What to Do When You’re Upside Down on a Car Loan

Being “upside down” on a car loan, also known as having negative equity, means the outstanding balance on your auto loan is greater than the current market value of your vehicle. This situation commonly arises because new vehicles experience significant depreciation the moment they are driven off the dealership lot, often losing 20% or more of their value within the first year. Extending loan terms beyond five years can also contribute to negative equity, as the vehicle’s value declines faster than the principal balance is paid down. This financial position can limit your options if you wish to sell, trade, or otherwise manage your vehicle.

Calculating Negative Equity

To calculate negative equity, you need your current loan payoff amount and the vehicle’s current market value. The loan payoff amount is the total sum required to fully satisfy your car loan, including principal, accrued interest, and sometimes a small administrative fee. Obtain this figure directly from your lender, through their online portal, customer service, or your most recent billing statement.

Ascertain your vehicle’s current market value using reputable online resources like Kelley Blue Book (KBB.com), Edmunds.com, and NADA Guides. These tools consider factors such as the car’s make, model, year, mileage, condition, and features, providing accurate estimates for trade-in, private party, and retail values.

The calculation for negative equity is straightforward: subtract the vehicle’s current market value from your outstanding loan payoff amount. For instance, if your loan payoff is $20,000 and your vehicle’s market value is $17,000, your negative equity is $3,000.

Options for Retaining Your Vehicle

For individuals who prefer to keep their vehicle despite having negative equity, several proactive strategies can help reduce the financial imbalance over time.

Make Extra Payments

Making extra payments towards the principal balance of your loan can significantly accelerate the reduction of your outstanding principal. Even small additional contributions, such as an extra $50 or $100 per month, help reduce negative equity more quickly. These payments directly decrease the amount on which interest accrues, saving you money over the loan’s lifetime.

Refinance Your Car Loan

Refinancing involves securing a new loan to pay off the existing one, often with more favorable terms. The goal is to obtain a lower interest rate, which can reduce your monthly payments and the total interest paid, allowing more of your payment to go towards the principal. You might also consider a shorter loan term, which increases your monthly payment but accelerates the payoff schedule, helping you build equity faster. Refinancing with negative equity can be challenging, as many lenders prefer not to finance more than the vehicle’s value. In some cases, you might need to roll the negative equity into the new loan, increasing the total amount borrowed and extending the time it takes to achieve positive equity.

Consider GAP Insurance

Guaranteed Asset Protection (GAP) insurance is prudent, especially with significant negative equity. GAP insurance covers the difference between your vehicle’s actual cash value and the amount you still owe on your loan if the car is declared a total loss due to an accident or theft. For example, if your car is totaled and its actual cash value is $15,000, but you still owe $18,000, standard auto insurance would only pay the $15,000. GAP insurance would cover the remaining $3,000, protecting you from out-of-pocket expenses. This insurance is offered by dealerships or insurance companies and can be an inexpensive addition to your policy, often costing between $200 and $700 for the life of the loan or as a small addition to your monthly premium.

Options for Selling or Trading Your Vehicle

If retaining your vehicle is not feasible or desired, there are specific strategies for selling or trading a car with negative equity.

Sell Privately

Selling the vehicle privately can yield a higher price than a trade-in, potentially reducing the negative equity you need to cover. To execute a private sale, sell the car for its current market value, then pay the difference between the sale price and your loan payoff amount directly to the lender. For example, if you sell your car for $17,000 but still owe $20,000, you would pay the remaining $3,000 out of pocket to satisfy the loan and transfer the title.

Trade-In at a Dealership

Trading in your vehicle to a dealership is a common approach, though it often means receiving less than the car’s private sale value. When trading in a car with negative equity, the dealership incorporates the outstanding loan balance into the financing of your new vehicle. This process, known as “rolling over” the negative equity, adds the deficit from your old loan to the purchase price of your new car. This increases the total amount you finance and your new monthly payments, making it more challenging to achieve positive equity on the new vehicle quickly.

Voluntary Surrender or Repossession

As a last resort, if you can no longer afford payments, voluntary surrender or repossession is a possibility, but it carries significant negative consequences. Voluntary surrender involves returning the vehicle to the lender, who sells it at auction to recoup losses. The auction sale price is considerably lower than the vehicle’s market value, and you remain responsible for paying the difference between the auction proceeds and your outstanding loan balance, known as a “deficiency balance.” This balance can be substantial, and the lender may pursue legal action to collect it.

Both voluntary surrender and involuntary repossession, which occurs when the lender seizes the vehicle due to non-payment, severely damage your credit score. This credit impact can last for up to seven years, making it difficult to obtain future loans at favorable interest rates. Lenders may also report the deficiency balance to credit bureaus, further complicating financial recovery. Therefore, exploring all other avenues for managing negative equity before considering surrender or repossession is advisable.