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.
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.
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.
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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