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Minimizing Damage When You’re Upside-Down on Your Car Loan
What to do when you have negative equity

If you unexpectedly need to pay off the entire balance of your car loan, you may face an unsavory bill if you are upside-down on your car loan — known as having negative equity, when you own more than the vehicle is worth. Negative equity can creep up on you through many ways, and similarly, there are several ways you can try to reduce it.

Pay off the loan or refinance it

The best way to get out from underwater is to continue making car payments on time, thereby bringing down the balance of the loan until you either own the car outright or are back to owing what it’s actually worth. To make the most of this method, you should check if your lender allows making extra payments toward the principal to increase your equity as fast as possible; alternatively, you could try to get the loan refinanced with a shorter term. “This will mean you’re paying down your loan more quickly so you can catch up with depreciation,” Nicole Arata explains in an article for NerdWallet.

Roll your car loan over

If you don’t want to pay it off, you can roll your old loan into a new car loan and trade in your current car. The benefit of this method is that you will be able to drive off the lot with a new car, possibly for a comparable monthly payment. However, there are downsides. “Most banks will not finance a new car loan for you if they need to loan you more than 100 percent of the value of your new car,” Miriam Caldwell of TheBalance warns. You will probably be asked to finance a long-term loan, which will lead to owing more interest over time; thus, you may find yourself in an even worse financial situation than before.

Sell the car yourself

An excellent way to escape an upside-down loan is to sell the car yourself at a high price and use the proceeds to pay off part or all of the loan. This is an involved process that will require you to get the car ready for sale, advertise it, communicate with prospective buyers and set a price that will not only seem fair to them but will also help cover your negative equity. This is a solution with great potential but one that will depend on your success as a seller. “If possible, sell your car to a private buyer, which tends to draw a higher price than trading it in at the dealership,” Arata advises. “With a good sale price, you may have a more manageable amount of debt.”

Find a new car with a large rebate

An interesting and potentially rewarding way to get out from underwater is to buy a car with a significant incentive, such as a large cash-back rebate. “Trading in your car and buying a new one with a substantial cash rebate can get you back into positive territory … but only if you do it right,” U.S. News & World Report contributor John M. Vincent of outlines. For example, if you’re $2,000 upside-down but find a car with a $2,000 cash-back offer, you can balance out your negative equity.

Remember that this method carries some risk because the value of most incentivized vehicles tends to drop more quickly in the first year of ownership. For this method to work effectively, Vincent says you should aim for a short-term car loan with the lowest interest rate possible. “That combination will allow you to pay down principal quickly and stay above water on the loan,” he explains. Another way to combat quick depreciation is to look for a less expensive, used vehicle.

Staying upside down on your car loan any longer than necessary is never ideal and could put you in a difficult financial situation down the road. If you’re having trouble with your loan, consult with an advisor about the steps you can take to minimize the damage.

Published by IH Credit Union
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Disclaimer - All content contained in this newsletter is for informational purposes only and should not be relied upon to make any financial, accounting, tax, legal or other related decisions. Each person must consider his or her objectives, risk tolerances and level of comfort when making financial decisions and should consult a competent professional advisor prior to making any such decisions. Any opinions expressed through the content in this newsletter are the opinions of the particular author only.

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