How do we get upside-down?
For most of us, auto loans are just a part of life. We need our vehicles to get us from point A to point B. But, these modes of transportation can be extremely expensive… so much so that most of us don’t have the funds to purchase them with cash. This is where financing comes into play. Instead of waiting for years to save up for the vehicle we need, we can borrow money from a dealership, bank, or financial institution and get the car the same day. Then, we just need to pay back our lender slowly over time. But, the “slowly over time” factor could be problematic, as it could initiate the down side of being “upside-down” on a car loan.
Read on to get the lowdown about being upside-down.
What does it mean to have an upside-down car loan?
Cars are some of the fastest depreciating assets that we can purchase. This means that the moment you finance your car, and take it home, it begins to lose value. And, the newer your vehicle is, the more significantly it depreciates during the first years that you have the car. So, for example, if you purchased a car for $20,000 in 2014, by 2016 it is likely to have lost thousands of dollars in value. Just how much value lost will depend on the type of car, your upkeep of it, how much it was driven, and other factors.
Because of this depreciation, and the long loan-terms that many people take on to pay off their vehicles, being upside down on a car loan is a very real concern. Having an upside down car loan, also called being “underwater” on a car loan, means that you owe more on your loan than your car is worth. Another term that may be used for this sticky situation is that you have “negative equity” in your vehicle. All of these terms (underwater, upside down, and negative equity) may be used interchangeably.
What's wrong with upside down car loan trade ins?
If you want to trade in your car, and you owe more on your loan than you are able to receive for your car… you will inevitably have some issues. It is likely that the dealer you are working with will tell you that it is no big deal, and he will “pay off your loan”. While this is technically true, he may leave out this important factor: you will have to pay him back for the negative equity.
This will probably come in the form of “rolling over” your loan. If you have rolled over the remainder of your previous loan into your new loan, then you will be paying for your new car, along with paying for what is left over from the one you just traded in. Frankly, this is an even more difficult situation to get out of because you are paying for both the old and the new car, and have instantly put yourself underwater on your new loan. So, instead of fixing the problem, you may just be creating greater financial issues for yourself.
What is Gap Insurance?
Another thing to keep in mind is that being upside down on a car can be a big problem if your vehicle is totaled in an accident. Even if someone else totaled your car, and you can only get current retail value for your vehicle from their insurance company, you will be responsible for the remainder of your loan. Because of this situation, many people may purchase “gap insurance” that can help protect you from this exact situation.
How can I avoid being upside down on a car?
As you can see, an underwater car loan can create some serious problems. Here are a few ways that you can avoid having an upside down car loan:
- Make sure you don’t pay too much for your car. If you haven’t done research on the value of the car that you’re interested in, you may end up overpaying on it. Then, even without factoring in depreciation, you immediately have negative equity on your loan. Be sure to look at vehicle prices, and then negotiate to receive a fair offer.
- Make a down payment. By saving up for a down payment, you may be able to instantly have positive equity in your vehicle. By investing a few thousand into your car, upfront, you would have a much lower chance of being underwater as time goes on.
- Try to get a lower interest rate. Now, if you have bad credit, it will be difficult to score a low interest rate. But, no matter your credit situation, shopping around could help to ensure that you get the lowest offer possible. Different lenders and dealers will provide you with different interest rates. So comparing, and choosing the lowest one, will help make sure that you will waste less money on interest… and so more money could go towards the equity of your car.
- Choose the shortest loan term possible. The longer you extend your loan term out, the more your car will depreciate while you are still paying it off. So, you have a higher risk of getting underwater.
- Choose a slower depreciating vehicle. Some vehicles will depreciate faster than others, and so it is important that you research which ones hold a higher risk of putting you underwater.
- Don’t roll over your loan. If you are already underwater on a loan, by rolling over your balance into your new loan, you are immediately placing yourself underwater again. If possible, pay off your loan… then buy your next car.
How do I find another lender?
When you are in need of another vehicle, finding the right lender or dealer is key in obtaining a good deal. If you need help finding lenders and dealers in your area, let Car.com help you. Our free, no obligation service will connect you with a lender and/or dealer who wants to earn your business. Plus, our service is totally free to you and you are under no obligation whatsoever to work with any lender and/or dealer we connect you with.