What is an Upside Down Car Loan? Strategies and Tips For Beginners

what is an upside down car loan

What is an Upside Down Car Loan?

Have you wondered what is an upside down car loan but have no idea what it means?

Well, it isn’t a great position to be in, unfortunately.

It is a situation where a driver might owe money to the lender that is larger than the vehicle worth.

So, you could owe the lender $10,000, but the vehicle is only valued at $7,000.

upside down car loan

 

It can be a big money mistake you could regret.

The industry terminology for the situation is “upside down”.

You might be familiar with other terms, such as being “underwater” or negative equity.

How Does It Happen?

So, why do people choose to pay a lender more for a car than its worth?

Well, because they are eager to own a brand new car, so may not have considered the financial implications.

The biggest benefit of an upside down car loan is that you can drive the car off the lot immediately.

A lender will more than likely ask for the driver to finance a long-term loan. So they will be stuck with the vehicle for a long time.

The vehicle owner makes a decision to buy a car with negative equity. It doesn’t happen by accident.

The Upside Down Car Loan Reasons

The are various other reasons why a person might end up with negative equity on a car, such as:

Rollover loans can happen when the outstanding amount on an old car loan rolls onto a new car loan.

This increases the loan amount and can result in negative equity.

Depreciation happens to every car once it leaves the lot. As soon as it is on the road, the value of the car depreciates.

The car’s value will also depreciate by 15-20% each year. So, the loan could eventually be worth more than the market value of the vehicle.

Small or no deposits can also result in an underwater loan because you have failed to pay off a large chunk.

man upside down

Can You Sell the Car?

You can sell the car, but you will still owe the money to the lender.

Depending on when and where you sell it, the sale price might not cover the amount you owe to the lender.

You can opt to trade the car in. A lender might promise to pay off the current loan, but you may owe more if you have negative equity.

What Happens Following a Car Accident?

An upside down loan can be a big risk when it comes to insurance.

If you experience a car accident, your insurance will only cover the cost of the car.

So, you will have to continue to repay the loan and foot the bill for a new car.

small blue car in auto accident

How Do You Get Out of the Loan?

There are various ways you can get out of the loan.

First of all, you can pay off the loan and keep the car – or you should do so until the loan amount is lower than the value.

Similar to a mortgage, aim to make large monthly repayments toward the loan principal.

This will allow you to pay off the car at a quicker rate and build equity.

There is also the option to transfer the car loan balance to a 0% interest credit card. Although, you must pay it off before the interest rate rises.

It is important to know what is an upside down car loan , so that you can make an informed decision. Review all the facts and, if you decide to go for it, have a financial plan in place and stick to it.

Have you taken out an underwater loan? What was your experience? Leave a comment below.

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6 Comments

  1. It’s crazy to me that people still purchase new cars!

    To literately lose 11% when you drive a new car off the lot….insane! But people still do it, because they want it now…and many people don’t like the idea of owning something someone else owned first.

    Any thoughts on how to get through to these people? I’ve got two teenage kids that are starting to look at cars and I want them to understand the impact of getting a new car, or more car than they really need.

    Somehow I need to instill in them the impact of what it’s means to be upside down in all things!

    Thanks for the article.

    I will at the very least have my kids read this so they know what to look for!

    • Yes it does seem crazy when you drive off the lot and lose 11% in value.  But I think there are unknown psychological forces at work when it comes to purchasing a car.

      Like you said people don’t want to own something used and there is that new car smell as well.

      There is no real way to get through to folks other than making available the facts. 

      If you buy, pre-owned or used, you let someone else take the depreciation hit, put enough money down and limit the financing, you won’t experience an upside down car loan.

      You get it, so keep working on your kids.  It will sink in one day.

      Best of luck.

  2. This was very informative. Thank you for providing this.

    I am young and still doing my research on cars because I want to purchase my first ever car but doing so with careful consideration.

    I’ve been pondering whether to get a loan or wait a little longer to save up and buy for cash.

    I didn’t realize there were many dangers to getting a loan!

    • Hi Flavia,

      Yes there are some pitfalls in the car financing process, but you don’t need to be afraid of getting a loan as long as you educate yourself.  Having some kind of credit besides credit card debt will help your credit score

      Many people buy more car than they need and nearly finance the whole thing. With this approach they run the risk of ending up with an upside down car loan.

      The best approach is to wait as long as you can and save up enough to make a substantial down payment.  Have your financing ready before you head to the dealership and be ready to negotiate the dealers rate.

      In addition, make sure you choose a car that is practical with a great repair record and you should be well on your way to avoiding the dreaded upside down car loan. 

      Best of luck.

  3. I didn’t know about negative equity when I purchased my car.

    Actually, my car is a used-car from 2011 and it was the first time I purchased a car alone.

    I still have negative equity from the car lender, but not very much as brand new car.

    After reading your article, I’m thinking I might pay off my car loan sooner.

    Thank you for information.

    • Actually no one ever does until something happens like a car wreck and the insurer will only pay for the value of the car.

      That’s when you get an upside down car loan and you need to come up with extra cash to pay off the loan.

      It’s a good idea to pay off your loan.  Especially if it’s running good and your value is less than the loan.

      When you buy again, buy something that has a great repair record and holds it’s value and put down a sizable down payment so you don’t get upside down.

      Best of luck.

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