Getting Out from Under an Upside Down Car Loan

So, you’ve found yourself in an upside down car loan situation. Don’t worry – you’re not alone. Many people end up owing more on their car loan than the car is worth. But while being upside down on your car loan can feel stressful, there are solutions. This article will walk you through what it means to have an upside down car loan, how you got there, and most importantly, the different strategies you can use to get out from under it.

What is an Upside Down Car Loan?

Also known as being “underwater” on your loan, an upside down car loan is when you owe more on the loan than the car is worth. For example, say you bought a car for $15,000. You put $2,000 down and financed the remaining $13,000. A few years later, the car is now only worth $10,000, but you still owe $11,000 on the loan. That $1,000 difference between what you owe and what the car is worth is called “negative equity.” And that’s what makes your loan upside down.

This happens because cars depreciate quickly. According to experts, vehicles can lose 20% of their value in the first year alone. But your loan balance goes down much slower as you make monthly payments. So it’s easy to end up in a situation where the vehicle loses value faster than you can pay down the loan.

How Did I End Up Upside Down?

There’s a few common scenarios that can lead to an upside down car loan:

• You rolled over negative equity from a previous car loan – When you trade in a car you’re upside down on for a new one, that negative equity gets rolled over into the new loan. This stacks debt on top of debt, immediately putting you underwater on the new loan.
• You took out a long loan term – Longer loan terms of 5+ years mean slower principal pay down. That increases the chance of depreciation outpacing your payments.
• You have a high interest rate – Higher interest rates mean more of your monthly payment goes to interest rather than principal reduction. Again, this makes it harder to get above water.
• You bought more car than you could afford – Getting a loan for a more expensive car means higher payments. And if it depreciates quickly, you may owe more than it’s worth.
• You got in an accident – Even a minor accident can significantly reduce a vehicle’s value. If your loan balance doesn’t decrease as quickly, this accident can flip your loan upside down.

How to Get Out From Under an Upside Down Car Loan

Alright, now for the good stuff. If you find yourself underwater on your auto loan, here are 6 different strategies you can use to get out from under it:

1. Pay Off the Loan Faster

The quickest way to get your loan right-side up is to simply pay it off faster. This reduces the principal balance and interest charges. And the closer you get the balance to the car’s value, the less upside down your loan is.

There’s a few ways to accelerate payoff:

• Make extra payments – Even an extra $50/month can make a difference over time.
• Pay a lump sum – Use savings, income tax refunds, bonuses, etc. to make a one-time principal reduction payment.
• Refinance – We’ll talk more about this later, but refinancing to a shorter term or lower rate speeds up pay down.

The faster you can chip away at the principal owed, the quicker you can get your loan above water.

2. Voluntarily Surrender the Car

This is an extreme option, but it is something to consider if you’re very upside down and can’t keep up with payments. By voluntarily surrendering the car to the lender, you’re released from the loan obligation.

However, the lender will sell the car at auction for much less than you owe. And you are responsible for this deficiency balance. Your credit score will also take a major hit. But it may still be a better financial option than continuing to pay on a car you can’t afford.

3. Trade it in for a Cheaper Car

Trading in an underwater car for a less expensive used car can help in certain situations. This avoids a voluntary surrender while getting you into a cheaper ride.

But this only works if the negative equity isn’t too severe. The new loan needs to cover the old loan balance plus the cost of the cheaper car. And qualifying for two loans at once can be difficult.

4. Refinance the Loan

Refinancing replaces your existing upside down loan with a new one. This works if you can get approved for a better loan term or interest rate than your original loan.

Refinancing to a lower rate reduces your monthly payment. And that frees up cash to pay extra each month to principal reduction.

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