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How to Get Out of an Upside Down Car Loan With Negative Equity

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In the housing industry, it’s called “negative equity.” In the automotive industry it’s called being “upside down.” In both cases, it means the same thing: You owe more money on an asset than the asset itself is worth.

When you’re upside down on a car loan, you can end up in big trouble because a car doesn’t grow in value like a house often does. You can list a car as an asset on your balance sheet if you want, but in reality, it’s not an asset or an investment. It’s an expense.

If you’re in this unfortunate position, you can’t lower your payment by refinancing, and selling your property won’t cover the whole loan. How did you get here, and what can you do?

Getting Upside Down on a Car Loan

To understand how to get out of trouble, you first need to understand how you got upside down on a car loan in the first place.

  • A car depreciates in value very quickly, especially in your first three years of owning it. When you buy a car with a low down payment – or no down payment at all – you immediately owe nearly the entire purchase price, but it’s already worth less. For example, if you buy a $20,000 car and only put a thousand dollars down, you’ll be upside down as soon as you drive the car off the lot. You owe $19,000, but the car is only worth $16,000.
  • It’s easy to overpay if you don’t do your research before buying a car. Your overpayment doesn’t make the car worth any more in the fair market, so if you pay $24,000 for a car that’s now worth $16,000 you’re upside down and already facing a big problem.
  • It’s not always your fault. When an unscrupulous car dealer takes advantage of you, you can end up owing more than you should.
  • When you add too many frivolous options to your car, you increase your final total, but not the value of the car. That’s a recipe for being upside down even faster.
  • If you’re already upside down on one car loan and you try to get a new loan, dealers will often roll the shortfall from the old car to the new car without even telling you.

Unless you’re on high alert when buying a new or used car, it’s easy to fall into these traps. In fact, it’s almost certain that you’re going to be upside down at some point. That’s why many people don’t even know when it happens to them. At first, it’s not necessarily a problem.

When Being Upside Down Becomes a Problem

Being upside down on your car loan doesn’t always require immediate attention. Sure, it’s not good news, especially if it means you overpaid. But as long as you got a fair deal on your loan, and you make your payments on time, the expense of your loan and the value of your car eventually even out, usually in no more than five years. The imbalance might only be temporary.

The trouble comes when you can no longer comfortably afford your monthly car payment, whether it’s due to unemployment or job loss, income reduction, or another major negative change in your overall financial situation. When you’re upside down and can’t cover your loan payment, you’re in a tough financial place.

car and stack of money

How to Get Out of an Upside Down Car Loan

The only real way to fix the problem of being upside down is by paying down the excess debt. You’ll have to go through a few steps and make some sacrifices to manage the loan or raise the cash, but the process is worth your time. You can get out from under a payment you can no longer afford.

1. Move the Excess Car Debt to a Credit Line
Although many people would rail against using credit cards, moving the debt to a credit line might be the best option. If you’re having trouble with a $600 monthly payment, moving to a more manageable rate on a $5,000 line can save you cash and buy you some time.

The key is to avoid more trouble. This plan only works if you can commit to the lower regular payments on a credit line. If you can, get a line with a low introductory APR, and pay as much as you can before the introductory period ends (i.e. 0% APR balance transfer credit cards). Consider using peer-to-peer lending networks like Lending Club or Prosper. A local credit union can also provide a personal loan at a reasonable rate.

2. Sell Some Stuff
If the credit line idea doesn’t sit well with you, then you’ll need to raise some cash. This means that you may need to sacrifice something else in order to cover the car payment. Selling major items like extra furniture or jewelry might help, or sell smaller items on eBay to raise money.

Don’t count out the idea of selling the car, even though it won’t cover your entire overage. If you owe $10,000 and you can sell the car for $7,500, the $2,500 will be much more manageable than paying your full loan. Keep in mind that your car will only continue to depreciate in value, so get as much out of the sale as you can.

3. Get a Part-Time Job
When you need more income, the only answer is often to get a second job. It doesn’t have to be a permanent arrangement, just a temporary fix until the car loan shortage is corrected. This situation might even be the push you need to start your own small business or find ways to make extra cash on the side.

woman with cash

Avoiding the Problem

Lets face it: Cars will always depreciate rapidly. As long as they have engines inside them, they’re going to drop like a rock in price. Car dealers know it, and they almost always make more money when you finance. When you’re ready for your next car, keep a few tips in mind so you can avoid being upside down on a car loan ever again.

1. Don’t Finance the Purchase
The easiest way to avoid being upside down is to not have a loan at all. You might have to settle for an older car, but try to save enough cash to buy the vehicle without taking out a loan.

Someday, I hope to be in a position where I can save up enough money to buy a new car without it being any kind of strain on my finances. Wealthy people don’t finance cars. They pay cash for them and drive them for a long time. Make it your goal to stop the cycle of going from one car payment to another. If you break that cycle, you’ll be one step closer to achieving independent wealth.

2. Pretend You’re Buying a House
Whether you’re shopping for a new luxury vehicle or an old car with low mileage, take the time to save the way you would for a mortgage. Try to have at least 20% of the purchase price available in cash. This down payment will be your best defense against the horrendous depreciation that your new car will experience over the next two years.

3. Pay More Than the Specified Monthly Payment
If you’re going to finance, try to get a five-year loan so your monthly payment will be small. Then, if you can, pay up to double the minimum payment. You’ll pay off more of the principal earlier, which means you’ll build up less interest. The faster you pay off the loan, the better.

4. Keep Up With Car Maintenance
Don’t rack up mileage. Stay on schedule with oil changes and engine maintenance, and take care of the paint job with frequent car washes and cleanings. If the “check engine” light comes on, address it quickly so a bigger problem doesn’t arise. Keep the interior clean. The better you treat the car, the higher the resale value will be. Make sure you can check off “excellent condition” when you look up the value.

auto mechanic in shop

Final Word

Being upside down on your car loan can be an extremely difficult and challenging prospect, but there is hope. By staying organized, disciplined, and employing some unique strategies, you can work your way out of this debt.

Are you upside down on your car, or have you ever been? How did you get in that position, and what did you do to get out and make things right? I’d love to hear about your experiences and insights!

Kevin Mercadante
With backgrounds in both accounting and the mortgage industry, Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He lives in Atlanta with his wife and two teenage kids.

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