What To Do with an Upside Down Car Loan

An upside down car loan is much more common than most people realize. The nature of car purchasing, depreciation and sales tactics at dealerships often lead to people who are upside down in a car loan, meaning they own more money on the loan that the vehicle is worth.

Another name for an upside down car loan is negative equity. This term means that instead of having equity in the car, or a portion of the car value that is already paid for and would return to the owner in case of a sale, the owner instead would owe the bank or lending institution money if the car were sold.

There are a variety of ways a buyer gets into a negative equity situation. The most common occurs when a person trades in an old car for a new one. Sometimes a car dealer acts unethically and doesn't fully disclose terms in this situation, but other times it is the responsibility of the consumer, who doesn't take the time to understand loan documents or buyers agreements.

A buyer often comes into a dealer with a car that is not paid off, but wants a new car. The dealer merely tells the buyer that they can arrange for a payment that is not much more or is no more than the current payment, without the buyer understanding that they are folding the loan on the old vehicle into the price of the new vehicle.

Another way a person gets into a negative equity situation is by purchasing a car with no money down. Cars depreciate 20% in the first year and 50% by the third year of ownership. They are not an investment, but rather, a liability. If you buy a new car with no money down, you are in a negative equity situation as soon as you drive off of the lot.

Another problem is excessively long loan terms, which stretch payments out so far that the payments don't keep up with the depreciation.

In an upside down car loan situation, there are a couple ways that one can combat such a troubling situation. The best thing to do is to keep the car and pay the car loan down as quickly as possible. Don't buy a new vehicle, because any dealer who would help you buy a new vehicle when you are already upside down is only going to make your situation worse.

Another option is to sell the car. If you sell the car and don't have to buy a new one right away, you can use the amount you get from a sale to pay down the loan, and then work for the next several months until you pay off the difference. Just because you sell the car does not mean the bank will forgive the difference.

Some lending institutions will call the entire loan due at the sale of the vehicle, so you would need to work with your lender to turn the loan into a personal or signature loan. However, they will only do this for people with excellent credit.

Some people recommend turning in a car when you are upside down on a leased vehicle. This may relieve the immediate pressure, but has the same end result. When the lease is up, you will still have negative equity unless you have made substantial extra payments.

For those trying to find a creative way to get out of an upside down car loan, you should avoid anything illegal that tries to get the insurance company to pay the debt. There are penalties for damaged or stolen vehicles. You will still owe the extra on the loan anyway, because the insurance only pays current market value or the car, not the entire amount owed on the loan.