By Jon Acuff
Longer loans, delayed payment offers and lower down payments have caused the number of borrowers who are upside-down in their auto loans to increase. Because cars can depreciate in value by 20-40% within the first few years, it's easy to go upside down without realizing it.
Here are three important things you need to know about being upside-down in an auto loan.
1. What is an upside-down loan?
Simply put, an upside-down loan is when you owe more money on a car loan than the car is actually worth. For instance, let's say you owe $6,000 on a loan for a minivan with an estimated value of $4,000. If you tried to trade the car in, you might owe $2,000 more than it's worth. This is often referred to as negative equity.
2. How do I avoid an upside-down loan?
It's surprisingly easy to find yourself in an upside-down situation, but there are a few things you can do to protect yourself.
Make a bigger down payment.
Every dollar you can add to the down payment reduces the amount of interest you'll pay over the lifetime of the loan. If you put $3,000 down on a $20,000 vehicle with a five-year loan, your monthly payment could be $50 less than if you didn't make any down payment. You could save more than $3,500 over the course of your payments. Better yet, you'd be much less likely to go upside down.
Decrease the term of the loan.
The monthly payment is not the only number you need to think about when purchasing a car. Shortening the length of the loan by paying a little more each month can put you in a much better financial position down the road.
Know your long-term car needs before you shop.
Upside-down loans are only an issue when you try to get a different car before the loan is complete. Even if you owe $5,000 more than the car is worth, as long as you keep driving it and making payments, there's no problem. Structure your loan according to how long you want to drive the car. If you intend to keep it three years, you might not want to get a five-year loan.
For many people, looking at used cars makes more financial sense than purchasing a new one. When you buy a used car, a degree of depreciation has already occurred, so you benefit from the reduced value with a lower price tag.
3. What do I do if I have an upside-down loan?
First, don't panic. Being upside down can be an uncomfortable financial situation, but you do have options. Be careful about rolling your debt into another loan. The challenges of an upside-down loan can sometimes multiply when you make them part of an even bigger loan. In some cases you may get a better interest rate with the bigger loan, but make sure you understand the long-term impact before you finalize a new loan.
Here are a few additional things to do if you think you're upside down:
Keep the car and make the payments.
The simplest, most effective step you can take to get out of an upside-down loan is continuing to make the car payments, if you're able. Make all the payments on time, possibly even paying more per month than you are required, until the loan is complete. Purchase another car when you no longer have negative equity. End of story.
Sell the car yourself.
Sometimes people discover they're upside down when they bring their car to the dealership and hear how low the trade-in value is. For instance, if you can only get $7,000 on a trade-in and still owe $9,000, then you're upside down. If you sell the car yourself however, there's a chance you might get more than you would by trading it in. Those additional funds can help you address an upside-down situation. For more information, read How to Sell Your Car. If you're ready to get started today, sell your car with AutoTrader.com.
An increase in the number of people who are upside down has helped trigger an increase in the number of people offering financial assistance. The same suggestion we might make in bad credit situations could be helpful here—a talk with a credit counselor or financial adviser. As with any service, make sure you work with someone who is knowledgeable and trustworthy. Help is certainly available.
Do your homework.
Depending on your individual needs, getting a different car might be your best option. If that's the case, do some research before you start shopping. Find out which cars have the best resale value. If a loan on a luxury sedan was a financial challenge, think about looking at less expensive cars. Check out cars that have longer warranties and better gas mileage. Weigh the car you want versus the loan you need and come to a realistic decision.
As with any aspect of finance, decisions about how you handle an upside-down loan should be based on your unique information and loan details. We suggest you work with your lender to discuss the best options for avoiding or addressing an upside-down loan.