Upside-Down Car Loan: How To Get Out of It
10 MIN READ
Published January 19, 2024 | Updated January 30, 2024
Having an upside-down car loan (otherwise known as having “negative equity” in the vehicle) means you owe more on a car loan than the car is worth. You can end up with negative equity when you choose a longer loan term, if you buy an overpriced vehicle, or if your car depreciates quickly.
In this guide, we’ll discuss what having an upside-down car loan means and strategies you can explore to get out of it, such as paying down your loan, refinancing, and selling the car.
What Is an Upside-Down Car Loan?
Being upside-down on a car loan or having negative equity means that you owe more on an auto loan than the value of the car you purchased using the loan. When you have more car debt than the vehicle is worth, it can be difficult to trade in your car or sell it since you’ll have to pay off the negative equity first.
For example, if your current loan balance is $15,000 and your car is worth $10,000, then you have a negative equity of $5,000. If you want to trade it in or sell the car, you’ll have to pay the lender $5,000 out of pocket.
How Does an Upside-Down Car Loan Happen?
Ending up with an upside-down car loan is common and can happen in a number of scenarios.
Car Value Depreciation
New vehicles usually depreciate by 20% in the first year of ownership and 40% in five years. The value of your car drops as it gets older and has more miles put on it each year. This decline in value each year is called depreciation. You may end up owing more on the car loan than you can sell it for if your car’s market value drops too quickly.
If you have a high-interest loan, more of your car loan payment may be going to the interest instead of the principal. With your car’s value depreciating each year, you may not have paid down the principal fast enough to keep up with the car’s depreciation. This can quickly result in an upside-down car loan. You’ll typically have a higher interest rate if you’ve borrowed a car loan when you had (or still have) bad credit.
Long Loan Terms
If you opted for a longer term to keep your car loan payments lower, your payments will be spread out so much that you may not be paying down the principal fast enough each month when your vehicle’s market value begins to fade.
In addition, while a longer loan term can make your payments more affordable, you’ll also be paying more in interest over the life of your loan than you would on a shorter loan. This is because you’ll be paying interest over a longer term and because the longer a loan’s term, the higher the interest rate will typically be on the loan, all else being equal.
5 Tips To Get Out of an Upside-Down Car Loan
If you need to get out of an upside-down car loan, the first thing you’ll need to do is to estimate your negative equity. Start by determining your car’s value and then subtract it from your current outstanding loan amount.
Once you know your negative equity, you can evaluate the strategies we’ve discussed below.
1. Pay Down the Loan Aggressively
If you have extra funds available, make extra payments towards the loan each month to pay off your loan faster. When making an extra payment on most loans that are issued in today’s auto loan market, most (if not all) of the extra payment will be applied to your loan’s principal, so you know that each dollar of additional payment is going to reduce your balance.
Paying off your loan faster will also help you save on future interest charges over the life of your loan. Be sure to check your auto loan contract to make sure there’s no prepayment penalty that you’ll have to pay when making an extra payment on the loan, and then prioritize the loan’s repayment as part of your monthly bills.
You can also use a car loan payoff calculator to determine how soon you’ll be able to pay off (or “amortize”) the loan with extra payments.
2. Explore Refinancing Options
When you refinance a car loan, you’re taking out a new loan to pay off the existing one. You may be able to get out of an upside-down car loan with an auto loan refinance if you have good credit and can secure a lower interest rate than the one that’s being charged on your current loan.
You’ll still owe the refinanced loan balance, but with a lower interest rate, it may be easier to get out of the loan faster by making extra car payments to the principal each month.
3. Consider Selling the Car Privately
Consider selling your car privately to pay off the outstanding loan, along with the negative equity balance. To make this strategy worthwhile, you’ll need to find a buyer who is willing to pay more than the current trade-in value of the vehicle, which isn’t always easy.
With a private sale, you’ll usually be able to negotiate better and net more cash than you would if you sold to, or traded your vehicle into, an automotive dealer, who must factor in a substantial profit margin when they go to sell your trade-in later on. However, if you don’t, you’ll need to pay the difference out of pocket.
4. Trade-In the Car With Negative Equity
You can trade in your car with negative equity. To do this, you can either pay off the difference out of pocket or roll the negative equity balance into a new loan on a new car purchase. If you have enough cash available to do so, paying off the negative equity yourself directly is a good option.
In some cases, you’ll be able to add the negative equity to your new car loan. However, this can lead to more problems down the road if you can’t afford the payments or if you end up with even more negative equity than you had.
5. Surrender the Car
As a last resort, consider voluntarily surrendering the car back to your lender to get out of an upside-down car loan. This may be a better option than allowing your vehicle to get repossessed if you can’t keep up with the payments. Keep in mind that if the lender auctions off the car and can’t get what you owe on the loan, you’ll need to cover the difference.
How To Avoid an Upside-Down Car Loan
With a little planning, you can minimize your financial risk and avoid an upside-down car loan. Here are a few tips to consider.
Research the Car's Value Before Buying
Whether you’re buying a new or a used car, research the car’s value and negotiate a fair price to avoid overpaying. Visit different dealerships and compare the prices of the model you’re interested in.
If the new car you want is widely available, you may be able to pay thousands below the Manufacturer’s Suggested Retail Price (MSRP) if you buy at the end of the month or purchase a new car at the end of the year when the next year’s new models have hit the showroom floors. Don’t hesitate to negotiate the car’s sticker price, even if it’s new.
There are many automotive buyers’ websites that can provide you with a new car’s “invoice” price, which is what a car manufacturer charges the dealership for the vehicle when it arrives on their lot.
The price you offer on a new car (assuming a good market supply of the make/model) should ideally be just slightly higher than the invoice price because the dealership will often receive additional incentives, cash back, and/or bonuses for selling a certain number of a manufacturer’s vehicles. So even when you buy the vehicle at the “invoice price,” the dealership is still making a very good profit on the sale.
“By not overpaying for a new car, you help reduce the chances of you becoming upside-down on your car loan before you have a chance to start making payments on it, and put a serious dent in your car loan’s balance,” shares Brad Reichert, founder and managing director of Reichert Asset Management LLC.
Make a Larger Down Payment
One of the best ways to avoid an upside-down car loan is by borrowing a smaller loan amount. You can do this by making a larger down payment or by buying an older and/or less expensive vehicle. If you begin with a smaller loan amount, you’ll be able to pay off your debt faster, so you can keep up with the car’s depreciation.
Opt For Shorter Loan Terms
When you choose a shorter loan term, your monthly payments will be higher, all else being equal. However, it’ll allow you to pay off the loan faster, save money on interest, and reduce the chances that your vehicle will depreciate faster than your loan will be paid off.
Consider GAP Insurance
When you sign the paperwork to purchase your vehicle, dealers may push a lot of add-ons that can be rolled into the loan as part of the deal. Most often, these add-ons aren’t really necessary, and they can drive up the amount you borrow very quickly.
However, some add-ons can be quite helpful. Guaranteed Asset Protection (GAP) insurance is one of these optional add-ons that you should consider if you want to avoid an upside-down car loan. GAP insurance covers the amount of the negative equity in your car if it is ever stolen or totaled in an accident.
Stay On Top of Your Car Loan
Trying to get out of an upside-down loan can be challenging and stressful. When evaluating your options, take your time to see what would be best for your individual situation. If you can, the best option would be to make extra payments on your loan to pay down the principal or make a lump sum payment to pay off the negative equity.
Avoiding this situation in the first place is ideal through strategies like making a larger down payment, not overpaying for a car, and opting for a shorter term.