly if the car is in good condition, usually have better results than trade-ins. Even if you are going to buy a cheaper or used car, look into selling the car first rather than trading it in.

Once you sell the car, consider using public transportation rather than replacing your car. While this isn’t an option in many areas of the country, if it is, the money saved on car maintenance, insurance and gas can help you pay off the remaining balance on your loan, or you can build savings for a down payment.

<H3>Voluntary Surrender

A last resort for getting out of an upside-down car loan is to voluntarily surrender the vehicle to the lender. This will have a significant negative impact on your credit score, making it harder to get a car loan in the future, as well as borrow for other things, get credit cards, and more.

That said, it’s a better option that a repossession by the lender. With a voluntary surrender, you call the lender, set the time and place, and avoid costly repossession fees.

Tips for Avoiding an Upside-Down Car Loan

The best way to avoid a car loan that you can’t afford is to not get one to begin with. Do your research before you buy a car to make sure you understand the cost of options, financing, taxes and best value on the make or model that you want.

That research may make it clear that your best option is buying a used car. Late-model used cars with low mileage make good financial sense. The original owner will have paid the price for depreciation in the first year, so the purchase price should be at least 20% off the original cost.

Don’t just look at the overall price tag when you buy – consider how much the car loan will cost you a month, including interest, taxes, possible added gas costs if it’s a bigger, less efficient model, and more. That’s the figure that has an impact on your day-to-day budget.

If you buy new, use the 20-4-10 rule – 20% down payment; 4-year (or less) loan; and the monthly car payment plus insurance isn’t more than 10% of your gross income. If you can’t make those numbers work, start looking at used cars instead.

Whether buying a used car or a new one, the following tips can help you avoid an upside-down car loan:

  1. Taxes and Fees: When you buy, pay taxes and fees upfront rather than rolling them into the loan.
  2. Repayment Plan: Choose the shortest repayment plan you can afford. The interest will be lower and it will be paid off faster. For example, borrowing $25,000 for three years at 3.5% interest (with a credit score of 661 or above) would cost $1,372 in interest over the life of the loan. Over four years it would cost $1,827. A five-year loan would cost $2,287. The lower your credit score, the higher the interest. A credit score of between 601 and 660 carrying a 6.07% interest rate means $2,408 in interest over a three-year loan; a five-year loan would cost $4,048. The average borrower in 2022 had a 60-month loan of $39,340, at 5.2% interest, for $5,420 in interest costs.
  3. Down Payment: Make a down payment of at least 20% to equal the immediate depreciation.
  4. Depreciation: Research values on Kelley Blue Book and Consumer Reports to estimate the value of the car and which models retain better value over the years. This will keep you from overpaying and ensure you have a car that’s worth more when you sell it or trade it in. If you plan to keep the car for longer than the life of the loan, you may be underwater at first, but you’ll build equity as you pay down the loan. Keeping up with regular maintenance and keeping the car clean and in good condition will also help maintain value when you sell it.
  5. Leasing or Buying: If you plan to keep a car for less than three years, consider leasing instead of buying. A lease means no loan, which means you can’t be upside down. Be sure you’re clear on the provisions of the lease – if you drive a lot, mileage costs may make it more expensive than buying.
  6. Incentives: Loo for dealers that offer cash incentives that make up the difference of the 20% depreciation.
  7. Pay Off: Pay off your car loan before you sell or trade it in.
  8. Loans for Bad Credit: If you have bad credit and need a car loan, shop for a personal loan with online lenders, a credit union, or look into a home equity loan. They may have lower interest rates than a dealership.

Using a Car with Negative Equity as Trade-In

If you’re considering trading in a car with negative equity, don’t end up with even more negative equity with our new loan.

Rolling the negative equity into the loan by trading in a car with negative equity means you will owe more than the new car is worth before you even sit in the driver’s seat.

For instance, if you still owe $7,000 on a car that’s worth $5,000, the dealer will credit you $5,000 for the trade-in and add the remaining $2,000 to the new loan. That means you’ll start off owing $22,000 on a $20,000.

Find a way to eliminate the negative equity before the trade-in. Pay it off with a personal loan, money from a home equity loan, or some other source that has a lower interest rate than the car loan (or no interest). If you can’t pay the full sum, pay as much as you can to lower it.

If you can’t afford to eliminate the negative equity, consider keeping the car rather than getting another one. Find ways to cut monthly expenses so you can afford the payments and, if possible, pay more toward the principal, increasing your equity until you can make a better deal on a new car.

Caldwell, of Edmunds, said. “Unless there has been a substantial change in your life circumstances – you’ve started a new construction business and now you need a truck; or you just had triplets and now you really need a mini-van – to have a new car loan and negative equity in your trade-in does not put you in a good place financially.”

Debt Relief Options to Consider

If you are so far in debt that strategies for getting out from under a car loan don’t apply, but you can’t afford your monthly payment, consider debt relief options. Two of the most common are debt consolidation and debt settlement.

Debt consolidation will combine your car loan with other debts into one large loan. The new loan typically comes with lower interest rates and better repayment options.

With debt settlement, you — or a settlement firm working on your behalf — will negotiate with your creditors to have your balances reduced to a level you can pay it off.

If you are in serious debt that you see no way out of, you may consider filing for bankruptcy, which can clear all or most of your debts.

Before taking action on any debt relief option, it’s a good idea to talk to a credit counselor from a nonprofit credit counseling agency. A credit counselor will review your finances and help you determine a budget, as well as discuss the pros and cons of various debt relief options. A situation that may seem impossible and overwhelming may become much more clear after such a discussion. Counselors at nonprofit debt agencies will have this discussion with you at no charge. They’re bound by strict rules that require them to act in your best interest, rather than push or sell a particular product. Talking to a counselor can be the first step to getting out from under a car loan you can’t afford, as well as other debt.

About The Author

Bill Fay

Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].


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