Finance

How to Get Out Of an Upside-Down Car Loan

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An upside-down car loan (also called being underwater on your loan or having negative equity) means your loan balance is higher than your car’s value.

Ending up upside down on a car loan is easier than most people think. If you struggle to make your car loan payments because you owe more on your vehicle than it’s worth, you’re not alone.

Here are some tips and strategies for getting out of an upside down car loan.

What to Do if You Can Continue Making Payments

If you find yourself upside down on a car loan, but your credit is good and you can continue making payments, consider these steps.

Determine the Scale of the Problem

You can whittle the problem down to size by calculating how far upside down you actually are. Here is how to do it.

  1. Ask your lender for the current amount it would take to pay off the loan. That figure is the amount you would have to come up with today.
  2. Ask for the total amount you will pay if you continue monthly payments until the loan is satisfied. This will be a different number than today’s payoff amount because you will incur interest if you stick with the loan until it is paid in full. 
  3. Calculate the value of your car. You can use an online calculator that allows you to enter the vehicle identification number (VIN) of your vehicle and find out the current value.
  4. Determine how features, mileage, and color may raise or lower the price of your car.
  5. Subtract your car’s value from the current loan amount at today’s payoff amount, and do the same for the amount if you keep the loan and continue monthly payments until the end.

💡 Tip: The average used car loses 15% in value per year, so include that figure in your calculations if you keep the loan.

Now you have a good idea of how large the gap between your loan balance and the value of your car is in two scenarios: if you hold onto your loan or if you refinance it.

If you’re only upside down by a small amount, you don’t have a serious problem. In a worst-case scenario, you can simply cover the difference. If the gap is large, you may want to take steps to protect yourself or even to replace your loan.

Get GAP Insurance

If you plan to keep your car and continue making payments, GAP insurance will keep you covered.

GAP insurance, also known as Guaranteed Asset Protection (GAP) insurance, pays the remaining difference between the actual value of a vehicle and the balance due on the loan. It comes into play if your car is financed and you make a claim for a total loss.

Say you wrecked your car or it was stolen, but you still owe your lender $35,000. Your insurance company decides that the actual cost value (ACV) is $30,000 and issues you a check for that amount. GAP insurance will then step in to cover the remaining $5,000.

GAP insurance will protect you if your car is totaled or stolen, but it will also add to your insurance bill.

Keep the Upside-Down Car Loan and Make Extra Payments

An additional monthly payment will help you accumulate equity more quickly and get rid of your negative equity, especially if your lender will apply the payments to the loan’s principal. You don’t have to make a double payment. Just add a percentage to what you pay, such as 10% to 25%. You will reduce your interest costs and build more equity.

Use the early payoff calculator below to see how much sooner you will be able to pay off a loan and how much you will save on interest with extra payments.

This is a good option if you have the means to make extra payments and your negative equity is relatively small.

Refinance

Auto refinancing means taking out a new car loan to pay an existing car loan. This can help you lower interest rates and reduce your monthly payments. It can also get rid of that upside-down loan.

The interest rate on your new loan will be largely based on your credit score. Know what’s on your credit report and work to improve your score. You could potentially lower the interest rate on your new loan.

💡 Tip: Call your current lender and explain your problem. Many lenders offer refinancing options, and they can structure a new loan to address your negative equity situation. If that doesn’t work, you can start looking at other low-fee refinancing options.

📚 Read more: Learn how car refinancing works, along with some tips on the best times to pursue refinancing.

Use the refinance calculator below to see how much you could save by refinancing your car loan.

Get a Less Expensive Car

If your credit score is good, consider stepping down in car value. Let’s go back to your $30,000 car with a $35,000 loan.

You find a used car for $20,000 and finance it. You now have a $20,000 loan. Roll over the $5,000 in negative equity into your new loan. Your new loan comes to $25,000. The payments will still be lower than they were for the first loan.

💡 Tip: Then you can sell or trade in the first car and use the proceeds to pay off its loan. You won’t have any negative equity to pay because you rolled that amount into the new loan.


What if You Can No Longer Keep Up With Payments?

The above remedies apply if you have good credit or can still manage to make payments. If you are having trouble paying, you still have options.

Sell Your Car

The moment you realize that you can no longer keep up with loan payments, you may have to sell your current car. You might sell it at market value and apply the proceeds to your existing loan but still owe negative equity.

You owe $35,000 and sell your car for $30,000 and apply it to the loan. You still owe $5,000 and you have no car.

⚠️ Warning: The lender will want the negative equity as a lump sum because you no longer have the car that was used as collateral.

You can try to take out a loan to cover the negative equity. You could borrow $5,000, and you would have much smaller payments than you had on the upside-down loan. This is why taking action the minute you realize you can’t keep up is vital. If you start missing payments, you will see your credit score decline and find it challenging to qualify for a new loan. 

Voluntary Surrender 

A final option to get out of an underwater car loan is to voluntarily surrender the vehicle to the lender. This will hurt your credit score, making it more difficult to obtain a car loan in the future. However, surrender is a much better option than waiting until your car is repossessed. Repossession will come with charges and will hurt your credit score even more than surrender would.


Prevention Is Best

There’s no magic solution to getting out of an upside-down car loan. All of these options will work, but most of them will cost money or harm your credit. That’s because you’re facing the fact that you owe more than the asset is worth. Resolving that involves either paying off the asset or putting up more money. The gap in value won’t just go away.

The best way to deal with this situation is to stay out of it. Use these steps:

  • Don’t buy more car than you can afford. Don’t let a dealer talk you into buying the latest and greatest with the newest features. Decide on a budget and stick to it.
  • Make a substantial down payment. A down payment means you have equity from the start and makes it much less likely that you’ll go upside-down.
  • Keep the loan term short. Long-term auto loans keep monthly payments down and make a car seem more affordable, but they are a fast road to an upside-down loan. If you can’t afford the payments on a 60-month loan, look for a cheaper car.

📚 Read more: Learn more about long-term auto loans and how they can affect your finances.

You can get out of an upside-down car loan, but you’ll save yourself money, time, and trouble by not getting into one in the first place!

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