- When you are upside down on your car loan, you owe more money on your vehicle than it is worth.
- Small down payments and long loan terms make it easier to put your loan on hold.
- Consider refinancing your car loan or contributing more money per month to reduce negative equity.
- Learn more about Personal Finance Insider loan coverage here.
Because most cars lose value quickly after you buy them, you could be upside down on your car loan. Fortunately, there are options to help lift yourself out of this financial burden.
What is a reverse auto loan?
When you are upside down on your car loan, you owe more money on your car than it is worth.
Suppose you took out a $ 20,000 car loan with a term of five years and an interest rate of 5%. However, the value of your car will depreciate as soon as you leave the lot. After two years, you still owe around $ 12,000 on your loan, but your car is only worth $ 10,000. This means that you are upside down, also known as having negative equity, of $ 2,000.
If you want to get rid of your car, you have to pay the lender the negative equity in the vehicle in addition to the amount you sell or trade it for.
Putting your loan upside down isn’t a bad thing in and of itself, but it can cause problems if you find yourself in certain situations.
For example, if your car is totaled, your insurance company will only pay the estimated value of your car. If you are upside down on your loan, you will owe the lender your negative equity, which could be thousands of dollars out of your pocket. Or say you want to switch from your current car to another. You will need to pay the amount you owe on top of the trade-in value of your original car to trade it in.
How do reverse loans happen?
Reverse loans are often the result of the terms you choose when you buy your car. Here are some of the most common reasons.
- Little or no money. Cars lose a percentage of their value almost immediately when you leave them, and if you don’t put down a down payment, you can instantly be upside down on your loan. Without the money, you will also end up financing the taxes, license, registration, and dealership fees, which will add to the total cost of the loan and already leave you more than the value of the car.
- Long term loans. Dealerships may offer terms of up to eight years, but your payments might not be able to keep up with depreciation. The longer the term, the more money you will pay in interest. Keep in mind, however, that shorter terms come with higher monthly payments.
- Overpriced cars. Do your research on similar makes and models and shop around to find the best deal possible. If you jump on the first offer you find, it could end up costing you thousands of dollars in the long run and speeding up your loan reversal.
- Unnecessary add-ons. The dealer might push you to buy things like extended warranties, sunroofs, or DVD players because they make a lot of money with these add-ons. However, with each additional purchase you make, you will have less money to spend on the car.
How to get out of a reverse loan?
Start by determining how much you owe on your car. To calculate this number, subtract the value of your car from the outstanding balance on your loan. The Federal Trade Commission recommends examining Guides from the National Association of Automobile Dealers, Edmunds, and Kelley Blue Book to estimate the current value of your car.
Then you can consider refinancing your car loan. You might qualify for a lower rate and shorter repayment term when you refinance, which would reduce the time it takes to get out of negative equity on your loan.
If you have enough money, you might want to pay off your negative equity in one lump sum payment, but check with your lender to make sure you don’t incur any prepayment penalties. You probably won’t want to completely empty your bank account to do this, as you’ll want to have cash on hand in an emergency.
You could also contribute more per month by rounding your payments to the nearest $ 50, for example. You’ll pay off your loan and get rid of your negative equity faster.
Discover our tips for repaying your car loan faster.
Selling your car privately through marketplaces like Craigslist or Ebay is another option to consider. You should try to get enough for the car to erase your negative equity, otherwise you will have to pay that money back yourself.
Finally, you can think about trade in your car at the dealership, but be careful before doing so. If you’re not careful, you could immediately end up with negative equity on your new car and fall into a cycle of debt. However, you could potentially be immune to your negative equity if you manage to downgrade and find a car worth more than its price.