You have an upside down car loan when you owe more than your car’s worth. And this situation complicates things when you want to sell the car, buy a new one, or trade it in. Against this backdrop, find out how you could get into an upside down car loan situation and what you can do to get out of it.
Getting Into an Upside Down Car Loan
Cars are like homes, they could lose their market value and the loans tied to them become negative equity, underwater or upside down. Depreciation aside, there are varying instances that lead to the car loans being upside down.
Depreciation versus True Market Value
While depreciation occurs naturally, some consumers are vaguely aware of a car’s depreciation rate. Cars can lose as much as 20% of their true market value when they skid out of the dealership. Three years down the road and half of the TMV would have been lost.
A TMV helps you make the appropriate offer when negotiating the price of the car. But, some buyers don’t even look up the estimated true value of the car and end up paying more for what it’s worth. Nor do they search car makes and models, which could have helped them finance a similar car at a lesser price. Inadequate research leads to overspending or borrowing far more than what you can actually pay for.
Little Down Payments, Too Many Add-ons
Down payments help build equity faster and if you make little or none at all on your car, you’d start off with an upside down loan right away.
Always be aware that if you purchase add-ons for your car, from wheel locks to seat protection, they’d only inflate the car’s purchase price. However, add-on costs are not easy to recoup and could either boost or hurt the car’s value.
Getting Out of an Upside Down Car Loan
Having an upside down car loan becomes a pressing matter if you decide to sell the car and its sale price is not enough to pay down the loan. This leaves you looking for extra funds to finish off the car loan instead of pocketing the extra money.
Or, when you get into an accident and the insurer only pays for the value of the car and not the loan.
In both instances, you are stuck with a car loan that you have to pay off. How do you get out this situation?
1. Keep the car and continue repaying the loan until you finish paying it off or reach a certain level where what you owe is less than what your car is worth. You can also put extra payments on your loan to pay it off faster.
Tip: At the onset of the loan, go for a shorter term loan. It may command higher monthly payments but it can be paid back faster. You can also build equity in your car faster as well.
2. Sell the car but transact with a private party. You’ll get a better price in private sales than trade-ins.
Tip: A trade-in is an opportunity to get a new car. But trading in a car with an upside down car loan will result in higher monthly payments as the dealer is adding the old car loan balance into the new car loan balance. Ask your dealer about incentives that could possibly reduce/offset the negative equity.
3. Take out a second loan. It’s possible to cover the negative equity by taking on a new loan. To get the “negative equity”, subtract the payoff balance from the old loan from the car’s market worth.
Tip: Consider refinancing to get a lower rate to help you manage your car debt better. Look for lenders who are willing to work with you despite your upside down car loan.