What to Do with an Upside Down Car Loan

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November 9, 2016


An upside down car loan is much more common than most people realize. The nature of car purchasing, depreciation and sales tactics at dealerships often lead to people who are upside down in a car loan, meaning they own more money on the loan that the vehicle is worth.

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Why a Negative Equity Loan Happens

Another name for an upside down car loan is negative equity. This term means that instead of having equity in the car, or a portion of the car value that is already paid for and would return to the owner in case of a sale, the owner instead would owe the bank or lending institution money if the car were sold.

There are a variety of ways a buyer gets into a negative equity situation. The most common occurs when a person trades in an old car for a new one. Sometimes a car dealer acts unethically and doesn't fully disclose terms in this situation, but other times it is the responsibility of the consumer, who doesn't take the time to understand loan documents or buyer's agreements.

A buyer often comes into a dealer with a car that is not paid off, but wants a new car. The dealer merely tells the buyer that they can arrange for a payment that is not much more or is no more than the current payment, without the buyer understanding that they are folding the loan on the old vehicle into the price of the new vehicle.

Another way a person gets into a negative equity situation is by purchasing a car with no money down. Cars depreciate 20% in the first year and 50% by the third year of ownership. They are not an investment, but rather, a liability. If you buy a new car with no money down, you are in a negative equity situation as soon as you drive off of the lot.

Another problem is excessively long loan terms, which stretch payments out so far that the payments don't keep up with the depreciation.

What Should I Do?

In an upside down car loan situation, there are a couple of ways that one can combat such a troubling situation. The best thing to do is to keep the car and pay the car loan down as quickly as possible. Don't buy a new vehicle, because any dealer who would help you buy a new vehicle when you are already upside down is only going to make your situation worse.

Another option is to sell the car. If you sell the car and don't have to buy a new one right away, you can use the amount you get from a sale to pay down the loan, and then work for the next several months until you pay off the difference. Just because you sell the car does not mean the bank will forgive the difference.

Some lending institutions will call the entire loan due at the sale of the vehicle, so you would need to work with your lender to turn the loan into a personal or signature loan. However, they will only do this for people with excellent credit.

Some people recommend turning in a car when you are upside down on a leased vehicle. This may relieve the immediate pressure, but has the same end result. When the lease is up, you will still have negative equity unless you have made substantial extra payments.

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For those trying to find a creative way to get out of an upside down car loan, you should avoid anything illegal that tries to get the insurance company to pay the debt. There are penalties for damaged or stolen vehicles. You will still owe the extra on the loan anyway, because the insurance only pays current market value of the car, not the entire amount owed on the loan.

Check prepayment options. By doubling or tripling up on payments, you can reduce outstanding terms on the principle owed. First, however, make sure your loan agreement does not contain prepayment penalties that finance companies usually place in terms to counter any effect prepayment would have on their profits.

Explore other refinancing options. Examine any opportunity to refinance the car to reduce interest rates by reducing payment term lengths or increasing monthly payments that can help get you out from under an upside down loan situation. Additionally, you may qualify for a home equity loan which is typically a loan secured at much lower rates than an auto loan.

Avoiding Problems with an Upside Down Auto Loan

Keep in mind that there are ways to avoid making this same mistake in future auto loan transactions by:

  • Making at least a 20% down payment.
  • Choosing length terms less than 60 months.
  • Choosing to buy a well-maintained used vehicle.

Retracing Your Steps

There are a number of factors that contribute to nearly 40% of the auto buying public winding up with loans and payments far greater than their vehicle's worth including:

  • Insufficient down payment.One of the greatest marketing ploys is the No Money Down (or very little) option that attracts consumers to an auto lot thinking this is the best way to get into a new auto. However, without sufficient money down you create two situations-greater interest and larger payments.
  • Payment terms.Consumers think that spreading payments out over 5 years or longer is a great idea when buying a new car. However, this only helps to increase the amount of interest on the total principle which usually winds up with total payments greater than the vehicle's worth.
  • Roll over.Consumers motivated by a desire to trade a vehicle in on a new choice are tempted to roll over the original balance into another loan that can not only increase a monthly payment but keeps the buyer in an upside down loan situation.
  • Excessive interest rates.Consumers seeking a quick transaction on a new car loan sometimes settle for the offered interest rate on a loan thus accepting a higher than desired rate. This can leave a consumer in an upside down situation where payments amount to much more than the car's worth.
  • High price tag. Consumers are always susceptible to emotional buys limiting any comparison shopping to negotiate the best price possible. Also, many emotional buys sometimes far outweigh a person's ability to afford a vehicle.

Other Ways to Manage Your Upside Down Car Loan

One thing that you can do to manage your loan is to include extra money with each monthly payment. If the money you owe to the bank for your car is far more than what it's worth, you should do your best to pay an extra $50 to $100 each month, or more if you can afford it. This can really make a big difference and it will help lower the negative equity a lot quicker.

You should also consider getting gap insurance for the car. If you get into an accident and the car is totaled by the insurance company, you are going to be expected to pay the difference in value on your own. The insurance company is only going to pay the loan company what they think the car is actually worth, not the amount of money that is actually owed on the car. If you have gap insurance, they will pay the difference. This can save a significant amount of money in a bad situation.

One reasonable thing to do is simply keep your car and pay the negative auto loan off. Many people are often tempted to stick with new cars they can use as trade in leverage, but with an upside down loan, it really is not a very good idea. If you do this, the lender will take the negative equity you have on your trade in and tack it onto the price of your new car. Then you will be practically back in the same spot you originally found yourself in with your new car.

Refinancing Your Upside Down Auto Loan

If you have been suckered into a car loan in which you owe more money to the lender than the car you bought with the loan is worth, otherwise known as an upside down car loan, a good way to get yourself out of this hole is to refinance your upside down auto loan. Many new car buyers each year are mislead by auto loan companies that try to take advantage of them by getting them to take out a loan that has a high percentage rate. Your auto loan can also go upside down if your car suddenly depreciates in value, such that if you sold it, you wouldn't be able to pay off your loan. To lower the total amount of money you will have to pay for your loan, you can take out a loan from another insurance company that has a lower interest rate to pay off your original loan all at once. This is called refinancing a car loan. The following is a guide that will help you apply for a loan to refinance your upside down car loan.

  1. Find a company that offers auto loan refinancing. You can easily find a list of financial institutions in your area that offer refinancing for auto loans with Google, and you can apply for quotes from these companies at their websites. Alternatively, you could use one of the many websites, such as LendingTree.com, that can connect you with lenders in your area that offer the types of loans you are looking for. To use this type of website, you fill out a single form with information about yourself and the car you are refinancing the loan for, and the website uses it to provide quotes from a whole list of lenders at once.
  2. Compare quotes. Once you have quotes for auto loan refinancing from many different lenders, you can compare them in order to find the best deal for you. Look for the quote that offers the lowest interest rate. Decide for yourself if you want high monthly payments, which will cost you a lot initially, but will save you money in the long run, or if you want lower monthly payments, which are easier to pay off individually, but will eventually end up costing you more money.
  3. Choose a lender and apply for the loan. Once you have found the best possible deal for you, go to the website of the company that offers that deal and apply for your loan. It will be easy to apply, and you will be given simple instructions throughout the process. If your application is accepted, the company will then pay off your loan and you will now make monthly payments to them, instead of your original lender.

If you have an upside down car loan, you should refinance it as soon as possible to save as much money as you can. There is no reason why you should stick with the plan you have if you can save money by switching to another one.

Your Current Finance Company

It's worth calling the company who owns your current auto loan to see if you're eligible to refinance your current car loan for a lower interest rate. Paying less in interest will help you to bridge the gap between what you owe and what the car is worth on the market. In some cases, the company may allow you to extend the loan terms for an additional year which would lower your payment as well. Negotiating the terms to that happy place where you'd be paying more on your principle than you are in interest will help mitigate the upside down loan effect.

Local Banks and Credit Unions

Unlike larger banks and finance companies, a local bank or credit union is more flexible in working with customers to creatively refinance your current loan. Often they have limits as to how much they can loan, however they may be able to help extend a line of credit at a lower interest rate or offer home equity loans to help pay down the gap in what you owe and what they can finance. Credit unions in general, have competitive car refinance rates and often have promotions for refinancing new loans for automobiles.

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