Upside Down on Your Car Loan? Learn What to Do When You Owe More Than It’s Worth
Negative equity, being upside down, or underwater on your car loan all mean one thing: you owe more on your vehicle than it’s worth. This is a common but frustrating situation for many car owners. Understanding the causes of negative equity and doing your research before buying can help you avoid overpaying and protect your finances. Learn how to prevent getting stuck with a car that’s not worth the payments!
The three reasons you may owe more than your car is worth:
Debt from your trade
If you decide you want to trade in a vehicle that you are still paying on, the payment you receive for the car should cover its loan balance. If the trade doesn’t cover the loan balance, you can either pay the difference out of pocket or roll the remaining loan balance into your new vehicle loan. When you roll the additional amount into the new loan, it can create negative equity on the new car by jacking up the loan to more than the new car is worth.
Additional expenses
When you purchase a car, whether through a dealer or private seller, you need to account for paying the taxes, title and registration fees, warranties, and/or extra protections. In most cases, these additional expenses are included in the loan, which can contribute to negative equity, bringing your loan balance to more than the vehicle is worth.
An oversized price tag
You may find a car that costs more than it is worth. If you aren’t able to negotiate the price lower, then you could begin your loan with negative equity.
Four ways to avoid ending up under water with your loan:
- Before you start, learn the value of the car you’re buying or trading. There are many websites that can help you value a vehicle; NADA, Edmunds, and Kelly Blue Book are three of the most popular. When valuing a vehicle, the type of value you’re looking at can make a difference – average trade in, clean retail, private sale, etc. – there will be different values depending on each situation. Be honest and realistic about the body condition of the vehicle and add in any options the vehicle has, as both play a role in determining the value.
- Don’t extend your car financing terms, because the longer the term is, the more of your payment goes to interest rather than principal. Paying aggressively, or taking the loan out for a shorter term, will help you pay the balance down faster. This will prevent you from ending up with more loan debt than the car is worth, which could lose more value than you pay down over the course of an extended term.
- Be mindful of your interest rate. The higher your interest rate is, the less you’re going to be paying on your loan balance each month. Oftentimes, your credit score impacts the interest rate that you’re approved for, so keeping your credit healthy will help get better interest rates (and save you money in the long run). If your credit score earns you an interest rate that is higher than you’d like, you can always look into refinancing the loan later.
- Make a down payment on the car. The more you put into a down payment, the better your equity position will be—this can be especially important when purchasing new vehicles, as they depreciate up to 20% in the first year.
If you’re upside down on your car loan, don’t panic—GAP insurance can save the day! Guaranteed Asset Protection (GAP) covers the difference if your car is totaled or stolen and your insurance payout doesn’t cover the full loan balance. Instead of paying out of pocket, GAP steps in to cover the remaining amount. Many companies offer GAP insurance, so it’s important to compare costs and additional benefits. While all GAP policies cover the unpaid loan balance, some also help with your insurance deductible or even provide money toward a replacement vehicle.
Being aware of how negative equity can happen and looking for ways to avoid it will allow for a much smoother vehicle buying process. You’re spending the money each month, so make sure you get the greatest bang for your buck!
About the Author
Oliver Ames
Oliver is EastRise’s Digital Content Strategist. With a background in science education, non-profit fundraising, business communication, media production, and membership-based organizations, Oliver brings a wealth of experience to his role.
Based in Vermont, Oliver is also a professional photographer and a USA Masters swimmer. When not at work, he enjoys spending time with his wife and son at their home in Montpelier. A proud parent, Oliver balances his professional and personal life with passion and dedication.
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