Underwater on Your Car Loan? How to Get Back on Track
Being “underwater” on a car loan, or “upside down,” occurs when the amount you owe on your vehicle is greater than its current market value. In other words, the loan balance exceeds what the car is worth if you were to sell or trade it in. This is a common issue, particularly for those who have financed their vehicle with a low down payment or have taken out a long-term loan. While being underwater on a car loan can feel overwhelming, there are several strategies and steps you can take to get back on track, reduce the financial burden, and eventually pay off the loan without further financial hardship.
In this article, we will explore the reasons behind being underwater on a car loan, the consequences, and practical ways to improve your situation.
Why Are You Underwater on Your Car Loan?
Before looking at ways to get back on track, it’s important to understand why being underwater happens in the first place. Several factors contribute to this situation:
- Depreciation: Cars typically lose value quickly, with some vehicles losing up to 20% of their value within the first year. The longer you keep your car, the more it depreciates. If your car’s value drops faster than you pay down the loan, you may find yourself owing more than it’s worth.
- Low Down Payment: If you put down a small amount upfront when you purchased your vehicle, it’s more likely that you’ll owe more than the car is worth early in the loan term. Many lenders offer loans with as little as 10% or no down payment at all, which increases the likelihood of being underwater.
- Long Loan Terms: Many car loans today are offered with longer terms (60, 72, or even 84 months), which results in lower monthly payments. However, during the initial years of a longer-term loan, more of your payment is going toward interest rather than the principal balance. This means that even if you’re making regular payments, your car’s value may depreciate faster than you’re paying off the loan.
- High Interest Rates: If you have a high-interest rate on your car loan, more of your monthly payments go toward paying the interest rather than the principal balance. This can delay the process of paying down the loan and increase the likelihood that you’ll be underwater on the car.
- Accident or Damage: If your car is involved in an accident or suffers significant damage, its value may drop more quickly than you can repay the loan. In some cases, this situation may be compounded by a lack of comprehensive insurance coverage, leaving you on the hook for more than the car is worth.
The Consequences of Being Underwater on a Car Loan
Being underwater on your car loan can have several negative consequences, including:
- Difficulty Selling or Trading In the Car: If you try to sell or trade in your car, the proceeds from the sale may not be enough to pay off the loan. This means you could end up still owing money on the vehicle after you’ve sold or traded it in, which is known as a “loan deficiency.”
- Limited Financing Options: If you want to purchase another car while still being underwater, you may struggle to secure favorable financing. Lenders may be hesitant to approve a loan for a new car if you still owe money on the existing one. Additionally, you might be required to carry over the remaining balance on your current loan, making the new car loan even more expensive.
- Financial Stress: The longer you’re underwater, the more difficult it becomes to get out of the situation. If you’re unable to pay down the loan balance quickly, you may find yourself stuck with high monthly payments that leave little room for other expenses. This can lead to financial stress and potentially damage your credit score if you miss payments or default on the loan.
- Increased Risk of Repossession: If you’re struggling to make payments on a car loan while underwater, you risk having your vehicle repossessed. Repossession occurs when the lender takes back the car due to nonpayment, and it can result in the loss of both your vehicle and the money you’ve already paid toward the loan.
How to Get Back on Track: Strategies for Managing an Underwater Car Loan
If you’re underwater on your car loan, there are several strategies you can use to address the situation and reduce the financial burden.
1. Pay Extra Toward the Loan Principal
One of the most straightforward ways to get back on track is to make extra payments toward the principal balance of your car loan. By doing this, you’ll reduce the amount you owe on the car faster than your standard monthly payments would allow, which can help the loan balance catch up with the depreciating value of the vehicle.
Here’s how it works:
- Extra Monthly Payments: Add an extra amount to your monthly payment, such as $50 or $100. The additional amount will go directly toward reducing the principal balance.
- Lump Sum Payments: If you receive a tax refund, bonus, or other unexpected income, consider using it to make a lump-sum payment on your car loan. This can significantly reduce the amount you owe and decrease the interest you pay over the life of the loan.
- Reallocate Savings: Review your budget to find areas where you can cut back on expenses and reallocate those savings toward your car loan. Even small, regular payments can help reduce the negative equity over time.
2. Refinance Your Loan
Refinancing your car loan involves taking out a new loan to pay off your existing loan. This can help you lower your monthly payment, reduce your interest rate, or both. However, refinancing does not eliminate the fact that you are underwater on your loan—it just makes the repayment terms more manageable.
When considering refinancing:
- Check Your Credit Score: To secure better loan terms, it’s important to have a good credit score. If your credit has improved since you originally financed the vehicle, you may qualify for a lower interest rate, which can reduce your overall payments.
- Shorten the Loan Term: Refinancing can allow you to shorten the loan term, which may increase your monthly payment but help you pay off the loan faster. This can reduce the period of time you are underwater on the loan.
- Look for Lenders Offering Competitive Rates: Different lenders offer varying rates and terms. Take the time to compare offers and find one that will help you get a better deal on your loan.
3. Consider a Trade-In
If your car is worth less than what you owe, you can consider trading it in for a new or used vehicle. However, you should be prepared to handle the “negative equity” or the remaining balance you owe on the current loan. Many dealerships will allow you to roll the remaining loan balance into a new loan, but keep in mind that this will only add to the cost of your next vehicle.
Before trading in your car:
- Determine the Loan Deficiency: Make sure you know how much you owe on the loan and how much your car is worth. If the difference is large, it may be difficult to find an affordable new car.
- Shop for a Vehicle You Can Afford: If you decide to trade in your car, choose a vehicle that fits within your budget, considering both the trade-in value and the additional loan amount.
4. Sell the Car Privately
Selling the car privately is another option that can help you get more money for your vehicle compared to trading it in at a dealership. In a private sale, you have more control over the selling price and may be able to secure a better deal, which can reduce the gap between what you owe and what you receive from the sale.
When selling privately:
- Ensure You Have the Title: If you’re underwater, you’ll need to work with your lender to arrange the sale and payoff. Make sure you know the process and have all necessary paperwork in place.
- Be Transparent About the Loan: Let potential buyers know that there is a loan balance remaining on the car. They may be willing to work with you on a price, or you may need to settle the loan before completing the sale.
5. Consider Voluntary Surrender (If Necessary)
If you are unable to keep up with payments and have no way of selling or refinancing the car, voluntary surrender may be a last-resort option. This involves returning the car to the lender, who will sell it to recover the loan balance. However, this option should be considered carefully as it will negatively impact your credit and may not relieve you of the full debt.
Conclusion
Being underwater on a car loan can be a challenging and frustrating situation, but it is not without solutions. Whether you choose to make extra payments toward your loan, refinance to secure better terms, or consider selling or trading in the car, it is essential to take proactive steps to address the issue. By carefully evaluating your options and working toward reducing your loan balance, you can eventually overcome being underwater and regain control of your finances.