If you recently found out that you owe more than your car is worth, you are dealing with an upside-down car loan, also known as a negative equity loan. This can be extremely frustrating if you are trying to trade in your vehicle or have costly car repairs on top of the car loan that you are paying off.
Unfortunately, during the pandemic, there has been a spike in negative equity car loans as 2020 had higher interest rates and record-high transaction rates. According to Edmunds.com, the share of trade-ins with negative equity was at 44% in April 2020. The average amount of negative equity was $5,571. While the situation may seem hopeless, there are some things that you can do when dealing with an upside-down car loan to improve your financial situation.
What is an Upside-Down Loan?
An upside-down car loan refers to a loan for a vehicle where the amount owed is greater than the car is worth. These loans happen for a variety of reasons which aren’t always the buyer’s fault. The following circumstances are likely to put you in an upside-down loan.
How to Deal with an Upside-Down Car Loan
Eliminating or reducing an upside-down car loan will be different for each person based on their circumstances and needs. It is important to explore the different methods of dealing with upside-down car loans to find one that is right for you and will fit your budget and lifestyle. The following steps will help you create a plan to deal with your upside-down car loan.
Calculate Your Debt
The first step is to calculate the negative equity that is in the loan. Check the Kelly Blue Book Value to find out how much your car is worth and check how much you owe on the loan. Subtract how much you owe from the value of the car at that time. For example, if your car is worth $9,000 and you owe $11,000 on it, your negative equity would be $2,000.
Contact the Lender to Negotiate Terms
Before you decide to pay off the loan early, contact the lender to find out if there are early payoff fees. Ask if they have options to help you reduce the negative equity. Lenders may allow you to make payments on the principal or allow for more frequent payments. This may help you cut down the negative equity and pay off the loan faster.
Sometimes refinancing can help you get a lower interest rate which would result in a lower APR. Eliminating some of the interest that you will pay can reduce the amount of negative equity. Shorter loan terms help you qualify for lower rates and enable you to pay off the loan faster. This may help you get right-side up on the car loan again.
If you’d like to keep your vehicle, saving up a down payment and refinancing with a lower interest rate helps to shrink your negative equity. This allows you to pay off the principal faster.
Sell It Privately
To get rid of the car quickly, you may want to sell it to another person rather than go to a dealership to sell it. You will most likely get more money for it, but it may take longer to sell because you’ll have to find the buyer yourself. You can list your car on Craigslist, Facebook Marketplace, or through local newspapers. Ideally, you will sell it for enough to wipe out your debt including the negative equity.
Trade It In
Trading in your car in is an option, but it likely won’t eliminate the negative equity. You may be upside-down in your new car loan if your negative equity is included in your new loan. This will trigger a cycle of bad credit and debt, so it isn’t a recommended option.
If you need to replace your car immediately, trading it in is an option. You can try to find a car that is priced significantly below its value to reduce the negative equity. For example, if you have $1,000 of negative equity, you could look for a used car that is priced at $1,000 below its retail value. In this situation, you would not be upside-down in your new loan.
Ask your dealership if it is possible to cancel the add-ons and receive a prorated refund. This would include extended warranties and service plans. The prorated refund will be sent to you as a check which can be used to pay off the negative equity in the car.
How to Avoid Upside-Down Car Loans
Once you have experienced a negative equity car loan, you want to avoid repeating that experience. For your next car purchase, do your research and understand all the costs and options. Online research is done by 92% of auto purchasers before making a purchase. For many people, this research will indicate that they should buy a used vehicle rather than a new car.
If you are buying a new car, make a substantial down-payment. Consider using a 20-4-10 rule which means that you put 20% down, your loan is no longer than 4 years, and car payment and expenses don’t exceed 10% of your gross budget. This will help you avoid getting stuck in an upside-down car loan.
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