How to Get Out of an Upside Down Car Loan
A car starts losing value the second you drive it off the lot. That makes it easy to get upside-down on your auto loan in a hurry — meaning you owe more money on your car than it’s worth.
Getting out of an upside-down car loan can be tricky, and what works for some people may not work for you. In this article, we’ll go over what exactly an upside-down car loan is, how to get out of an upside-down car loan and how to avoid getting upside down the next time you buy a car.
What is an upside-down car loan?
Being upside-down on car loan means you owe more money for the car than the car is worth. It’s also called “being underwater.” In this situation, the difference between what you owe and what the car is worth is called negative equity. If your car is worth $8,000 and you owe $10,000 on the loan, then your negative equity is $2,000 and you have a upside-down car loan.
How do you get upside down?
There are several ways your car loan can wind up carrying more debt than the car is worth. Understanding how it happens may help you to understand how to get out of an upside-down car loan.
Small down payment. The quickest way to have an upside-down car loan is to not make a down payment when you buy it, or to put only a small amount down up front. A car loses value over time, and this is especially true with new cars. As soon as you buy a new car, it’s no longer new; it’s used — and that means a big drop in its value.
Add-ons. Adding extra products into your auto loan, like a $200 roof rack or a $2,000 extended warranty, can mean your auto loan is for more than what your car is worth right off the bat.
High price. If at all possible, try to make sure you’re getting a fair deal on the car you buy. If you do end up paying more than it’s worth, your auto loan might rapidly be upside down. To find out the value of any car, you can use free online tools at KBB and NADAguides — and be prepared to negotiate on car price.
High APR. When you pay on your auto loan, you’re not just paying for the car. You’re also paying the lender for giving you the loan, and the lender wants its money. The first part of every payment goes to paying interest to the bank, not to paying the principal on your car. The higher the APR, the more you have to pay the bank. If you have a high APR, you could make a lot of payments and still owe quite a bit of money, since most of what you pay is going to the lender. If you finance through the dealer, know that they, too, often increase your APR so they can profit; the average hidden interest rate added by dealers is 2.47%. To know what APR you may be able to get without going through a dealer, you can read here about the best auto loan rates in 2018.
Taxes and fees. If you can’t pay for the taxes and fees out of pocket, then you have to add them to your loan — this could mean you’re upside down as soon as you start. Taxes and fees overall usually add up to 8% to 10% of the car’s price, and this is added on top of the car’s price.
Long loan term. While small payments are definitely enticing, taking out a long-term auto loan to have small payments means you will pay more in interest over time. It also means you’re paying down the loan more slowly, letting the car lose more value when you’re still paying.
Negative equity from your former car. If you traded in an old car that had negative equity, that amount of money you owed doesn’t go away; it instead gets added to your new loan. You can get into some deep debt without really noticing if you do this.
7 ways to handle an upside-down car loan
Here are seven ways you can get out of an upside-down car loan. You could use one or several of them at once to help get above the water.
1. Pay it off. This is also called “riding it out.” By paying off the auto loan as scheduled, you won’t owe anything on the car and therefore there won’t be a difference between what you owe and what the car is worth.
2. Make extra payments. You don’t have to double your car payment — you can simply put extra money that you have towards the car, whether it’s $50 or $200 at a time. When you make these payments, write on the check or tell the lender that the payment should go toward the principal, not the interest.
Many lenders do not penalize you for paying off auto loans early — but you should still look at your paperwork, or call the lender or the dealer to double check that you won’t get a fee for taking care of business.
3. Make payments every two weeks. Another way to essentially make an extra payment, but without forking over extra money, is to make a half-payment every two weeks instead of one payment each month. Over the course of a year, this means you’re making an extra payment without too much pain. Again, be sure that you won’t run into a prepayment penalty.
4. Refinance. If you have a high interest rate and your credit has improved since you signed for the auto loan, you may be able to get a better rate. If you got your car loan from “buy here, pay here” establishments, which are known for predatory lending practices, definitely consider shopping around for refinance. Look for the best auto refinance companies and find potential auto refinance offers.
5. Trade it in. This is only advised if you find a car that is priced sufficiently below its value to make up for your negative equity. For example, if you find a used car that is priced $2,000 below what KBB or NADAguides say it is worth, and you have $2,000 negative equity, then it makes up for the difference and you should not be upside down on your new car loan.
6. Cancel any add-ons. If possible, cancel any add-ons you added to the loan. You should be able cancel things such as GAP, extended warranties and service contracts, all of which are services offered over time. Any pro-rated refund should either be sent to you as a check (which you can then use to pay down your auto loan) or be directly applied to the amount you owe on the loan. You probably can’t “cancel” products such as an appearance package or a roof rack.
7. Sell it privately. You are more likely to get more money for your car by selling it privately than you if you trade it in to a dealership. You could post the car for sale on eBay, Craigslist, Facebook Marketplace and other sites. The ideal situation is if you can sell the car for enough to cover what you owe on the car. If that is not possible, you could put the money from selling it towards the loan immediately and then continue to make payments on what is left.
How to get out of an upside-down car loan
1. Figure out how much negative equity you have. This step has three parts: First, find out how much you owe. Then, find out how much your car is worth and subtract the two.
- To find out how much you owe, call the lender and ask. Simply ask “how much do I owe on my car loan” or “what is my auto loan payoff?” — a payoff is how much it would take to completely satisfy your loan. Also write down whether you can pay off the loan early without penalty, how you can make payments to the principal and what your APR is.
- To find out how much your car is worth, use a free online industry guide. Both KBB and NADAguides are used by lenders to determine car value and you can use either.
- Subtract how much you owe from what the car is worth. If you owe $10,000 and your car is worth $8,000, then the difference is $2,000. In this case, that is $2,000 in negative equity.
2. Find the method that’s best for you — and work it. Based on how much negative equity you have, consider the methods of how to get out of an upside-down car loan and choose what works best for you. Maybe you found your APR is pretty high and you shop around for refinancing. Or you plan to ride the loan out but consistently pay half your monthly payment every two weeks. Many situations are different, so do what works best for you.
How to avoid an upside-down car loan
The best way to get out of an upside-down car loan is to not get in one in the first place. These are some ways you can avoid going underwater on your auto loan. And if you still do go underwater, these methods might help you from going very deep.
Make a down payment. You don’t have to put down a huge sum — even a few hundred dollars could fend off negative equity and help you stay right-side up.
Buy used. Car values drop like a rock during their first year of use. Buying a car that’s only a year or two old can save you a lot of money and prevent you from becoming upside down on your car loan due to depreciation.
Get preapproved. The best way to make sure you get the lowest APR is to get preapproved for an auto loan. Apply to a few lenders so you know what APR you qualify for. If the dealership says they can only offer you a high APR, tell them you already have an auto loan preapproval with a lower APR, so you’ll go with that loan offer.
It does not hurt your credit score if you apply to multiple lenders within a 14-day window any more than it would if you applied to one lender, so don’t be afraid to shop around for the best loan.
Don’t miss payments. When you miss payments, you have to pay interest on the interest you should have paid. “Double interest” is not good.
Don’t get add-ons. If you can’t buy add-ons with cash, consider foregoing them. If you really need or want an add-on, look for other places you can buy them. Local auto detail shops offer appearance packages including things like mud flaps and window tint; for example, a paint sealant, which might cost as much as $4,000 at a dealership, could be found elsewhere for only $300. Roof racks are available new on eBay for $83 instead of $200 from the car manufacturer.
Get a short-loan auto term. The shorter the loan term is, the less you’ll pay in interest over time and the quicker you’ll pay it off.
Choose a car that holds its value. Some cars depreciate faster than others. There is little sense in paying a lot of money for a car that will only be worth half of what you paid in a couple years. You could Google the car model you’re interested in along with the phrase “depreciation rate” or “how does it hold value” to find out.
Cover the taxes and fees out of pocket. Pay for the taxes and the fees upfront instead of financing them into your auto loan. The idea behind this is to not finance anything but the car so that your loan will never be for more than what the car is worth.