What Is an Upside-Down Car Loan?
When you have an upside-down car loan, the amount owed exceeds the vehicle’s market value. This circumstance may also be referred to as having negative equity. If you have negative equity in your car and would like to trade it in, you will first need to pay that off before you can get a new loan to buy another car.
There are various methods you can employ if you have negative equity to pay off your car loan.
How Do Upside-Down Car Loans Happen?
There are several reasons why car owners can find themselves in a negative equity situation. You may be in default on a car loan, for instance, if you:
- possess a longer-term loan and the value of your car has substantially decreased since you bought it
- took out a zero-down car loan or paid more than the car’s suggested retail price because you added extras.
- bought a pricey car that hasn’t held its value as predicted
- opted for a loan with a high interest rate, meaning that the interest will take up a larger portion of your payment than the principal
Depreciation refers to how quickly an asset loses value. For cars, the value of the vehicle decreases in the first year by approximately 2020%, and the depreciation continues every year after that.
This is an illustration of how depreciation can result in an upside-down auto loan: Let’s say you spend $30,000 on a brand-new vehicle. If you adhere to the 2020 depreciation rule, you can anticipate that it will be worth $24,000 after a year. In the interim, you have settled $4,000 of the $30,000 auto loan you obtained to purchase it. The amount you owe on the loan is $26,000, which is $2,000 more than the car’s true value. You’re now upside down on the debt.
Using a tool like Kelley Blue Book or Edmunds can help you to estimate vehicle values before making a purchase, which could help you to avoid an upside-down loan scenario.
How to Get Out of an Upside-Down Car Loan
There are several ways to get out of a car loan if you’re underwater on it. Which is best for you may depend on how much you can afford and whether you plan to keep the car.
Pay Off the Loan
The first step in resolving an upside-down loan is to accelerate your repayment. You can get rid of that debt sooner if you pay off the loan quickly.
There are several ways to pay off an auto loan more quickly:
- Pay extra to the principal each month.
- Apply windfalls to the principal balance.
- Make one lump-sum payment to pay the debt in full.
Examining your savings and budget can help you determine which course of action would be most beneficial. Additionally, you can add one-time windfalls to the principal, like a tax refund, a gift, or a work bonus.
Refinance the Loan
Taking out a new loan to settle an existing debt is known as refinancing an auto loan. If you are able to obtain a new loan with a lower interest rate, you may refinance to avoid an upside-down auto loan.
Refinancing doesn’t eliminate your auto loan debt completely. You’ll still owe the loan balance that you refinanced. But a lower interest rate might make it simpler to pay off more principal each month and pay off debt more quickly.
You can get a better sense of whether it makes sense to try to get a new loan to lower your current interest rate by shopping around for auto loan refinance rates.
Sell the Vehicle
You could sell the car to raise the money needed to settle the loan, including the balance owed on the negative equity. Selling to a private buyer may provide you greater leeway in negotiating a price that would enable you to receive sufficient funds to offset the negative equity.
Just keep in mind that you will have to pay the difference out of pocket if the sale doesn’t bring in enough money to cover the negative equity.
Surrender the Vehicle
Giving the car back to the lender is the last resort for obtaining a way out of an upside-down loan. Giving up your car voluntarily may be a better choice than letting the lender take it back.
The lender has the right to auction off a repossessed car, but if the proceeds are less than what is owed on the loan, you might be held legally liable for the difference.
When it comes to an upside-down auto loan, vehicle surrender should be considered a last resort because you will forfeit the vehicle and the debt may still be reported as unpaid to credit bureaus.
Tips for Avoiding an Upside-Down Car Loan
With some forethought before you make your purchase and some smart planning afterwards, you can avoid getting into an upside-down auto loan. Here are some strategies to reduce the likelihood that you will have an upside-down auto loan.
- Put more money down: The more you put down, the less you have to borrow. Choosing a smaller loan could help you keep up with depreciation and pay off the debt more quickly.
- Avoid the add-ons: Add-ons, like guaranteed auto protection (GAP) insurance, can raise your overall borrowing costs and frequently work more to the advantage of the dealership or lender than of you. By carefully reading the loan agreement and deciding not to purchase unnecessary add-ons, you can lower your payment and lower your risk of going into default.
- Select a shorter loan: Higher monthly payments may result from a shorter loan term. On the other hand, paying off the loan sooner can result in interest savings and spare you from having to take out a loan for a car that is losing value quickly.
- Pay taxes and other fees up front. You may be able to choose to have them rolled into your loan by your lender. That translates to less money you’ll have to pay upfront, but increasing your loan costs can make it more likely that you’ll default on the loan.
- Compare rates: You can save more money on an auto loan if your interest rate is lower. Finding the best rates on loans can be facilitated by reviewing your credit scores and taking into account the minimum score requirements of various lenders.
- Select a trustworthy lender: Buying a car can occasionally result in negative equity if the buyer selects an unreliable lender. Your cost of a new car may go up if certain dishonest lenders tack on fees or other unstated costs. You can prevent these dishonest lenders by reading reviews and getting recommendations from friends and family.
- Establish a budget before you buy a car. Take into account how much you can afford to pay for a loan. A strict budget can prevent you from taking on a larger loan than you can afford or from purchasing an automobile that is too costly for you.
Can I get out of a car loan without damaging my credit?
Paying off the loan in full with the proceeds from the sale of a car can help you get rid of the debt without damaging your credit. To prevent harm to your credit score, you might also think about trading in the car and rolling any negative equity into a new car loan; however, doing so could result in additional debt that you would have to pay back.
How much does a car depreciate every year on average?
Vehicles typically lose 20% of their value on average during the first year of ownership. The make and model, the vehicle’s ability to hold its value, and the owner’s level of attention to maintenance and upkeep to reduce wear and tear can all affect how much depreciation happens in each subsequent year of ownership.
How do you calculate car devaluation?
You can deduct a car’s fair market value from its purchase price to determine how much value it has lost. That can provide you with a ballpark figure for the depreciation of an automobile. To find out whether you have any negative equity, you can also compare the fair market value to the current loan value.
Can you refinance a car if it’s upside down?
If you can locate a lender who will approve you, you can refinance your auto loan even if you’re upside down. When deciding whether to approve a loan refinancing, lenders may take into account a number of factors, including the vehicle’s value, the outstanding loan balance, your income, and credit scores.
What is GAP insurance?
The purpose of guaranteed auto protection (GAP) insurance is to fill in the financial hole left by your vehicle’s loan amount in the event that it is stolen, totaled, or damaged. When buying a car, your dealership or lender might offer GAP insurance as an optional add-on, but it’s not always required.
The Bottom Line
Although an upside-down auto loan may seem like a financial hardship, there are strategies to manage it. Additionally, it’s beneficial to know how an upside-down debt scenario can occur and what precautions you can take to avoid it if you’re looking around for a new auto loan. Article Sources: Investopedia mandates that authors cite original sources to bolster their claims. These consist of government data, original reporting, white papers, and conversations with professionals in the field. When appropriate, we also cite original research from other respectable publishers. You can read more about the guidelines we adhere to when creating impartial, truthful content in our
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FAQ
How do you get out of a car that you are upside down in?
Selling the car or refinancing the loan are two of the most popular strategies for handling negative equity. You might also think about trading in your car for a different model, but if you’re rolling over the original loan balance, that could result in more auto loan debt.
Can you trade in an upside down car loan?
You have negative equity in your vehicle, sometimes referred to as being “upside-down” or “underwater” on your auto loan, if the value of your vehicle is less than what you still owe. You will be responsible for paying the difference between the loan balance and the trade-in value when you trade in an automobile with negative equity. You can pay it with cash.
How do I get out of a car loan without ruining my credit?
To get rid of your car without damaging your credit, you can sell it. This is most straightforward if your car’s value is equal to or greater than the loan balance. If someone else agrees to take over your current loan and is approved for financing, you can also transfer it to them.
Will a bank refinance an upside down car loan?
Yes, depending on how much you owe, you might be able to refinance your car even with an upside-down car loan. Typically, borrowers with good credit are eligible for up to 80% of the car’s value, while those with bad credit are only eligible for up to 12% of the value.
Read More :
https://www.investopedia.com/dealing-with-upside-down-car-loan-7484134
https://www.debt.org/credit/loans/auto/upside-down-car/