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5 ways to get out of an upside-down car loan
What to do when you owe more than your vehicle is worth.
An upside-down or underwater auto loan is when your loan balance is worth more than the value of your car. Being underwater on your car loan can be risky, especially since standard insurance policies only cover up to the value of your car. But there are a few ways to turn things back around — or get out of an upside-down car loan.
1. Make extra repayments
One of the simplest ways to get out of an upside-down car loan is to make extra repayments. This reduces your balance until you’re back above water and get you out of debt faster.
Before you get started, calculate your negative equity — the difference between your loan balance and how much your car is worth.
Negative equity = Your loan balance – your car’s value
Negative equity gives you an idea of how much you need to repay to flip your loan right-side up and how long it’ll take.
How much is my car worth?
You can figure out how much your car is worth by getting it appraised by a mechanic. You can also get a ballpark idea from an online site like Edmunds, the National Automobile Dealers Association (NADA), Blue Book or Kelley Blue Book.
Watch out for prepayment penalties
Some lenders charge a penalty when you repay your loan early. Not only does this mean you won’t be able to save on interest, but it’ll also cost you more to get above water.
Reach out to your lender to find out its prepayment policy before you start making extra payments.
2. Refinance with another lender
Refinancing involves trading in your car loan for another, ideally with more favorable rates and terms. Refinancing for a shorter term could be a good option if you can afford to pay off your loan early but your lender charges prepayment penalties.
Generally, you need to have good to excellent credit and a low debt-to-income (DTI) ratio to get the best deal on refinancing. Refinancing also might not be the best choice if you have a large amount of negative equity, since some lenders have maximum loan-to-value (LTV) ratios for refinancing applicants.
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3. Sell your car
When extra repayments and refinancing aren’t an option, you can sell your car to a private party and use the profits to pay off most of your loan. You’ll still be responsible for the rest of the balance — and be out of a car. But it could prevent you from defaulting on your car loan and taking a hit to your credit score.
Consider making repairs or having your car detailed so you can up the price — or at the very least give it a good wash. The more you’re able to sell it for, the more you’ll save.
4. Trade it in for a less-expensive car
If you’d rather not sell your car, you can also trade it in at a dealership for a less-pricy used vehicle. Try to go for a car with a value that’s close to your loan balance.
But watch out for dealership financing: It’ll often roll what’s left of your old loan into the new one, which could land you with another upside-down car loan.
5. Consider credit counseling
If none of these options seem viable, consider signing up for a session with a credit counseling agency. These nonprofit organizations can help you figure out your best plan of action and come up with strategies to better manage your personal finances.
The Department of Justice has a list of government-approved credit counseling agencies on its website.
How does a car loan become upside down?
A car loan can go underwater in several situations. Financing a new car with a long term is one common way — especially if that term is longer than 60 months.
Having a high interest rate, foregoing a down payment or buying a car that’s out of your budget can also lead to an upside-down car loan. And rolling over a previous loan during a trade-in also puts your loan at risk of becoming upside down.
How to avoid going upside down on a car loan next time
Here are a few strategies to keep your car loan above water the next time around:
- Buy a used car. Used cars depreciate at a much slower rate than new cars — a new car drops 10% in value the minute you drive it off the lot.
- Opt for a lease instead. Since you’re essentially renting the car for a few years, the car’s value isn’t your responsibility.
- Make a sizable down payment. Putting at least 20% down when you buy a car reduces your loan balance, lowering the likelihood of it becoming upside down.
- Go for a shorter term. A short term on a car loan means your repayments can better keep up with your car’s rate of depreciation while also helping you save on interest.
- Get gap insurance. Unlike standard car insurance policies, gap insurance covers the difference between what your car is worth and the amount you owe on it — should you get into an accident.
Bottom line
There’s more than one way out if your car loan is worth more than the value of your vehicle, especially if you have good credit. Not sure which is right for you? Consider calculating your negative equity and going from there. For more information on how car loans work, check out our guide to auto financing.
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