November 14, 2017
What does it mean to be upside down on your car loan?
Being upside down means that you owe more than your car is actually worth. For example, if you have a $20,000 car loan, but now the car is only worth $15,000, you are upside down. You have $5,000 in negative equity.
How does this happen? Cars are known for their rapid depreciation, meaning that they decrease in value quickly. This is especially true for new cars. Just driving a new car off the lot causes a big drop in its value. Of course, the car loan attached to the car does not decrease just because the car’s value decreases. You still owe the same amount.
When does this become an issue? While being upside down is never good, the scenario can cause havoc when you find yourself needing to sell the car, maybe because you are no longer able to make the monthly payments. Not too many people will buy a $15,000 car for $20,000.
So what do you do? Here are a few suggestions:
- Know what you owe. This will be your starting point. Figure out how much negative equity you have in the car. In our example, you owe $20,000 with $5,000 in negative equity.
- Don’t trade-in. Trading-in your car at a dealership is usually the worst financial move to make. The dealership will take your negative equity and place it on the new car you purchase. So you are not really eliminating your negative equity. And you may find yourself even more upside down on your new car. Additionally, the new interest rate may be higher, causing you to pay more for that $5,000. Sometimes, a cash back offer can help balance out the negative equity, but be very, very careful before doing this.
- Pay down the loan with cash. This is the best option. Pay down your car loan and sell the car. If you don’t have the money to do this, maybe you can find a few items in your house that you can sell to raise some quick cash.
- Refinance with a shorter term. If you are struggling with the monthly payment or needing to sell your car immediately, this is probably not an option for you. A shorter term will result in a higher monthly payment, but you will pay down the loan (and get out of the negative equity position) more quickly.
- Take out a loan for the amount owed. Admittedly, these are tough to get because they are unsecured. But check with your local bank or whoever holds your current car loan. Using our earlier example, use a $5,000 loan to get the car sold and pay off the loan. Of course, this means that you still owe $5,000. But this is a lot better than owing $20,000. Then, go get a really cheap car until you can actually afford something else.
Of course, most of this scenario could have been avoided by purchasing a car with cash. Buy what you can really afford. That is the best decision you can make.
Written by Art Rainer, member of the Summit Stewardship and Generosity Ministry Leadership Team.
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