Reducing the effects of an underwater car loan may take some work but can ultimately save you money in the long run. From running the numbers to re-negotiating the terms of the loan, research, persistence, and communication can save you thousands of dollars. Read on to learn how.
What Is an Upside-down Car Loan?
A person is upside down on a car loan when they owe more on a car loan than what the car is worth; this is also known as negative equity. For example, a driver would be upside down on their car loan if their loan had a balance of $25,000 while their car was worth $18,000.
The difference between the value of the car and the cost of the loan is made up primarily of interest and other fees. Therefore, every time you make a payment on an auto loan with those terms, more money than necessary is going toward the lender, rather than the actual value of the car. Therefore, if your auto loan is upside down, you should consider working to rectify the situation as soon as possible.
How Upside-down Car Loans Happen
Equity becomes negative equity when getting rid of the asset takes money out of your pocket. Cars can take on negative equity in a few ways.
For example, picking longer repayment terms can result in owners being upside down on their loans. People may choose this option because the longer the repayment term, the lower the payments. However, given the speed at which cars depreciate in value, the borrower may be paying the full sticker price for a car worth half that much.
Another way a driver can find themselves upside down is by financing with a small down payment or no down payment. Cars lose as much as 20% of their value when driven off the lot and more if it’s a luxury or sports vehicle type that depreciates faster than expected.
Why it’s risky
Being upside down on a car loan provides significant risk to the borrower. For example, if you total a car that is upside down, you will owe the lender the difference between the value of the car and the value of the loan. This poses significant financial problems for those already struggling to make monthly payments.
If you find yourself in this situation, you could further damage your financial reputation, making it harder to do other necessary things, like renting a property.
How to Get Out of an Upside-Down Car Loan
The best way to avoid a potentially disastrous financial situation is to avoid entering into a loan with poor terms in the first place. However, for a variety of reasons, this is not always realistic. People with poor credit may not have much choice if they need to borrow money to finance a car. Others may have overlooked or misunderstood the terms of their loan agreement.
For that group of people, here are a few strategies you can take to free yourself from the debt:
Calculate Negative Equity
Owners can calculate the negative equity in their vehicle by subtracting the Kelly Blue Book value from the loan balance. If the dollar amount is negative, you owe more now than the car is worth. While some may be afraid of finding how much money they actually owe, knowing the extent of the debt allows you to accurately plan how to eliminate it.
Contact Your Lender
Reach out to the lender once you understand how much you owe. The lender may look kindly on this communication and may be more willing to work with you, as it ultimately benefits them. If you default on a loan, the lender also loses money, so it is in their best interest to come to an agreement that allows the cost of the car to be paid in full.
If your lender allows it, attempt to make extra payments at regular intervals (such as bi-monthly instead of monthly) or pay more than what is required due. As the loan amount drops, the owner will gain more equity in the vehicle, slowly taking them from upside down on the loan to right side up.
Continue Making Payments
Make sure you continue making the payments while trying to find a way to get right-side up on the loan. While you are putting yourself at financial risk by being upside down, you don’t want to make things worse by being late on payments or getting the vehicle repossessed.
Refinancing an Upside-Down Loan
Refinancing the loan often allows the borrower to reduce the APR (otherwise known as interest) on the car. This is easier to do when you have more equity in the vehicle; that’s another reason it is beneficial to pay as much, as often, as possible.
Selling Your Upside-Down Vehicle
Selling an upside-down vehicle often leaves some leftover debt. Those in this situation may choose to take a second loan on the remaining money owed. Given that you’ve likely paid off a significant amount of the money owed on the vehicle by selling it, the loan will be substantially less. Therefore, because you’re borrowing less money, the terms may be more favorable to the borrower than the previous loan.
Voluntary Surrender
Voluntarily surrendering the vehicle is when the borrower arranges a time and date with the borrower to return the car. Voluntary surrender will have a massive negative impact on the borrower’s credit and should be a last resort to fix negative equity in a car. The benefit of voluntary surrender is that it avoids repossession by the lender, which saves the borrower fees and additional negative hits to their credit.
Pay It off in a Lump Sum
A lump sum payment is a single, large payment that can wipe out negative equity on the vehicle, saving some accrued interest and other fees. Some lenders may even provide a discount for paying the entire debt.
Trade It In
Trading a car that is upside-downfor one that’s more budget-friendly can give the owner a chance to become right side up on their loan again.
For example, suppose you got a loan for an expensive luxury vehicle but would rather have an older, gas-efficient, used sedan. In that case, the value of the more expensive vehicle may roll over to the cheaper car. Remember that whatever negative equity was on the original vehicle will be transferred to the new vehicle at sign-up.
Cancel Any Add-ons
Additional services and other add-ons add debt to the car loan. The owner has to pay for the services they’ve used or received up to that point. However, they can cancel any services or extras to avoid additional expenses.
Ride the Loan Out
Riding the loan out means to keep making the payments as initially planned. Cars depreciate the fastest at the beginning of the loan period, so it’s easy to become upside-down on the loan for a while. But depreciation evens out as the car ages. If the borrower can keep up with the payments, the loan balance will eventually catch up with the car’s value.
Pay Ahead of Schedule
Every day your debt sits, it accrues interest, which you’ll have to pay as a part of the loan. Borrowers are saving themselves interest and paying less overall by paying their debt ahead of schedule.
Take Out Another Loan
The vehicle owner can take out another loan to pay off the negative equity for their current vehicle loan. The best time to consider this option is if the owner wants to sell the vehicle or trade it in. They can pay back the lender in a lump sum and spend the rest of the loan term paying the negative equity back to the second lender.
Debt Relief Options to Consider
Debt relief options are available for consideration for those who can’t keep up with their payments and are upside down in their car loan. Generally, debt relief is a way for borrowers to get out of debt when the amount owed becomes too much to manage successfully.
The methods to reduce debt differ depending on whether it is secured or unsecured. Secured debt is attached to collateral assets (such as a home or vehicle), while unsecured debt does not.
Filing for bankruptcy can be an option for debt relief, though it should generally be considered as a last resort and if you have debt on various other assets as well.
Filing bankruptcy for an auto loan essentially breaks your contract with the financier. The borrower has to return the car to the dealer, and they don’t have to make the payments anymore. However, bankruptcy stays on your credit report for up to 10 years, and you are still responsible for paying the debt. Further, if you utilized a co-signer, they become solely responsible for debt repayment.
Debt Consolidation
Debt consolidation combines several debts, including car loans, credit card debt, medical debt, plus any other debt the borrower may have, into a single, large loan. The loan usually comes with better repayment options and lower interest rates.
Debt Settlement
Debt settlement offers the collector a portion of the debt in a lump sum payment. Some collectors will accept between 10% and 50% of the loan amount in a lump sum in exchange for forgiving the loan in its entirety.