Upside-Down Car Loans: What It Is and How to Get Out

Written by Kim PinnelliUpdated: 16th Feb 2022
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If you’re upside down on your car loan, it’s not a good thing. Even with the best intentions, it often happens fast, leaving you owing more money than your car is worth.

The good news is there are ways out. The bad news is, no matter which way you slice it – it will cost you money.

What Is an Upside-Down Car Loan?

If you’re upside down on your car loan, you owe more money than the car is worth. If you were to sell your car today, you wouldn’t earn enough money to pay off your loan, leaving you on the hook for the remainder.

Known as ‘negative equity,’ you are responsible for covering the difference either by paying it out of your own proceeds or wrapping the negative equity into your new car loan.

How an Upside-Down Car Loan Works

Unlike homes, cars depreciate. This means they are worthless money as time goes on.

If the car depreciates faster than you pay down your loan (often occurs if you make a low-down-payment), you could end up owing more than you’d get if you sold the car.

Why does this happen?

It could be a few reasons. First, cars depreciate as much as 60% in the first five years. Second, if you take a loan with a long term, you pay more interest than principal, which puts you at risk of negative equity.

It could also happen if you miss payments. Interest and fees will accrue, leaving you with a higher balance and potential negative equity in the car.

If you’re upside down on your car loan, it’s not the end of the world, but you should know how to get out of an upside-down car loan.

How to Get Out of an Upside-Down Car Loan

#1. Take A Pulse Check on Current Situation

Before you do anything, figure out your situation. Even if you know you’re upside down, you should know the facts.

How far upside down are you? With this knowledge, you can choose your next steps, so do this first:

Review Current Loan Balance

How much do you currently owe? Look at your most recent statement. If you don’t have one, call your lender.

Most lenders have an automated system that tells you how much you owe without talking to a live person. It takes 2 seconds to find out how much you owe.

Determine Your Car’s Value

Find out how much your car is worth. A quick search on Kelley Blue Book or Edmunds will tell you fast. Just search for your car’s make, model, and year, being honest about its condition to get the fair market value for your car.

Quick Math Calculations

With these two numbers, you can determine if you have positive or negative equity. If your loan balance is higher than your car’s value, you have negative equity. If you’re lucky, you’ll squeak by with a higher car value than the loan value.

If you come out of this step frowning because you have negative equity, here’s what to do next.

#2. Start Making Extra Payments

Pay down that principal as fast as you can. Any extra payments you make will go toward the principal. This knocks down your loan balance and helps you save money on interest in the end.

Look over your budget and see how much extra you can pay. If you don’t have extra money right now, see where you can cut back and use the extra money to get out of your upside car loan status.

#3. Refinance Your Car Loan

If you took out your loan when you had bad credit or took a long term because you wanted the lower payment, consider refinancing.

If you have better credit or can afford a higher payment now, you can knock your loan balance down faster, getting you out of a negative equity position. Make sure you read the fine print and know the loan’s total costs before using this option.

#4. Consider Getting Rid of Your Car

It’s probably not your first choice, but the sooner you sell your car that has you in an upside-down position, the better off you’ll be.

But don’t make the grave mistake of rolling the negative equity into your next car loan. Your dealer will try to convince you it’s smart – it’s not.

Cut your losses, sell the car, pay the difference and then buy a car you can comfortably afford and can keep yourself out of an upside-down car loan position.

How to Avoid an Upside-Down Car Loan

  • Make a Down Payment: It all comes down to the down payment. The less money you invest in the car upfront, the more you borrow and the higher your chances of going upside down become. When you invest in the car, you borrow less. You still stand a chance of losing money if the car depreciates too much, but you won’t have the unpleasant task of figuring out how to make up negative equity.
  • Choose a Shorter Loan Term: The longer you stretch out your car loan term, the more likely you are to go upside down. A shorter-term means you pay more principal because you have less time to pay it in full. Conversely, a longer-term may feel smarter because its payment is lower, but you’ll pay more interest and less principal, increasing your chances of going upside down.
  • Buy a Used Car: New cars depreciate as much as 20% in the first year. Most people don’t pay 20% or more of their principal balance in the first year, making it easy to go upside down. Instead, buy a used car that already depreciated. While it will still decrease in value over time, it won’t be as drastic as a new car experience.
  • Don’t Miss Payments: When you miss a payment, interest accrues on the balance and the unpaid interest. Essentially, you’re paying double interest. Paying interest one time is more than enough – why pay it twice? This makes it harder to get your balance paid down and increases your chances of going upside down.
  • Avoid Fancy Add-ons: It’s easy to fall for add-ons. Who doesn’t leave features that make our cars more fun or convenient, right? But those add-ons don’t increase the car’s value, but they do increase its price. If you don’t pay for those add-ons yourself and instead finance them, you increase your chances of going upside down on the loan.
  • Choose a Car that Holds Value: Some cars hold value better than others. Do your research using Kelley Blue Book or Consumer Reports. Find out which cars hold their value best and which don’t. Avoid the cars that don’t and find one that you like that doesn’t depreciate as quickly.
  • Cover Fees & Taxes Out of Pocket: Dealers will convince you to wrap everything into your car loan. It sounds amazing – no money out of pocket? Sure, sign me up! But what does that do? It increases your loan amount, but your car still depreciates at the same speed. So now you have a larger loan amount and a depreciating car. Instead, pay the fees and taxes yourself and keep your loan amount as low as possible.

Can You Get Out of an Upside-Down Car Loan?

Yes, you can get out of an upside-down car loan, but it takes a little work. First, figure out your situation – how upside down are you?

Then look at your options, including auto loan refinancing, making extra payments on your current loan, selling the car, or keeping it as long as possible so you ‘drive thru’ the upside-down period and come out on the other side.

>> Learn More: How to Refinance Your Auto Loan

What Do I Do If I AM Upside-Down on My Car?

You have several options when you’re upside-down on your car. The goal is to get out of the upside-down status.

This may mean selling the car if you’re too far upside down. But if you have the finances and can buy your way out, that’s an option too.

It depends on how badly you want to keep the car and if you have the finances to make it work.

Can I Trade in My Upside-Down Car for a Cheaper Car?

You can definitely trade your upside-down car for a cheaper car, but you have to make good on the negative equity.

Ideally, you’ll pay the balance off with your own funds rather than wrapping it into another loan, though.

Bottom Line: Upside Down Car Loans

Upside down car loans are frustrating, but you can avoid it if you play your cards right. Before you take out a car loan, figure out how much you can invest in it.

Put as much money down on the car as you can and watch your financing terms – choosing the shortest term possible to reduce your chances of ending up upside down.

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Kim Pinnelli
Kim Pinnelli

Kim Pinnelli is a Senior Writer, Editor, & Product Analyst with a Bachelor’s Degree in Finance from the University of Illinois at Chicago. She has been a professional financial writer for over 15 years, and has appeared in a myriad of industry leading financial media outlets. Leveraging her personal experience, Kim is committed to helping people take charge of their personal finances and make simple financial decisions.