Trading in an upside down car loan or trading in a car that is worth less than you owe on the loan can cause financial problems. This is a trap that vehicle owners should do their best to avoid without proper knowledge of the long-term effects.
Even if you are offered a low-interest car loan with low car payments, it is tough to escape negative equity or an upside down car loan. Getting another bad credit car loan with longer loan terms to replace the current car loan is only going to make it worse.
So how do you get out of a car loan with negative equity and what if you desperately need it to get another car? Let's look closer.
How Do I Fix a Negative Equity Car Loan?
Essentially, negative equity is when you have an asset on loan such as a car that is worth less than the loan itself. In the auto loan business, this is also known as an upside-down car loan or an underwater car loan. To pay off your car loan, you will have to pay more money than the car is worth.
In most cases, the car has lost value over time, or the borrowed amount has increased due to a refinanced loan. This is typical because the value of the car will change over time. Having the value of the car decrease faster than you can pay off your loan will eventually put you upside down on your car loan and leave you with negative equity car value.
When this happens, people start looking for advice on how to get out of a car loan that has negative equity. The Federal Trade Commission has more information on negative equity in the auto business.
The primary fix is to pay off the negative equity either with cash from your pocket.
Pay down the loan
Trade the car or loan for another
Both of these will require paying for the negative equity over time.
Another choice is to Reduce the amount you owe by finding a better financial deal.
- Trade the car and combine the loan with a car that sells for a great deal less than what it is worth such as an end of the year clearance or a new car sold as a used car demo.
- Refinance the loan at a better interest rate, go with higher payments for a shorter time. This will allow the payments to catch up with the value of the car as it depreciates over time.
Can I Get a Car Loan If I Am Upside Down With My Car Loan Now?
Yes! Getting a better car loan after your existing negative equity car loan is a common practice. The key is to be very careful what your new car loan looks like. People who refinance or trade in their upside-down car loan often accept large loan payments or longer loan terms to try and reverse the negative equity and afford the new car loan.
By committing to larger monthly payments, they add to their financial strain and increase their chances of defaulting on the loan altogether. With a few simple tips and some planning with a negative equity car loan calculator, you can avoid this problem with your next loan.
What about being underwater on a car loan with bad credit?
How to Get Out of a Negative Equity Car Loan with Bad Credit?
Is it possible to get out of a bad car loan with bad credit? If you owe more than the car is worth, it is possible to get rid of your negative equity car loan and refinance it with a better, high risk car loan at a lower interest rate. You can also get yourself out of deeper debt and repair your credit score at the same time if you purchase another vehicle that is sold significantly lower than its regular resale value.
- Sell your car for the maximum amount it is worth and get a new car loan that will cover the new car and the negative equity of the old loan.
- Pay attention to the value of the cars you are buying and selling. You may even be able to get your FICO score up while paying off the loan on your old car, so be careful with your choices.
Can I Get A New Upside Down Car Loan To Roll My Loan Over?
It is always going to depend on the car, the existing loan, and the lender. The bad credit bank or lender is likely to use NADA or Kelley Blue Book to assess the value of the vehicles. Then, the bank will probably allow the car dealer to sell for around 15% more than the trade-in price listed in the guides you checked. Car dealers that exceed the 15% could put you in a situation that can damage your situation further. Only western banks use Kelley, but you may want to check the values yourself in both guides, no matter where you are.
Is the dealer being ripped off if they roll over the loan?
The simple answer to this question is no. A dealer is not going to do business with you if he cannot make a profit. The idea is to make it, so the selling price (remember, it is about 15% over trade-in value) will pay for the existing negative equity car loan that the lender is buying. The dealer may get some wiggle room at the selling price to accommodate you, but you should be prepared to get a no, if not.
Car Dealers will Suggest Combining The Loans
You will find that your car dealer is willing to take your upside down car in trade and combined the remainder of what you owe into a loan for the new car. The problem with this is it does not get rid of your upside down car loan it just transfers it to a different vehicle.
At first, this sounds ok until you look closer at the paperwork. You will see the new loan fees, taxes and the interest on both loans. You have the same problems combined with higher debt. This type of vehicle transfer may have been what got you into an underwater car loan, to begin with.
- If you choose to go this route because you need to replace the vehicle, then we strongly suggest purchasing gap insurance.
- With gap insurance, the difference between what you owe on the car loan and the total replacement value of the car is covered in the event the car is damaged beyond repair in an accident.
Trading out of Your Debt
Anytime you decide to get out of an upside down car loan with another car or car loan use caution. Remember the goal is to eliminate the bad equity, not carry it to the next car.
Pay close attention to the negative equity part of the transaction and know exactly how the debt is going to be paid down. What the dealer is paying and what your responsibilities are. Car dealers have a tendency to make a car loan sound like a real deal until you sign the paperwork and find out that you are still responsible for the unpaid part of your old loan. This can make you lose trust in a dealer real fast.
Don't sign any contract before you know the facts about your new structured loan, debt and how the payment of your old car loan will take place.
Simple Steps to Prevent An Upside Down Car Loan
Trading in cars you are still paying on and adding that outstanding amount to your new car loan should be avoided. It is easy to fall into the trap of trading in vehicles that you have not paid the loan balance off on and rolling loans together to get a larger payment.
Another big reason consumers wind up with a negative equity car is long-term auto loans.
Car dealers and in house financing dealers try to offer a lower monthly payment in exchange for longer terms to make the deal financially attractive. Banks are collecting interest for a longer period when they offer you more months to pay off your loan, but the value of the car drops faster than the loan amount you owe.
By accepting long loan terms with low payments, you run the risk of an upside down car loan. It is very likely that you could damage your credit further in the event something happens to the car, or your financial situation changes before you pay down the loan.
Paying Too Much For The Car To Begin With
If you do not take the time to compare car prices and car deals you may find that you have paid too much. As the car ages, the value of the car can drop faster than the overpriced car loan.
Also, buying extra options drives the price of the car up but doesn't necessarily increase the resale value. Many overpriced options will not help the resale value at all, like additional maintenance programs or upholstery treatments.
Choose A Good Quality Used Car Over a New Car
- Used cars are a better option because the depreciation on the car has been absorbed by the first owner.
- Many newer used cars carry a large remainder of the original manufacturer warranty and are in fine working order.
- Used cars are reasonably priced and will maintain their resale value longer. This resale value will make up some of the equity lost in the first car loan that had negative equity.
Some drawbacks to purchasing a used car are evident. You may not find the exact make and model with the color and options you would like. Lenders will not loan money for the older model used cars, so finding a high-value car with a low selling price will be a greater challenge.
Refinance your negative equity car
The best way to repair a negative equity car loan is to pay it down. If you have a low APR and easy monthly payments now, then stick with it until you can pay off the car. However, if you have a high APR and difficult car payments, then it is time to refinance the loan.
Also, even though a down payment is not needed for an auto refinance loan, we suggest paying as large of a down payment as you can to reduce the negative equity that exists. This will also help to lower your monthly payments.
Some lenders would suggest a personal loan to pay off the negative equity when refinancing or purchasing another car, but this will cause more expense and add another monthly payment. Unsecured personal loans always carry a higher interest rate than a car loan for the same credit rating.
Know When to Refinance Your Car Loan
A fast way to go upside down on your car loan is to refinance your loan and take the Cash Back incentive some lenders offer. It sounds like easy money, but the money they offer you is being added to the loan amount. In most cases, you will have additional charges for the service and you will have to pay interest on all this.
Auto Refinance vs. Personal Loans
Not all auto refinancing loans to remove the equity in the form of cash is bad. The trick is to know when to refinance your loan. If you have an unexpected debt or need to make emergency repairs or purchases, refinancing your car can be a good choice. We have a blog that explains How to get money to pay for a divorce lawyer or legal processes like child custody cases and other large, unexpected debt.
Serious financial needs pop up without time to plan and many people turn to personal loans.
Emergencies and unexpected debts can hit anyone at any time, so if you do not have extra money tucked into a savings account, you will find yourself turning to a loan of some kind.
Divorce cases and legal representation are expensive, and the loans that provide the money for these services come at a high interest rate. Personal loans with high interest added to your monthly payment including a car loan will leave you owing money for a long time. Refinancing your car loan will give you the option to get the money you need and even though your vehicle will have negative equity for a time, you will have one loan and one monthly payment with a lower APR. Many times this new payment can even be lower than your old car payment.
Choose a New Car That Has a Discounted Price
Trading in your underwater car for a new car and car loan can help if you find a new car that has been discounted. Dealers will offer end of the year clearance sales to clear out new car models from the previous year. Many of these cars will also have customer rebates and other discount incentives.
Buying a car below its replacement value can add equity to the car and compensate for the transferred debt portion of your old loan.
Upside Down After a Bad Lease Buyout Deal
If you have leased a car and are at the end of the lease term or you need to buyout the leased car early to avoid penalties you need to check the resale value before buying.
The leasing company will assign a residual value to the car at the beginning of your lease term. Many times this amount is exaggerated and will not represent the correct amount of fair market value. Just buying a leased car without checking its proper trade-in value could leave you upside down if you finance the lease buyout. Unfortunately, unlike “rent to own cars,” none of the money you paid during the lease period will go toward the lease car buyout.
The High Cost of Bankruptcy
People that have found themselves in a bad credit cycle have turned to bankruptcy as an alternative. Bankruptcy should always be your last choice for how to get out of a car loan because it will leave you with years if financial trouble and will make it difficult to buy anything on credit from that point. Even car loans after bankruptcy have to be approved by the court and have to be handled by special finance lenders. Most Chapter 7 bankruptcies will dissolve your present car loan. With a chapter 13, if you have to keep the vehicle loan you have then you should renegotiate the loan for easier payments.
Answers to Negative Car Equity
Sometimes, you do not have any choice but to take the negative equity of your current car loan payoff and roll the remainder into the car loan you are replacing it with. In this situation, even though your old car is gone, you are still paying for it while you are paying for your new upside down car loan.
Always try to pay a large down payment when buying a car, so the amount you owe on the loan will always be lower than the value of your vehicle.
By the way, the new car is also going to go down in value during that time. If you are not careful, you may wind up paying more than what both cars are worth. Your only recourse is to pay off as much of the new car loan balance as possible and offer as large of a down payment as you can.
Car buying scams are everywhere, even at the largest and most trusted dealerships. You are not going to get an ideal interest rate with a negative equity car loan. Do your best to avoid this trap when you are considering financing your automobile or any equity loan trade.
If your current negative equity car still runs, it does not make sense to roll it over into a new car loan. Of course, you may get incredible gas mileage on your new option or better insurance rates. If so, it may make up the difference. If not, stick with the money pit you have or sell it for the amount you owe and start with a new car loan. With your next purchase, build a simple budget that will help you get a good down payment and help with the car payments until you refinance with a better APR or find a new car.
Upside Down Auto Loan Math
Say you have a 2-year loan with your bank or loan creditor. This would leave you paying only about 4% of your loan every month. Now imagine that your new car has lost a quarter of its value in the first year of your loan. You are okay. You will have paid at least that much in the first half-year of your loan. However, stretch that loan out to 60 months and the depreciation will outrace the payments by several months thanks to you only having to pay about 1.5% of the loan monthly. You will be upside-down on that loan quickly.
Tips to Fast Equity Accumulation.
- Pay more than your monthly payment requires. Paying more than the minimum amount of your monthly payment adds money to the equity and in return lowers the amount of interest you will pay. It is a double blessing. More equity, less interest.
- Keep your car in excellent condition. Repair things that break, stick to the regular maintenance schedule and repair body damage. This will keep up your car's trade-in or resale value. This, in turn, slows the effect of depreciation and makes the car easier to sell or negotiate a higher trade-in value.
New Help For An Old Problem
Okay, a negative equity car loan replacement looks pretty darn attractive when you are standing there next to a shiny new car. You know you will be still paying off more than it is worth. However, you should avoid rolling negative equity into a new loan at all costs. You are going to get a high interest rate on your new loan, and you are likely to wind up in negative equity on that one as well.
If all of your bad credit is bundled up in one neat package, It is still a neat package of wrong investment strategies with high monthly payments for a long time. The longer the term, the greater the chance of default and car repossession by the creditor.
Now, a significant cash down payment can lower the negative equity you are rolling into your new loan a lot. If you can manage this, you may even wind up with a trade in that is worth more. You can start this process by looking at your budget and start building your plans for a big down payment. A simple budget can show you how to pull extra money from the income you already have.
In short, unless you have to do it, never, ever roll negative equity into a new, upside-down car loan. You are not going to be the winner in that situation. Having the ability and funds to get out of a car loan that is upside down hard to do.
Do your best to keep your old car on the road and not funneling money out of your wallet until you can manage to pay it off or sell it for what is worth. Use a large down payment for the next car loan and get a 36 to 60 month or less auto loan to avoid an upside-down car loan in the future.