When the outstanding balance of an auto loan is more than the market value of the car against which it is written, the borrower is “upside-down” in that loan. Other terms you’ll hear to describe this situation are “negative equity” and “underwater.”
Whatever you call it, the bottom line is the person owes more than the car is worth. The good news is the situation can be resolved. The bad news is it’s always going to cost you money.
Here’s everything you need to know about upside-down car loans.
How It Happens
One of the most common ways people wind up in this situation is taking a 72- or an 84-month loan to make the payments affordable. This can also happen with 60-month loans if you aren’t careful about how you get into them.
Other ways to stumble into this situation include buying a car with a minimal down payment or trading in a car before it’s paid off and rolling the balance due into the new car loan. Given all cars depreciate, the financial toll adds up pretty quickly when depreciation is combined with any of the circumstances above.
Overpaying for a car is another thing about which you need to be careful. Dealers will sometimes markup pricing to reflect demand when a hot new car comes onto the scene. However, when the market cools, people who took out loans at those inflated prices will be in trouble.
What to Do About It
There are ways to “right side up” the situation. However, all of them involve paying the difference between what you owe and the value of the car. With that said, some strategies for doing so are a bit less painful than others.
Refinance: If your long-term loan is still relatively new, you can often qualify for refinancing car loans with shorter terms to help you get out of the situation. If nothing else, you’ll pay the loan off before depreciation can take its full toll.
Accelerated Payments: Adding extra money to your monthly payments will pay the loan down sooner and help you get out of the car while it’s value is higher. You’ll still pay the total loan amount, but at least the car will be newer when it’s paid off.
Sell the Car: Done right, you’ll always get more money when you sell your car yourself than you will by trading it in at a dealership. Dealers will only give you a wholesale price to leave enough of a margin to make a profit when they resell it. However, when you sell it to a private party, you can get closer to the retail price. The trick will be to sell it for your loan amount — or have enough cash to put with what you sell it for to satisfy the loan.
Be Patient: Yes, new cars have nifty features like back up cameras, proximity sensors, smart cruise control and self-parking. And yes, the ads make those cars seem like dreams come true. However, if your car is running fine and your only problem is you owe more than it’s worth; why dig yourself into a hole just to get a newer car?
Be patient; pay it off and vow to never let yourself get upside down in a car loan again. Remember, what’s new today will be old tomorrow. If you wait until you can get into your new car the right way you’ll enjoy it much longer. If you’re impatient you’ll just keep yourself on a treadmill to nowhere.
Disclaimer: This content does not necessarily represent the views of IWB.