I Owe More Than My Car Is Worth. What Should I Do?
Owe more on your car than it's worth? Learn what negative equity means, your financial options, and how to avoid it next time.
Many car owners owe more on their auto loan than their vehicle is worth, a situation called “negative equity” or “upside down.” This financial challenge impacts flexibility and purchasing power; understanding it is the first step to addressing it.
What Negative Equity Means
Negative equity occurs when a car loan’s outstanding balance exceeds its market value; if sold, the car’s price would not cover the loan. Vehicle depreciation, the loss of value over time, is the driver, with new cars losing over 20% of their value in the first year.
A small or no down payment means the loan starts near or above the car’s depreciated value. Long loan terms (e.g., 72 or 84 months) slow equity build-up, making it harder for the loan balance to fall below the car’s depreciating value, while higher interest rates also prolong the time until positive equity is achieved.
Rolling over negative equity from a previous loan into a new one is a contributor, adding the deficit to the new car loan and putting it underwater. Mileage or wear can also accelerate depreciation, causing market value to drop faster. These elements combine to make the loan balance outpace the car’s market value, leading to negative equity.
Navigating Your Options
Car owners facing negative equity have options. One approach is to keep the car and reduce the loan balance by making extra principal payments. This lowers debt, accelerates positive equity, and even small, consistent payments can reduce interest and shorten the loan term.
Another strategy is to refinance the loan, if eligible, for a lower interest rate or shorter term. A lower rate reduces loan cost, directing more of each payment to the principal. A shorter term increases monthly payments but speeds up principal reduction, outpacing depreciation. Review credit scores and current interest rates before refinancing to determine eligibility and savings.
Selling a car with negative equity requires management. The loan balance must be paid off at sale. If the sale price is less than the loan, the owner must cover the shortfall. This deficit can be paid out of pocket or, sometimes, financed via a personal loan, with higher interest rates. Once the loan is satisfied, the lienholder releases the title for transfer.
Trading in a car with negative equity is impactful. The negative equity is rolled into the new loan, increasing its amount, payments, and term. This can perpetuate cycle of negative equity. To minimize this, some pay off the deficit with cash before the trade-in.
Voluntary repossession is a last resort due to credit implications. The owner returns the vehicle to the lender, indicating inability to pay. While avoiding repossession, it results in a negative mark on the credit report for seven years, hindering loans, cards, or housing. The lender sells the vehicle, and the owner remains responsible for any loan balance after the sale, plus repossession and sale fees.
Preventing Future Negative Equity
To avoid future negative equity, strategies are essential. Making a down payment is effective for establishing equity. A 20% or more down payment for new cars is recommended, as it reduces the loan amount and buffers against depreciation.
Choosing shorter loan terms also prevents negative equity. Financing over 36 or 48 months, instead of 72 or 84, allows faster principal paydown. This accelerated repayment helps the loan balance decrease faster than depreciation, leading to sooner positive equity. Shorter terms mean higher payments but reduce loan cost due to less interest.
Researching vehicle depreciation rates before purchase informs sound decisions. Some car models hold value better, mitigating negative equity risk. Resale values and depreciation trends are available from automotive resources. Selecting a vehicle with strong resale value provides a cushion against value declines.
Avoiding add-ons and warranties that don’t contribute to resale value is important. Additions like rustproofing or paint protection increase the loan amount without adding equivalent market value, widening the gap between loan balance and actual value and increasing negative equity likelihood. Focusing on the vehicle and features keeps the loan manageable. Understanding the cost of ownership—including insurance, maintenance, and fuel—provides a view for informed long-term financial health decisions.