What Does It Mean To Be Upside-Down In Your Automobile Financing?

Ahhh that new car smell. Finding the new car of your dreams is one of life’s precious moments. Pair that with comfortable automobile financing terms and you’re in heaven, right? Maybe not.

Little or no down payment, a long-term auto loan and low monthly payments can be the kiss of death when it comes to automobile financing. What initially seems like a good deal may soon turn against you. Here’s why: New cars can lose up to 25% of their value as soon as they’re driven off the lot. The result of this drastic depreciation is that, after driving it for just a few feet or a few months, your car is no longer worth what you paid for it. If you financed the car, you now owe more on your automobile loan than the car’s current market value.

Financially speaking, this is known as being upside-down in your loan or having negative equity on the car: The difference between the value of an asset and the outstanding amount of the loan taken out to purchase it.

Unfortunately, this uncomfortable position is rather easy to get into. In fact, up to 40% of new car buyers are upside-down. On average, these unfortunate drivers owe nearly $4,000 more than the trade-in value for their autos.

What happens next is a vicious cycle that may take you deeper into the hole come trade-in time. You have two options: Either get rid of the car and make payments on a car you don’t own anymore, or roll the remaining loan into a new loan, ending up even more upside-down on the new car.

But don’t worry; we’ve put together a few tips to help you in this upside-down ordeal:

  • Your best bet is to hang on to the car and keep making payments until it’s paid for, or at least until the amount you owe is equal to the car’s market value – otherwise you won’t have any negotiating power in the new car transaction. Find out your car’s current market value using Kelley Blue Book.

  • If the reason you want to get rid of the car is high monthly payments, consider refinancing – you may be able to get a better interest rate on your auto loan. You also may want to consider extending the loan term. Although it may end up costing more in the long run, since you will be paying interest for longer, that little extra room every month may give you enough air to get back on your feet. With that said, remember that once you’ve worked out your problems or reached an equity balance, the goal is to pay off your auto loan as quickly as possible.

  • Sell the car yourself – Put the money in your pocket and not the dealer’s. If you need help, read our sell my car tips.

And for next time:

  • Don’t finance a car for longer than you expect to own it. The golden rule is: The longer the car loan term, the more likely you are to be upside-down in the loan.

  • Do the math before you buy. Not all cars depreciate the same, so pick the ones that hold their resale value better.

  • Make at least a 20% down payment.

  • Be sure you really like the car, and it will be reliable. In life, as in car buying, if you’re going to make a long-term commitment, you better be sure you know and like what you’re getting into.

  • Consider other options. There may be better options for you out there, such as a Certified Pre-Owned vehicle or car lease.

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