The problem of upside-down loans isn't new. It's existed as long as car loans have, but it is on the rise. In fact, some reports indicate that up to 40% of consumers are upside down right now. So if you think you might be, you're certainly not alone.

Why has this number increased so dramatically in the last few years? Longer loans, delayed payment offers and lower down payments. Because cars can depreciate in value by 20-40% within the first few years, it's easy to go upside down without realizing it.

In this article, we'll address the three most important things you need to know about this financial situation.

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 stumble into an upside-down situation, but there are a few things you can do to protect yourself.

Don't shy away from the 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.

Focus on more than just the monthly payment
The monthly payment is an important number, but it's not the only one you need to think about when purchasing a car. Look at the big picture. Consider paying a little more per month to reduce the amount of time you spend upside down or eliminate that possibility altogether. Shorten the length of the loan to put yourself in a much better financial position down the road. Determine how a down payment will change your loan. Think through all your options before finalizing a loan.

Know your long-term car needs before you shop
Upside-down loans don't become an issue until 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. That's why it's important to 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.

Consider used
For some 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. Instead of being concerned about the value of the vehicle diminishing, you benefit from the reduced value with a lower price tag.

3. What do I do if I have an upside-down loan?
First and foremost, don't panic. It certainly can be an uncomfortable financial situation but you do have options. The most important thing to remember is to 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. There are some cases where you'll get a better interest rate, 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
If you're able to, this is the simplest, most effective step you can take to get out of an upside-down loan. Make all the payments in a timely fashion, 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, try selling your car with AutoTrader.com.

Get help
An increase in the number of people who are upside down has helped trigger an increase in the number of people offering financial assistance. Similar to what we suggest in bad credit situations, we encourage you to think about talking with credit counselors and financial advisers. As with any service, make sure you work with someone knowledgeable and trustworthy, but 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, upside-down loans are a personal issue 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.


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Jon Acuff is a staff writer for AutoTrader.com.

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