You can get out of an upside-down car loan with a number of strategies, including by making extra payments toward the loan, refinancing the loan, or selling the vehicle. Learn more about what being upside down on a car loan means and ways to get out of it.
Key Takeaways
- Being upside down in a car loan means you have negative equity, or, in other words, you owe more than the vehicle is worth.
- Refinancing the loan or selling the vehicle are two of the most commonly used ways to deal with negative equity.
- You may also consider trading in your vehicle for a different car, though that can lead to additional auto loan debt if you’re rolling the original loan balance over.
- Defaulting on an upside-down car loan can be damaging to your credit and make it more difficult to get other auto loans later.
What Is an Upside-Down Car Loan?
Being upside down in a car loan means that you owe more than the vehicle is worth. You may also hear this situation referred to as having negative equity. If you want to trade in your car but have negative equity, you would need to pay off that amount before you could take out a new loan to purchase another vehicle.
If you have negative equity, you can use several strategies to get out of your auto loan.
How Do Upside-Down Car Loans Happen?
Car owners can find themselves in a negative-equity situation for a number of reasons. For example, you might be upside down on a car loan if you:
- Have a longer-term loan and your vehicle has significantly depreciated in value since you purchased it.
- Took out a no-money-down auto loan or paid above the vehicle’s sticker price because you included add-ons.
- Purchased an expensive vehicle that has not held its value as expected.
- Accepted a loan with a high interest rate so that more of your payment is going to the interest than the principal.
Depreciation refers to how quickly an asset loses value. In the case of vehicles, cars lose about 20% of their value in the first year and continue to depreciate each subsequent year.
Here’s an example of how depreciation can lead to an upside-down car loan: Assume you pay $30,000 for a brand-new car. Following the 20% rule for depreciation, you can expect it to be worth $24,000 one year later. Meanwhile, you’ve paid off $4,000 of the $30,000 car loan that you took out to buy it. You owe $26,000 to the loan, which is $2,000 more than what the car is actually worth. You’re now upside down on the debt.
Important
Using a tool like Kelley Blue Book or Edmunds can help you to estimate vehicle values before making a purchase, which could help you to avoid an upside-down loan scenario.
How to Get Out of an Upside-Down Car Loan
If you’re upside down in a car loan, there are some options for getting out of it. The one that is best for you can depend on your budget and whether you’re committed to keeping the vehicle.
Pay Off the Loan
The first solution for an upside-down loan situation is to accelerate your payoff. The faster you pay the loan off, the sooner you can eliminate that debt.
There are a few options for paying off an auto loan faster:
- Pay extra to the principal each month.
- Apply windfalls to the principal balance.
- Make one lump-sum payment to pay the debt in full.
Reviewing your budget and savings can give you an idea of which option might work best. You can also apply one-time windfalls, such as a tax refund, a gift, or a work bonus, to the principal.
Refinance the Loan
Refinancing an auto loan means taking out a new loan to pay off an existing debt. You might refinance to get out of an upside-down car loan if you can get a new loan with a lower interest rate.
Refinancing doesn’t eliminate your auto loan debt completely. You’ll still owe the loan balance that you refinanced. However, having a lower interest rate could make it easier to pay off more of the principal each month and get out of debt faster.
Tip
Shopping around for auto loan refinance rates can give you a better idea of whether it makes sense to try and get a new loan to lower your current interest rate.
Sell the Vehicle
You could sell the vehicle to get cash to pay off the loan, including the negative equity balance. Selling to a private buyer means you might have more room to negotiate a price that would allow you to get enough cash to cancel out the negative equity.
Just remember that if you can’t get enough from the sale to pay off the negative equity, you’ll need to make up the difference out of pocket.
Surrender the Vehicle
The last option for getting out of an upside-down loan is handing the vehicle over to the lender. Voluntary surrender can be a more favorable option than allowing the lender to repossess your car.
When a vehicle is repossessed, the lender can auction off the vehicle, but if they get less than what’s owed for the loan, you could be sued for the difference.
Warning
Vehicle surrender should be seen as an option of last resort for dealing with an upside-down car loan, since you’ll lose the vehicle and the debt can still be reported to the credit bureaus as unpaid.
Tips for Avoiding an Upside-Down Car Loan
Avoiding an upside-down car loan is possible with a little planning before you buy and some strategic thinking afterward. Here are a few ways to minimize your risk of ending up in an upside-down car loan.
- Increase your down payment: The larger your down payment, the less you have to finance. Opting for a smaller loan could allow you to pay the debt off faster and keep pace with depreciation.
- Skip the add-ons: Add-ons, such as guaranteed auto protection (GAP) insurance products, can increase your total cost of borrowing and often only serve to benefit the lender or dealership rather than you. Reviewing the loan agreement carefully and opting out of add-ons that you don’t need can reduce the amount you pay so that you’re less likely to become upside down.
- Choose a shorter loan: A shorter loan term can mean a higher monthly payment. However, paying the loan off faster can save money on interest, plus you won’t be left with debt for a rapidly depreciating vehicle.
- Pay taxes and other fees up front: Your lender might give you the option to roll taxes and other fees into the loan. That means less cash you’ll have to pay out of pocket; however, adding to your loan costs can increase the likelihood of becoming upside down.
- Shop around for rates: The lower your interest rate, the more money you can save on an auto loan. Checking your credit scores and considering the minimum score requirements for different lenders can help you find the loans at the best rates.
- Choose a reputable lender: Sometimes car buyers can end up with negative equity simply because they choose a bad lender. Some disreputable lenders may add on fees or other hidden charges that can increase what you pay for a new car. Checking reviews and asking friends and family for referrals can help you avoid these bad lenders.
- Plan your car-buying budget: Consider how much you can afford to pay for a car loan. Having a firm budget can help you avoid buying a car that’s too expensive for you or taking on a larger loan than you can handle.
Can I get out of a car loan without damaging my credit?
Selling a vehicle and using the proceeds to pay off the loan in full can help you eliminate the debt without hurting your credit. You might also consider trading in the vehicle and rolling negative equity into a new car loan to avoid credit score damage; however, that can leave you with more debt to repay.
How much does a car depreciate every year on average?
Typically, vehicles lose 20% of their value on average during the first year. The rate at which depreciation occurs each subsequent year of ownership can depend on the make and model, how well the vehicle holds its value, and how much attention the owner pays to maintenance and upkeep to minimize wear and tear.
How do you calculate car devaluation?
To calculating how much value a vehicle has lost, you can subtract its fair market value from its purchase price. That can give you a rough estimate of how much a car has depreciated. You can also compare the fair market value to the current loan value to determine how much negative equity you might have, if any.
Can you refinance a car if it’s upside down?
It’s possible to refinance a car loan when you’re upside down if you can find a lender who’s willing to approve you. Lenders can consider the value of the vehicle, the current loan balance, and your credit scores and income when making approval decisions for loan refinancing.
What is GAP insurance?
Guaranteed auto protection (GAP) insurance is designed to cover the gap between the amount you financed for a vehicle and what it’s worth if your car is stolen, damaged, or totaled. Your dealership or lender may offer GAP insurance as an add-on product when purchasing a vehicle, though it’s not always necessary.
The Bottom Line
An upside-down car loan can feel like a financial burden, but there are some ways to cope with it. And if you’re shopping around for a new car loan, it’s helpful to understand how an upside-down debt situation can happen and what steps you can take to avoid it.
