How To Get Out Of An Upside Down Car Loan

July 15, 2010

How To Get Out Of An Upside Down Car Loan

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What can you do if you are caught in a car you cannot afford? First, you’ll probably end up with an upside down car loan. Longer term loans, like the six-year loan in the example, are appealing to many people because it means a lower payment. Many car buyers believe it’s a way for them to buy more car without breaking the budget. The flip side of longer loans, though, is that while you do have a lower payment, you’re also building less equity. Especially with new cars, where the value drops so quickly after the purchase, the value of the vehicle is dropping faster than the balance due on the car loan, leaving you upside down.

Americans are in love with their cars, but at what cost? Here are a few sobering statistics:

The average middle class family spends as much as 20% of their take home pay on car payments. That’s $800 per month if you take home $4000 per month.
According to Edmunds.com, 90% of loans for new cars and 81% of loans for used cars are longer than four years.
According to DaveRamsey.com, one-third of car buyers take out a six-year loan on a vehicle with an average sticker price of $26,000. With an average interest rate close to 10%, this car will cost about $33,000 when it’s paid for, it will have an average monthly payment of about $475, and, at that point, it will only be worth about $6000.
New cars, on average, lose about 25% of their value as soon as you drive off the lot, and will lose about 70% of their value in the first four years.

It Happens All the Time

All of these statistics help explain how so many Americans are ending up upside down on their car loans. What does it mean to be “upside down”? Upside down is an extremely undesirable financial situation that means you owe more on your car than the car is worth. If you buy the $26,000 car with a six-year loan and a $475/month payment, after two years you may still owe $20,000, but your car may only be worth $17,000. If you tried to sell the car in this situation, you’d still have to come up with the extra $3000 even if you were able to get full price for the car.

Rollovers Start You Out Owing

Another factor contributing to car owners being upside down is starting in the hole when you take out a new loan. You’ve seen the ads. Car dealers offer to pay off your existing loan no matter what you owe. Or you’re getting close to a deal on that new car you just can’t live without, but you still owe a few thousand on the old car. The dealer graciously offers to roll that balance over into your new loan to get you in the car of your dreams. The consequence, however, is that you start out owing more than your new car is worth before you even drive it off the lot.

If you find yourself in an upside down situation on your car loan, what are your options?

First, know your car’s value. Sources like Kelley Blue Book or NADA make it easy for the average person to figure out the fair value of your car. Before you make any moves with your car, it’s important to have a realistic idea of what your car is worth.
Sell your car. Ideally, this would mean being able to pay off your existing loan and then buying something cheap that you can purchase with cash. Even if this isn’t a realistic scenario for you, it is possible to sell your vehicle for less than you own on it and get a separate loan for the balance due.
Sell to private parties not dealers. Dealers will only offer you the trade-in value for your car which is generally much lower than the retail or private party values. Try selling the car yourself on sites like Craigslist (it’s free!), eBay or Auto trader. Leave yourself some room to negotiate when you set your asking price.
Refinance. Try to get a better interest rate or a shorter term so that you can get out of your upside down situation sooner.
Repossession. This should be a last resort as it ruins your credit plus you will still own the difference between what the car sells for after being repossessed and what you owed on it.
Keep it until you finally reach the point where you are no longer upside down. Then sell it and buy something you can afford.

Unfortunately, none of the above options are appealing. That’s why it’s best to avoid getting into a car loan if you cannot pay it off with in 3 to 5 years. Don’t choose the cheapest monthly unless the car is affordable enough that you can pay it off quickly. Your best option, out of those offered here, is to either sell the car now and take the hit or keep paying until you can sell it and then buy something more affordable…even if that means your uncle’s 1975 Volvo with 300,000 miles.

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