There’s nothing better than smelling that new car scent as you traverse down the backgrounds in your brand-new ride. But what most new car buyers don’t know is that the moment you drive that new shiny car off the lot, it can lose up to 10 percent of its value after one month of driving, and up to 20 percent after a full year, according to a report by CarFax.
Soon, that new car smell will be replaced by the smell of burning money. If you don’t budget correctly and finance your new car properly, you may find yourself in a potentially damaging financial situation where you end up with an upside down car loan.
If you’re upside down on a car loan, or underwater, it means the value of your car loan is greater than your car’s overall value. Being in a situation like this can be frustrating and stressful, especially if you’re struggling to pay that loan off. If you’re looking to get out of an upside down car loan, this article may come in handy. We’ll go over how to get out of an upside down car loan and answer other important questions, that can be reached using the jump links below.
- How do you get an upside down car loan?
- Best ways to avoid getting an upside down car loan
- Key takeaways on how to get out of an upside down car loan
What is an upside down car loan?
When you’re underwater on your car loan, it means the value of your car loan is greater than the actual value of your car. For example, if you have an auto loan for $12,000, and your car is only worth $9,000, you’re upside down. That $3,000 difference is considered negative equity, and is what brings you “underwater.”
As previously stated, cars depreciate at an alarming rate, which can make catching up on your upside down loan difficult because as your car’s value continues to plummet, you’re stuck with expensive loan payments.
How to get out of an upside down car loan
Now that you know what an upside down car loan is, it’s time to get down to what you’re probably wondering: how to get out of an upside down car loan. There are a few ways you can get out of an upside down car loan, from riding the loan out to refinancing. Below, we’ll go over each option that can help you get out of debt, so you can determine which one may work for your financial situation.
1. Ride the loan out
This may not sound ideal, but one option for paying off debt on your car is by riding out the loan. This means sticking to what you’re already doing and paying the same monthly payments until the loan is completely paid off.
2. Pay ahead of schedule
Another way to build equity and reach the surface rather than being trapped underwater is by paying your loan ahead of schedule with extra payments. This doesn’t mean every paycheck you earn should go towards your auto loan. All it means is putting any extra cash you have, whether 25 dollars or 300 dollars, towards your auto loan. This tactic will help you get right side up, slowly but surely. However, you should make sure you read the fine print of your loan agreement. Some lenders may add a fee if you decide to pay your loan off early.
3. Take out another loan
Yes, you read that right, you can refinance a car loan that is upside down. Taking out another loan may help you get out of an upside down car loan. Refinancing your car loan is an option that allows you to take out a new loan to pay for your current one. The reason people may opt for this is because the new loan may have a lower interest rate, which means more of your monthly auto loan payments will go towards the principal value of the car, rather than towards interest collected by the lender.
4. Sell your car
It’s worth knowing how to trade in an upside down car, as trading in versus selling your car may lead to different results. Debt.org explains how selling your car privately can be a much better option than trading in an upside down car, because you can sometimes make more money selling privately than trading in with a dealer. So, listing your car on sites such as Craigslist, Facebook Marketplace, and eBay are good options to look into.
It’s also important to check the value of your car on sites such as Kelley Blue Book, Edmunds, and the National Automobile Dealers Association Guides, according to the Federal Trade Commission. This will allow you to get an accurate quote for your car, which can help you sell your car at a price that can cover the loan, or even more.
If you do want to sell your car back to the dealership, you might consider trading in your upside down car for a cheaper car. Doing so can help eliminate your negative equity. For example, if your vehicle is worth $11,000 and your car loan is $15,000, you have $4,000 in negative equity. If you trade your $11,000 car in for a used car worth $7,000, that can cover the cost of your new, used car along with your negative equity.
How do you get an upside down car loan?
Now, you’re probably asking yourself, “How do you get an upside down car loan in the first place?” There are a variety of scenarios in which you could find yourself with an upside down car loan. Knowing the potential causes of an upside down car loan may help you understand how to get out of an upside down car loan. Take a look below at some of the most common reasons you may find yourself underwater:
- You bought a car that was too expensive: Distinguishing between our wants and needs can be tough. Especially when the latest luxury car, with its interior ambient lighting, Bluetooth surround sound speakers, and high-speed performance, hits the market. However, are all of those amenities necessary? Buying a car that is out of your price range is one way you may end up with an upside down car loan. It’s important to never forget your other obligations, such as your student loans, mortgage, food, and other basic necessities.
When buying a car and taking out an auto loan, you may want to consider choosing an affordable car with a shorter loan. A report from the Consumer Financial Protection Bureau found that longer-term auto loans cost more than shorter-term auto loans, and those with longer-term auto loans exceeding six years are more likely to default.
- You didn’t make a large enough down payment: Down payments serve as an upfront payment that goes towards the vehicle you’re going to purchase. It shows creditors you have some financial backing and a larger down payment will decrease the amount of money you need to borrow in the form of a loan.
However, if you made a down payment that was too small, that means you may have to take out more money in the form of a loan. Because cars depreciate in value over time, your loan value can quickly creep up and surpass the value of your car. Autotrader.com recommends placing a down payment of at least 20 percent when buying a car.
- Your loan’s interest rates are too high: When you take out an auto loan, lenders will charge interest, which is a percentage of the amount you’re borrowing. Sometimes, dealers or your bank will tack an extremely high interest rate onto your auto loan, which can be upwards of 10 or even 15 percent. The higher your APR, the more money you will owe your lender, which won’t count towards the principal value of your car.
Best ways to avoid getting an upside down car loan
Knowing how you end up with an upside down car loan can help you avoid sinking underwater and accruing unmanageable debt. If you want to stay afloat on your car loan, follow these tips:
- Don’t buy a car that’s out of your budget: Purchasing a newer model of a used car is a great way to save money while still driving a safe and reliable vehicle. As previously stated, new cars lose up to 20 percent of their value within the first month. So, finding a used car that’s only been in commission for a few months or a year can save you some big bucks and still have low mileage and wear and tear.
- Pay on time, every time: It’s easy to miss an auto loan payment. Between cell phone bills, utility bills, student loan payments, rent, and so on, falling behind on your auto loan payments can become easy. However, you should make a hard effort to budget correctly, or set up automated payments, so that you don’t miss any loan payments.
- Opt for a shorter loan: As you now know, longer-term loans can cost you more money and have a higher default risk. With a shorter loan, it can become easier to make your payments on time and avoid going underwater.
- Place a hefty down payment: It can be difficult for most Americans to come up with $30,000 and pay for a new car out of pocket. However, saving up enough money to make a substantial down payment is another way you can avoid ending up with an upside down car loan. A larger down payment means you may not have to take out a larger loan that takes longer to pay off. Additionally, you’ll have less interest to pay over the course of your loan as well.
Key takeaways on how to get out of an upside down car loan
Being underwater is never fun. If you have an upside down car loan, it’s important to act fast, so you don’t fall further into debt. While your car begins to depreciate, your loan and its interest rate will still be there. From refinancing your car to selling it, these tips on how to get out of an upside down car loan will help you stay afloat and build equity in your vehicle.